Month: September 2019

Insights From Inside Saudi Arabia

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Key Points:

• Expect restraint or an unconventional response from Saudi Arabia

• The kingdom is concerned with being viewed as rational and self-reliant

• Threats of internal unrest concern the kingdom as much as external attacks

General Stewart, who is currently on the ground in Saudi Arabia, provides his thoughts on the kingdom’s response to the Iranian attack on Saudi oil facilities. 

Saudi Arabia’s Perspective:
At this stage, unless pressured, the Saudis are unlikely to push for a kinetic military response.  Despite early indicators that Iran carried out the attack, they insisted on “conducting an investigation.”  I didn’t get the sense that there is any desire for conventional conflict.  Rather, they want to demonstrate their resilience, get the refinery back online, and demonstrate restraint in the face of this attack – avoiding a wider, more destructive strike on the kingdom.  To Saudi Arabia and Mohammed Bin Salman, their two greatest concerns are the Iranians (and their regional aspirations) and internal unrest in the kingdom that threatens the regime.  When discussing a response, talk of their own proxy forces and hybrid/cyber warfare are more appealing than a conventional approach.

The kingdom cites failure of intelligence to warn and detect the attack in timely manner.  As a result, they want to accelerate their intelligence transformation efforts with an emphasis on indications and warning, integrated intelligence picture, missile defense, and counter-drone capability. They view their oil industry and the religious sites (Mecca and Medina) as the Saudi “source of power” their adversary will do anything, including attacking the holy sites, to undermine their source of power in the region and cause internal instability. Saudis are concerned that the U.S. has lost interest in the region and that Russia and Iran will fill the vacuum, leaving the kingdom on their own.  Currently, there is a lot of talk about self-reliance.

The final sentiment I heard while on the ground, was turning the crisis in to an advantage—translation, resilience and restraint.  The feeling on the street is almost like nothing has happened—limited short-term impact and Saudi Aramco is committed to getting their IPO done.

Academy’s Head of Macro Strategy, Peter Tchir, weighs in on the market impact of this sort of response. 

As Admiral Heinrich pointed out on Bloomberg Radio, the sanctions have been effective and should remain a focus.  The President tweeted this morning that he asked the Treasury Department to look at increased sanctions. I think that this leads to the best outcome for the markets.  Increased economic pressure on Iran and an increased vigilance, without an attack, since any military response leaves room for escalation and/or unintended damage. This approach will also allow  time to build a coalition. Additionally, it should calm oil markets, but more importantly, it leaves open the potential for global growth to emerge as the surprise story of the quarter.  Initial reaction to the attack was more “risk-off’ than it should have been.  The events of this past weekend impact China and play into Academy’s long held view that any trade deal will include commitments to buy LNG as securing a “stable” alternative source of energy should be a priority for China.

 

 

Original Post 9/18/2019

Drone Attack on Saudi Oil

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Key Points:

• Iran is ultimately responsible for the drone attack on Saudi oil infrastructure

• Expect escalation between Iran, Saudi Arabia, and Israel in the region

Background:
Yemen based, but Iran backed, Houthi rebels took responsibility for a drone attack in Saudi Arabia that damaged two plants critical to the Kingdom’s oil infrastructure. The result of the attack on Saturday could temporarily cut Saudi Arabia’s  oil output in half. How can we expect regional players to respond and how will this impact the energy market?

What Has Happened: “Clearly this is not Houthi technology.  This attack is an extension of the proxy war in Yemen but quite sophisticated unlike past Houthi attacks. Just like Iranian Quds Force and Hezbollah IED proliferation, this is a new tool we should expect to see flourish. Not surprising to see the attack focused on Saudi oil infrastructure as it targets the heart of the Kingdom’s economic power.  It is very hard to defend against this type of attack.  We can expect to see retaliation and escalation between the involved parties.”  General Frank Kearney
“Tehran is responsible for this attack.  We see Iranian influence and its aggressive policies continuing. I would expect retaliatory strikes by the Saudi Air Force, and the Israel Defense Force will take advantage of the regional chaos and strike into Syria. Despite a challenged history, at this moment, and especially against Tehran, Riyadh and Jerusalem are “partners”. For Iran’s response, watch the Strait of Hormuz. Iran will declare innocence with regard to the drone strikes and will claim its increased provocation is defensive.” General Spider Marks

Why it Matters:

Comments from Head of Macro Strategy – Peter Tchir

1)  Clearly the price of oil will go up and we should see Brent Crude rise faster than WTI.  This fits with our ongoing theme that securing “safe” energy sources should be paramount to many companies’ strategies and supports our ongoing National Defense efforts for full domestic energy self-sufficiency.
2)  While traditionally an attack of this magnitude would create a ‘risk off’ moment, we don’t think that will be the case right now.  As a net exporter, we have exhibited great resilience to disturbances in the Middle East.  In fact, the argument could be made, and we’ve  made it repeatedly, that higher energy prices, especially when the result of supply disruptions in the Middle East or elsewhere are very good for the U.S. economy and energy companies.  It will also ensure D.C. remains focused on the issue of domestic supply and continues to support, rather than antagonize, that industry.  So, energy equities and bonds may continue to see a bounce in prices that started in late august and accelerated last week.  The energy field service providers could also be interesting as any retaliation and further attacks will likely just create more future business for them (harsh – but likely accurate).
3)  On the treasury/rates side of the equation, the ‘traditional’ reaction would be for a flight to safety.  We may see that as a knee-jerk reaction, but unless there are clear signs of significant escalation, rather than ‘just’ retaliation, we think the rally in treasuries will be short-lived.  In fact, this only adds to the inflationary pressures we have seen creeping into the market with some recent data.

 

 

Original Post 9/15/2019