Risk of stagflation and recession from drone attack on Saudi oil facilities

Business, China, Company Strategy, Economics, Middle East, Naphtha & other feedstocks, Oil & Gas, Olefins, Polyolefins, US

By John Richardson

ANY major change in US government foreign policy always carries major risks because, for the time being at least, the US remains the world’s No1 economic and geopolitical Superpower.

This is the point I’ve been making since January 2017, when it first became evident that Donald Trump’s election rhetoric on confronting China on trade and geopolitics was far more than just election rhetoric.

Another big shift in US foreign policy was the decision to pull out of the nuclear deal with Iran.

US efforts to bully China into a trade deal on terms set by the US has clearly failed. Instead of rolling over and agreeing to the White House demands, China has responded to US tariffs with tariffs of its own.

Similarly, it was never going to be the case that Iran would lie down to the US pulling out of the nuclear deal, which was followed by renewed US sanctions on Iran. As with China, Iran believes it has too much to lose economically and geopolitically to acquiesce to American demands.

China’s biggest advantage in the trade war, is the size of its local market and its ability to deny US PE and other companies access to the market. For Iran, its big weapon is its location combined with a military strength that has long given it the ability to disrupt Middle East oil and gas supplies. Once US foreign policy had shifted so decisively against Iran, it seemed only a question of time before an attack happened.

The inevitable now appears to have happened, as Iran was likely behind the drone attacks on Saudi Aramco’s Abqaiq oil processing plant and the Khurais oil field on 14 September.

What might have emboldened Iran were frequent comments from White House officials since last year, including from the president, that the US was willing to hold talks with Iran “without preconditions”. The drone attacks, if confirmed to be the responsibility of Iran, could be an attempt to gain leverage in any negotiations.

Even the best-laid military plans can go wrong

The good news, as Gideon Rachman in the Financial Times points out, is that none of the parties in this crisis – the US, Saudi Arabia and Iran – want a full-blown conflict. The bad news is that all three countries are led by headstrong politicians prone to taking risks.

The US may also feel obliged to take military action if it is proven that Iran was responsible. Otherwise, it is hard to see how the US would be able to maintain credibility as the global policeman.

On any occasion after the shooting starts, decisions on the ground are made under tremendous pressure. Mistakes can easily happen, even in the best-laid military plans, leading to rapid escalation.

How would Iran respond if it came under attack and events spiralled out of control? By perhaps sealing the Strait of Hormuz. In 2018, 21m barrels a day of petroleum liquids moved through the strait, 21% of the global total.

Around 20% of all Middle East petrochemicals exports either move through the strait or go past Yemen, according to Jonas Oxgaard, analyst at Bernstein.

There is therefore a risk of oil prices spiking to the $80/bbl level, the minimum viewed as being necessary to trigger a US recession. Global petrochemicals shortages would add to stagflation – a spike in inflation as the slowdown in the global economic slowdown continues.

Some petrochemicals producers might benefit in the short term due to reduced Saudi supply. But demand is the real problem.

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