Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Hurricane Harvey has devastated the Gulf Coast, and its impact is now spreading out to the rest of the U.S., chiefly at gas pumps.

But America's resurgent role in the global energy trade means the ripples extend far beyond its own shores. One place they are lapping onto is Saudi Arabia.

In theory, the de-facto leader of efforts by OPEC, Russia and other members of the so-called Vienna Group stands to gain from disruption at the nerve center of the shale boom that has helped to suppress oil prices. In practice, things are a bit more complicated.

As I wrote here, the shale boom has moved a lot of U.S. oil production inland and contributed to a glut of barrels building up in storage. So Harvey's biggest impact on the region's energy industry has been the closure of ports, refineries and pipelines -- and keeping many drivers off highways that have turned into lakes and streams.

The net result is depressed demand for crude oil due to absent refiners and panic buying of refined products such as gasoline for the same reason.

So even as Saudi Arabia sees prices of the end products of its industry spiking, by and large it is not capturing that windfall for itself:

The Harvey Spread
The extra margins generated by Harvey's disruption have accrued largely to refiners, not producers, of crude oil
Source: Bloomberg
Note: Rotterdam gasoline converted at 8.35 barrels per tonne.

The disruption should cause U.S. inventories of refined products to fall as they are used to cover shortages and stocks of crude oil and products to drop elsewhere as, for example, European refiners run flat-out to send fuel to the U.S. to capture higher prices. This ultimately helps Saudi Arabia.

Again, though, there's a complicating factor.

Saudi Arabia has explicitly targeted the U.S. in its strategy to drain the glut; shipments of its oil to America have dropped noticeably this summer:

Ghost Ships
Saudi Arabian exports of crude oil to the U.S. have dropped by several hundred thousand barrels a day in the past three months
Source: Energy Information Administration

That's partly because, unlike in much of the rest of the world,  America's inventories are laid out in a detailed government report every week. So clearing those offers the best way to show Saudi Arabia's strategy is working.

And Gulf Coast refineries are geared toward processing heavier grades of crude oil, such as those from Mexico, Venezuela -- and Saudi Arabia. This potentially gives Saudi Arabia some leverage, says energy economist Philip Verleger. If it can squeeze the supply of those barrels refiners crave the most, then bids should rise, not just in America but Asia, too.

There has been some evidence this approach is working:

That Giant Gurgling Sound
U.S. oil inventories have been draining since mid-July and are now 40 million barrels below where they started the year
Source: Energy Information Administration
Note: Cumulative change in U.S. commercial oil stocks since December 30, 2016.

Now along comes Harvey.

As of Thursday evening, a sixth of U.S. refining capacity was still shut down completely, but reports of imminent re-openings have been a constant feature on newswires and Twitter feeds for days. Ports have been closed to both imports and exports of barrels. The impact on demand is unknown but believed to be large, given Houston's size and driving habits. Meanwhile, shale production has been hit to some degree -- particularly in the Eagle Ford basin in south Texas -- but the scale and duration of outages are again unknown at this point.

The sum total of this is that, at least for the next few weeks, those inventory reports are going to be all over the map. Harvey just switched off Saudi Arabia's banner ad.

Moreover, most of that idle refining capacity is the target market for those heavier grades of crude oil -- and that includes Saudi Arabian Oil Co.'s own giant refinery in Port Arthur. So Harvey has messed with that element of the strategy, too.

And finally, the build-up of crude oil awaiting refining has blunted, at least for now, a third prong of the strategy: flipping the shape of the oil futures curve (see this for an explanation of fun things like "backwardation" and "contango"). The short story is that Saudi Arabia would dearly love to see the curve flip into a downward slope, raising its own revenue and making it hard for rival shale producers to hedge their future output. After some progress on this front, Harvey has also stepped in:

Trouble With The Curve
Near-term crude oil futures prices have collapsed once again under Harvey's influence
Source: Bloomberg
Note: Nymex crude oil futures curve.

The specter haunting the whole approach of Saudi Arabia and its partners is that their old playbook just isn't suited to a more competitive and complex oil market. Harvey presents another wildcard.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net