There are several theories about why oil prices have collapsed nearly 50% in the last 6 months, despite global demand only dropping roughly 1%. It certainly is a head scratcher when one solely looks at the supply and demand argument.
However, when you combine classic panic selling among traders, ‘this time is different’ fear mongering from the media, and one powerful and paranoid Middle Eastern producer who has refused to cut production because it is a chief beneficiary of the collapse, the picture clarifies.
Saudi Arabia driving oil prices lower
Saudi Arabia, the largest producer in the OPEC cartel, and the highly distrusted ally of the West, is the driving force behind this oil price collapse.
Ironically, the world’s top oil exporter is intentionally adding momentum to this collapse so it can pick off its enemies and competition, one by one. It’s remarkable to see such geopolitical tactics played by the Saudis, and documents just how scared they are of threats to their kingdom…
We saw a glimpse of the Saudis paranoia surrounding domestic security, and fear of losing their seat on the global stage, in 2011, during the Arab Spring. Leaders of the kingdom feared that the uprisings would spread into their region. So, as a proactive measure, they enacted unprecedented, multi-billion dollar social welfare spending programs and job creation projects to keep their people happy… it worked. However, as a consequence, Saudi Arabia now faces the distinct possibility of a budget deficit in 2015, according to the IMF.
In light of such an unusual fiscal disadvantage for this oil powerhouse, logic suggests that the Saudis would do everything in their power to get oil’s price back up to more profitable levels… or would it?
Phase 2 in Saudi Arabia’s paranoid plan: regain #1 oil producer status.
When concerned about being attacked or weakened by one’s enemies and competitors, it’s time to go on the offensive. And that’s exactly what Saudi Arabia is doing right now. Evidence suggests that they’ve been planning this for a while.
Saudi Arabia’s battle strategy will inflict pain on its own balance sheet in 2015 by suppressing oil’s value; but the gains, in their eyes, far outweigh the negatives.
In order to stay safe, and relevant for decades to come, the Saudis believe now is the time to pursue economic war on their competitors.
Right before our eyes, the Saudis are boldly waging their war on US oil producers, Russia and Iran.
Before going any further, it is imperative that readers understand 4 key pieces to this puzzle:
1. Saudi Arabia is disliked, and even hated, by most of its neighbours in the Middle East. Because of its strong economic ties to the West, the Kingdom is under constant threat from Iran, Syria, and rogue terror groups, such as ISIS.
To put it lightly, a weakened Saudi Arabia would be welcomed by much of the Middle East. The Saudis, through force and Western influence, have clung to their power in the region for several years now.
2. The Saudis’ #1 enemy is Iran. They are extremely paranoid of Iran gaining more influence in the Middle East, and are terrified of it becoming a nuclear power.
$90+ oil prices have emboldened Saudi Arabia’s enemies in recent years, particularly Iran – a nation which relies on robust crude markets to expand its military and nuclear program.
3. Russia is the Saudis’ biggest competitor in the global oil market. Saudi Arabia is the world’s number one exporter of oil; Russia is number two. Furthermore, Russia has played critical roles in recent years defending both direct threats to the Saudis: Iran and Syria. A weakened Russia positively serves the Saudis’ economic and national security interests.
4. The US and Saudi Arabia have been allies solely for economic purposes, but that relationship has been strained in recent years, particularly since America has become the world’s largest oil producer. At $75+ per barrel WTI, the US is virtually energy self-sufficient. At $50 WTI, the shale revolution in the US, which is responsible for the country becoming the world’s largest producer, is not economic. At current oil prices, it’s only a matter of time before the US begins increasing its oil exports from Saudi Arabia once again.
By attempting to keep oil below $60 per barrel in 2015, the Saudis can, at the very least, pause America’s shale revolution (which would keep the US as a large customer and almighty protector), drive Russia into a severe recession (if not a depression), and likely end Iran’s nuclear development program unless they also want to go into a depression.
That sounds like a fair trade off for Saudi Arabia; run a couple years in a deficit to regain world #1 oil producer status while simultaneously quelling its most immediate national threats.
Saudi Arabia proves its willingness to lose in the short term to gain geopolitical power in the long run
Bloomberg reported that “the break-even price in U.S. shale is estimated at $60 to $80 a barrel, according to the IEA.”
The article went on to state that “Shale output drops faster than production from conventional methods. It will take 2,500 new wells a year just to sustain output of 1 million barrels a day in North Dakota’s Bakken shale, according to the Paris-based International Energy Agency.”
source: http://www.bloomberg.com/news/2014-02-27/dream-of-u-s-oil-independence-s…
According to Tom Bemis, Editor at MarketWatch, Iran needs oil at $131 a barrel to balance its budget. Russia needs oil at $107 for a chance of getting its finances in order.
source: http://www.marketwatch.com/story/iran-venezuela-russia-may-face-pain-fro…
The Saudis have chosen the ‘who can withstand the most economic pain the longest’ battle plan. And given their ambitions, it’s the right move (for them).
You see, according to Trading Economics, in August of last year the Saudis amassed an all-time high for their foreign exchange reserves. They now have the third largest foreign exchange reserves of all countries in the world, behind only China and Japan. Russia, a country among the world’s top ten for foreign exchange reserves, doesn’t have half of what Saudi Arabia does. Iran hardly registers a blip on the radar in that department.
And Saudi Arabia’s debt to GDP ratio is less than 3%!
Moreover, numerous US oil drillers in key shale plays are so extremely leveraged that if prices don’t head north in short order, many risk defaulting. The Wall Street Journal reported this week that “American oil and gas companies have gone heavily into debt during the energy boom, increasing their borrowings by 55% since 2010, to almost $200 billion.”
The article continued “Energy analysts warn defaults could be coming. “The group is not positioned for this downturn,” said Daniel Katzenberg, an analyst at Robert W. Baird & Co. “There are too many ugly balance sheets.”
source: http://www.wsj.com/articles/deep-debt-keeps-oil-firms-pumping-1420594436
According to Zero Hedge, the amount of shale energy companies that are now credit risks has exceeded 1000 firms. Click image to read related article from Zero Hedge
So, if a battle of economic attrition is in store, which it appears that is what Saudi Arabia wants, they are extremely well prepared. From our vantage point, the timing could not be better for the Saudis.
Why do you think Saudi Arabia has defiantly opposed OPEC production cuts despite pressure from the rest of the world to do so?
They’ve been accused by numerous countries of purposely trying to drive the price down to inflict harm upon others. The longer the Saudis can keep oil prices around $50 per barrel (or drag them lower), the more market share they will regain, inevitably bringing them back to world #1 for oil production (currently held by the US).
Reported by CNN just before Christmas, Saudi Energy Minister Ali al-Naimi told a reporter “If they want to cut production they are welcome, we are not going to cut, and certainly Saudi Arabia isn’t going to cut,” al-Naimi said. “[That] position we will hold forever, not [just] 2015.”
source: http://money.cnn.com/2014/12/22/news/economy/saudi-arabia-oil-production/
*Click image below to watch CNN’s interview with Saudi Arabia’s Energy Minister on December 22, 2014
Taking Down its Primary Competitor
On Monday, it was announced that Saudi Arabia would be making significant cuts to its monthly oil prices for European buyers (particularly in northwestern Europe), while simultaneously hiking prices for oil shipped to Asia.
Why would Saudi Arabia cut prices for a European region that it only sends about 6% of its oil exports to?
For years, Russia has been dubbed the ‘gas station of Europe’. The rising demand from Europeans for Russian oil has been largely responsible for the communist nation fixing its balance sheet disaster of the late 90’s, and reasserting itself as a world power. However, with Western sanctions against the Russian economy intensifying in recent months, the Saudis see a huge opportunity to steal market share from Russia, a nation which has been supportive of the Kingdom’s most prominent enemies (Iran and Syria).
The discount the Saudis are offering Europeans, in comparison to what they are charging their biggest customer (Asia – particularly China), is $2 per barrel, the largest on record going back more than a decade.
By further cheapening prices to key European nations, the Saudis have extended an olive branch to Russia’s main customers. Remember, Saudi Arabia is the world’s #1 oil exporter, and Russia is #2. The Saudis are offering oil to northwestern Europe right now for a $4.65 discount to the Brent Weighted Average, according to Reuters.
source: http://www.reuters.com/article/2015/01/06/us-saudi-oil-price-idUSKBN0KE1…
Saudis hope to destabilize Iran and weaken its economy by driving down oil price
As mentioned, Saudi Arabia is particularly disliked by its neighbours in the Middle East. The Kingdom’s immediate threat, and number one enemy, is Iran.
The two nations have a hatred for each other dating back decades. And Iran’s nuclear program has the Saudis on edge, to put it lightly. The Saudis are petrified of Iran obtaining a nuclear weapon because
that would shift influence in the unstable region.
As you know, Iran’s economy is heavily reliant on strong oil prices. Estimates suggest roughly 65% of the government’s revenue comes from oil. You are also likely aware that for years the United States has been trying to destroy Iran’s nuclear development program, both covertly, and with sanctions. Nothing has worked so far.
Rather opportunistically, The Obama Administration has ramped up efforts in recent months to try and negotiate a nuclear deal with Iran while the country is in economic shambles (due to numerous Western sanctions and a collapsing oil price). Keeping Iran nuke-free has been a geopolitical priority for the US for years; but for the Saudis, keeping Iran nuke-free is a matter of survival. After all, you wouldn’t want your #1 enemy to have access to a weapon that could vaporize your country.
The Saudis believe that Iran can’t take too much more economic pain. And the lower oil falls, the more desperate Iran will become to get its economy back on track.
It is believed by the Saudis that the worse off Iran’s economy is, the more open they will be to negotiate a nuclear deal with the US in exchange for sanctions being lifted.
Defanging the Iranians, by not allowing them to build a nuclear weapon in exchange for some economic sanctions being lifted, would be a major victory for Saudi Arabia.
And the Iranians are well aware of what Saudi Arabia is up to… Jamie Detmer of the Voice of America reported,
“The weekly newsletter affiliated with Iran’s Islamic Revolutionary Guards Corps (IRGC), the elite military group that protects Iran’s theocratic Shia Muslim regime, last month threatened revenge on the Sunni-ruled Gulf kingdom “with all the means Iran has at its disposal.”
source: http://www.voanews.com/content/iran-accuses-saudis-of-oil-conspiracy/258…
Saudi Arabia Clinging to US Protection
It’s no secret that Saudi Arabia and the United States have been allies because they each have something the other wants. The US needed the Saudis’ oil while the Middle-Eastern power needs America’s protection. Unlike Western allies, Saudi Arabia and the United States don’t share common ideologies, however. And for a long time, many Americans, including some politicians, have wanted to cut ties with Saudi Arabia due to its rather questionable human rights record. But, because of the Saudis’ cheap oil, economically that just wasn’t a realistic possibility for the US…until the shale revolution kicked into high gear in 2012.
The shale revolution in the US, only possible because oil prices took off north of $90 per barrel, scared the pants off the Saudis. It turned the United States into the world’s largest oil producer. And with the US virtually energy self-sufficient for the last two years, the Saudis feared a potential end to the two nations’ long-standing ‘you scratch my back and I’ll scratch yours’ relationship.
Without US protection, which includes direct military support, intelligence and state of the art weapons, the Saudis are vulnerable to attacks from any one of their Middle Eastern enemies.
The Saudi leaders are also aware that there is a swelling bipartisan movement in congress unfolding that risks tarnishing Saudi Arabia’s image even more with the American people…
The American public, and even members of congress, have been skeptical of Saudi Arabia and their true intentions for a very long time.
Relations between Saudi Arabia and the US haven’t been this shaky for more than a decade. Just last week, in a bipartisan effort, members of congress “ramped up efforts to get President Obama to release 28 top-secret pages from a 9/11 report that allegedly detail Saudi Arabia’s involvement in the terror attacks”, according to Joseph Weber of Fox News.
According to Weber’s article, released on Wednesday, North Carolina GOP Rep. Walter Jones and “other lawmakers have described the documents’ contents as shocking.”
Weber’s article continued, “That 15 of the 19 hijackers were Saudi Arabian citizens is already known. But Graham and the congressmen suggested the documents point to Saudi government ties…”
source: http://www.foxnews.com/politics/2015/01/07/house-ramps-up-effort-for-oba…
If these allegations become mainstream news, it could spell major problems for Saudi/US relations.
Saudi Arabia and the Glory Days
Prior to 2010, the Saudis enjoyed decades of inferior competition and almost total control over the price of oil. They’ve gotten fat at the head of the OPEC table. They’ve grown accustom to state dinners in the US capital, red carpet ceremonies in Asia, and a general sense of entitlement. They are desperate not to lose these privileges…
But things have changed in the world oil market, especially over the last 5 years. The Saudis have gone from the world’s number one producer to as low as third, and recently bumped back up to second. They’ve lost some of their political power on a global level, which naturally frightens them. Without oil dependence from the West, the Saudis risk being attacked by any one of their numerous enemies in the Middle East.
While there are limits to how long the Saudis can keep oil prices depressed, it will likely be several months before a consistent uptick returns. Before the Saudis ease up on their oil price suppression, they’ll want to see a definitive US/Iran nuclear deal, Russia’s economy in a depression, or many US oil producers bankrupted.
All the best with your investments,
PINNACLEDIGEST.COM
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