Don’t Add Oil to the Wall of Worry Just Yet

by: Richard A. Anderson, CFA

The attacks on Saudi Arabian state-owned oil facilities that sent oil prices surging were the story for financial markets for the first half of last week, until the Fed announced it was once again cutting interest rates.

On Saturday, September 14, coordinated drone strikes on two Saudi Arabian state-owned oil facilities disrupted more than half of the country’s oil production, or 5.7 million barrels a day. Saudi Arabia’s Interior Ministry confirmed the drone strikes on the oil-processing facility in Abqaiq and an oil field in Khurais, which are both owned by state-owned Saudi Aramco. The facility in Abqaiq is both Saudi Aramco’s largest oil processing facility and the largest crude oil stabilization plant in the world.

Yemen’s Houthi rebels have claimed responsibility for the drone strikes, but a spokesperson for the Saudi-led coalition in Yemen said that Iranian weapons were used in the oil field attack. Investigations are still ongoing to determine who is ultimately responsible for the attack and what other parties were involved. This most recent attack adds more tension to the conflict-laden Middle East.

In addition to the political ramifications of the attacks on the Saudi Arabian oil facilities, there are also significant effects on the financial markets and economy.

On Monday, September 16, the price of oil spiked as fears mounted that the attack on the Saudi Arabian oil facilities could disrupt the global supply of oil for some time. U.S. oil futures rose 14.7%, the biggest one-day increase since January 2009. Futures of Brent crude, the global benchmark, were up 14.6%.

However, on Tuesday, September 17, oil prices retreated following a report that Saudi Arabia was on track to restore 70% of the oil production lost during the weekend attack on its oil facilities. A report from Reuters also added that full oil production would return to normal within two to three weeks.

Saudi Arabia is the world’s largest oil exporter, producing about 10% of the total global supply of 100 million barrels per day. A prolonged period of production slowdown could mean a spell of higher oil prices. Oil prices are determined by supply and demand. If demand remains the same and supply is restricted, price will increase.

Higher oil prices also mean higher gasoline prices. And few things get consumers to cut back on their spending like rising gasoline prices. Higher gasoline prices affect consumers in two ways. First, it means more disposable income is spent on filling our gas tanks, which means fewer dollars to spend on other goods and services. Secondly, higher gas prices result in higher inflation as producers pass on higher transportation costs to consumers.

With consumer spending making up nearly 70% of U.S. GDP, downward pressure on consumer spending could result in an economic slowdown. However, as we have highlighted in previous posts, consumer spending has been driving U.S. economic growth, remaining resilient despite the trade wars.

It is worth noting that, despite the recent uptick, the national average gas price is $2.667, according to AAA. This is about 9% lower than one year ago when the national average gas price was $2.850. It is also well below the highest recorded average price of $4.114 in July 2008.

While the political fallout from the drone strikes on the Saudi Arabia oil facilities will continue to linger, the financial and economic impact will be limited. Ultimately, the long-term impact of the shock to oil markets will depend on how long it takes Saudi Aramco facilities to fully restore production. From the most recent reports, it appears that will be sooner rather than later. This bodes well for consumers and the U.S. economy.

With the never-ending trade negotiations between the U.S. and China, Fed policy reversals, and a slowing global economy as the foundation for the wall of worry for investors, it’s nice to know oil prices are a brick we won’t be adding to the wall of worry for now.

Author’s Bio

Richard A. Anderson is a portfolio analyst at HIGHLAND Financial Advisors, LLC based out of Wayne, NJ. HIGHLAND Financial Advisors, LLC is a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, employer retirement planning, and investment management services to help clients focus on what matters most to them.

Richard graduated from Ramapo College of New Jersey where he earned a Bachelor of Science degree in Business Administration with a concentration in Finance. Richard joined the firm in June 2013 and is responsible for assisting HIGHLAND’s Wealth Advisors in developing portfolios to help individuals, families, and institutions reach their financial goals. He is a Chartered Financial Analyst (CFA) charterholder and member of CFA Society New York. For more of Rich’s thoughts on the markets and sports, follow him on Twitter and connect with him on LinkedIn.