CNA Explains: Saudi Arabia’s East-West pipeline is down. Why its oil ‘insurance policy’ matters

Why does Saudi Arabia have limited options?

The problem is not simply that Saudi Arabia has lost one pipeline. It has lost a route that was specifically designed to provide an alternative to Hormuz.

Loadings at Yanbu had been a “rescue option” because Saudi Arabia had been relying on the Red Sea route as an alternative to Hormuz, Janiv Shah, vice president of oil commodity markets at Rystad Energy, told CNA on Wednesday (Sep 16).

If anything happens to the East-West pipeline, it would severely constrain Saudi export volumes, he said.

There are no other Saudi pipelines with comparable scale and capacity, he added.

Saudi Arabia is now looking at other ways of moving crude. Reuters reported that Saudi Aramco had offered additional crude cargoes to Asian refiners using ship-to-ship transfers off Oman’s Sohar port, suggesting the kingdom is already looking for ways to work around its disrupted export routes.

Riyadh could also try to send more oil through Hormuz, including through so-called “dark shipments” in which vessels switch off their tracking systems.

But Mr Shah said that would be challenging given the security situation in the strait.

“So Saudi, what it’s trying to do now is trying to export or push more volumes through Hormuz, but again, this is gonna be very challenging considering the state of play and the effective closure, although barrels are still flowing through the strait,” he said.

Professor Mark Goh from the National University of Singapore Business School’s Department of Analytics and Operations shared a similar view, saying that Saudi Arabia has “few true substitutes” for the East-West pipeline.

He noted that the country could tap its overseas stockpiles or redirect crude to domestic refining.

However, those options are constrained by logistics and infrastructure, and would not provide a long-term replacement for the pipeline.

“The harsh reality is that the East-West pipeline is Saudi’s key insurance policy against the Strait of Hormuz risk,” Prof Goh said.

“Without the East-West pipeline, Saudi Arabia loses its main land bridge from eastern oil fields to the Red Sea.”

What happens if there is a prolonged outage?

The impact will depend heavily on how long the pipeline remains offline.

A decline in Saudi oil flow would push already elevated oil prices to potential record highs, with Yanbu reportedly now having stocks to maintain exports for just five to seven days.

It would worsen the global supply crunch, which has spurred worldwide inflation and sent US bond yields to the highest levels since the 2008 financial crisis. 

Trade sources told Reuters on Tuesday that Saudi Arabia has already cut some oil shipments to Europe.

Oil prices rose US$3 (S$3.80) higher on Tuesday over such concerns, with Brent crude settling up 2.9 per cent at US$108.75 a barrel and WTI gaining 4.4 per cent to US$105.83. Both contracts closed at their highest since May 19.

Mr Shah expects the pipeline to remain offline for about three to five weeks, a disruption that could reshape the crude, refined products and tanker markets. 

Buyers would likely have to source from other suppliers, and if the outage is prolonged, the current shortage in diesel, jet, and gasoline is unlikely to be built back up because the prices are too high, he said. 

“Margins are strong, great, but the price for the consumer is too high,” Mr Shah said. 

Prof Goh said markets would be pricing in not just the loss of Saudi barrels but also the possibility of further attacks on energy infrastructure.

A short outage mainly creates a price and risk-premium shock, said Prof Goh. 

“The tangible outcome of a short-term outage is typically in the knee-jerk reaction evidenced in the higher costs of crude, freight, insurance, and options volatility before physical shortages appear,” he said.

A multi-week outage, however, could lead to more tangible supply problems, including missed cargoes, delayed loadings and refiners having to find replacement grades.

Governments could begin considering the release of strategic petroleum reserves if disruptions become sufficiently severe.

Prof Goh also cautioned that the global market could absorb only a brief disruption, as Saudi Arabia is a “central stabiliser in the oil production system”.