Saudi Arabia’s rash gamble on oil prices

Saudi Arabia has embarked on a risky adventure with its decision not to cut back on oil production to absorb the surplus on the market, currently estimated at about one million barrels, writes Abdel Bari Atwan.

This decision means that the price of crude oil has crashed to $66 per barrel whereas the fiscal break-even point (the amount required to balance the national budget) for Saudi oil production is $98 per barrel. The decision is even more worrying for fellow OPEC members in the Middle East – fiscal break-even for Yemen is $160, Algeria $132, and Iraq $111.

This crisis has to be put in the context of increasingly efficient production from Shale wells in the US and in the general geo-political upheaval (most notably the Islamic State) across the region.

Saudi oil Minister Ali al Naimi took his country’s strategy to last week’s OPEC meeting in Vienna and succeeded, by threat and intimidation, to impose his point of view on his counterparts, despite vigorous arguments that cuts of up to 1.5 million barrels per day were needed across the organization to boost prices.

Naimi told his counterparts that “the oil price will stabilise itself eventually.” Russia, Iran, Venezuela, Algeria and Iraq did not agree and Venezuela’s President Ramirez stormed out of the meeting.

Oil war

So why has Saudi Arabia taken on this defiant stance, firing the opening gambits in what some commentators are already calling the “oil war?”

The Saudis appear to be using oil as a weapon but not against the USA as some suggest. The US will become a net exporter of oil by 2016 according to most analysts. America’s oil production is up 80% since 2008 due to the shale revolution.

No, the enemies in this war are enemies the Saudis share with the US: Russia and Iran.

Russia broke ranks when it annexed the Crimea and became militarily involved in Eastern Ukraine; Iran – whilst being tentatively courted by the US at the same time – is still regional enemy number one because of its support for the Assad regime in Syria and its refusal to make concessions in negotiations in Vienna last week about its nuclear enrichment programme.

Iran and Saudi are regional enemies
Iran and Saudi are regional enemies

Iran’s fiscal break even point is a very high $131 per barrel; Russia’s is $105 per barrel.

The Saudi Government’s justification for this policy is slightly implausible – a gung-ho challenge to runaway shale production in the US. Riyadh’s analysts may calculate that shale production costs are so high that prices will have to rise but many shale sites, including the massive Bakken field in Dakota, have a “long-tail phase” where initial land and infrastructure costs are completely offset and then production costs can fall from the average $70 – $80 per barrel to below $30.

In addition, history show us that this is not the case in practise. The same argument was used about North Sea oil in the 1980s when its production costs amounted to more than $10 a barrel to $2.5 for Middle Eastern oil. Nevertheless, oil production in the North Sea did not stop, not even when oil prices fell to less than seven dollars in the mid-1980s.

Do the Saudis really imagine that their strategy would eliminate expansion in shale production, returning the US to a state of energy dependency on the Middle East? That big scale domestic and international shale energy companies would simply destroy their investments in oil shale mining operations, estimated at tens of billions of dollars?

Russia and Iran

I believe this is primarily a political decision to tighten the screws on Iran and Russia, and destroy their economies; the same thing happened in the mid-1980s to accelerate the collapse of the Soviet Union, and in 1988 to put a stranglehold on the then Iraqi President Saddam Hussein whose regime had to cut back drastically on social spending, leading him to the very edge of the trap that had been carefully prepared for him…and the rest of the story is well-known.

Saudi Arabia, which has a Sovereign Fund of more than $ 675.9 billion might not be affected in the short term from the drop in oil prices, nor would Kuwait with a fund of $410 billion dollars, the UAE with $773 billion or Qatar with $170 billion. But that is only in fiscal terms – the political losses both at home and regionally could be very high indeed.

King Abdullah Bin Abdul Aziz
King Abdullah Bin Abdul Aziz

Not all influential Saudis are happy with the policy either. Billionaire investor Prince Alwaleed Bin Talal criticized Al-Naimi’s “complacency” on his website in an open letter to the oil minister, condemning “statements designed to minimize or underestimate the negative effects” of a price crash and emphasized the kingdom’s dependence on petro-dollars.

In the mid-1980s, the Kingdom pumped millions of barrels to accelerate the fall of the Soviet Union in coordination with America, the government of the Soviet Empire became weakened and collapsed, its people were psychologically and politically defeated. Two Western-looking Presidents hastened seismic change – Mikhail Gorbachev and his successor, another heavy drinker named Boris Yeltsin.

Russia is now on the ascent, and has regained its status as a great power, ruled by a strong, elected, President named Vladimir Putin. Ten days ago, Foreign Minister Sergei Lavrov accused the US of “seeking regime change” in Moscow by political means.
The reduction of oil prices provoked the late President Saddam Hussein to the occupation of Kuwait, which led to the overthrow and destruction of the country at the end of the day, as the United States wanted.

But the long term results were disastrous leading to a regime in Baghdad that is loyal to Iran, and a dangerous sectarian division which informs the current turmoil in the region, which has enabled the Islamic State not only to establish itself but expand with terrifying rapidity.

All of this threatening the Saudi Kingdom’s own stability and security.

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