It’s not often hackers manage to hit critical energy infrastructure like Colonial’s East Coast pipeline system, but the vulnerability of a major delivery system between Gulf Coast refiners and New York metro area on the cusp of the summer driving season should set alarm bells ringing.
The Colonial Pipeline hack has, so far, not sent gasoline and diesel prices soaring. That’s primarily because the pipeline is expected back online by the end of the week, and the market believes there’s adequate fuel stockpiles available to cover the down period. Upward pressure on prices is also being undermined by the pandemic’s persistent impact on demand in Asia.
The disruption should worry market traders nonetheless, prompting questions about whether such supply risks – whether cyber or user-error like the blockage of the Suez Canal in March or natural disasters like Winter Storm Uri in February, are fully priced into crude oil and products.
Disruptions like those listed above are becoming increasingly commonplace.
The ransom malware attack that struck the heart of the U.S. downstream network prompted only a 3 percent increase in refined product prices as of Monday. But that could change if the pipeline shutdown is prolonged or if consumers spook and start hoarding.
A prolonged outage of North America’s biggest petroleum pipeline – Colonial transports more than 2.5 million barrels a day of refined products from the Texas Gulf Coast to New Jersey – could spark shortages of gasoline, diesel, jet fuel and heating oil from New York to New England.
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Colonial is critical to the East Coast’s energy supplies after several refineries in the region closed in recent years due to poor profitability. The sprawling 5,500-mile pipeline network supplies nearly half of the refined products consumed up the Atlantic seaboard, a region as dependent on heating oil as it is gasoline.
On Sunday, the White House declared a state of emergency in 17 eastern states in response to the shutdown. The quicker pipeline operations are restored, the smaller the impact. But with no solid timeline in place for restoring operations, rising prices remain a risk.
Similar to the February freeze crisis from Winter Storm Uri, the market impacts will be localized. While drivers in northeastern and southeastern states may see increased fuel prices at the pump, other regions with more robust product inventories are unlikely to be affected.
The shutdown could be a big opportunity for European refiners, which may be able to step in and increase refined product exports to the U.S. market. However, the arbitrage opportunity is greatest for cargoes already at sea, as the two-week journey across the Atlantic is a gamble if the pipeline is restored quickly.
The pipeline closure could also mean that U.S. crude exports, which surged to 4.1 million barrels a day last week, are kept onshore and fed into domestic refineries to replenish domestic inventories. Storage in the northeast and southeast regions is poised to be heavily tapped in the coming days as the pipeline remains offline.
The real problem is that the disruption comes as the economy is just beginning to reopen. That is boosting the demand outlook. U.S. crude and gasoline inventories are largely back to pre-pandemic levels – these markets are essentially balanced. But the Colonial outage is draining inventories further, a bullish gift that will stay with traders for some time.
The hack attack was reportedly carried out by the Eastern European criminal gang DarkSide, according to U.S. officials.
This is not the first ransomware cyberattack on an oil and gas company – and it won’t be the last – but it is the most serious. DarkSide reportedly disrupted operations at two Brazilian state-owned electric utilities, Electrobras and Copel, earlier this year.
Saudi Aramco, the world’s largest oil company, has been targeted by cyberattacks mutiple times over the last decade. RasGas, a huge liquefied natural gas producer in Qatar, was also victimized by the same virus as Saudi Aramco in 2012.
Experts say groups like DarkSide are increasingly targeting industrial sectors because of the companies’ deep pockets and willingness to pay to regain control of their systems, acknowledgment that downtime for these companies can cost millions.
Oil markets are fixated on the demand picture these days, which makes sense given the continued setbacks from the pandemic in Asia and the pace of recovery in the United States and Europe. That all makes for a messy picture. But with the OPEC-plus cartel sitting on more than 6 million barrels a day of spare production capacity, the chances of a global supply crunch and price spike in the near term are remote.
Disruptions in the refining and transportation segments of the petroleum supply chain can cause regional shortages and price spikes, as we saw in the Gulf Coast with Winter Storm Uri. When such disruptions occur at a major facility like the Colonial pipeline or a critical global choke point such as the Suez Canal, there can be an outsized effect even on markets – even if they appear oversupplied.
One look at the Middle East, where most of OPEC’s spare capacity is located, provides ample examples of mounting geopolitical risks. Whether it’s the rivalry between Saudi Arabia and Iran, Tehran’s distrust of Washington, the unilateral moves by Israel to ensure its security or Iran’s support for militias in Iraq, Lebanon and Yemen – the region has long been a powder keg.
Saudi Aramco’s facilities have been targeted by Yemen’s Iran-backed Houthis rebels many times already this year, and in 2019 they were temporarily able to knock off half of Aramco’s upstream oil production.
There’s far more to petroleum markets – and prices – than just supply and demand. The Colonial cyberattack is just one more reminder that what looks secure today may not be tomorrow. Traders will eventually begin including the risk of a major supply disruption into the price consumers pay at the pump. That’s what it may take before policymakers to start to take these threats seriously.