17 Dec

Recent analysis about the rapid drop in crude oil prices depicts the Saudis in a market share battle with the frackers of North Dakota and Texas. Underlying it all is a false assumption—that Saudi Arabia, the world’s largest oil exporter and the strongest voice in OPEC, is acting merely to restore its position in the U.S. market.

“One theory for why OPEC is allowing prices to fall is that the cartel (and particularly Saudi Arabia — it’s largest member) is attempting to fight off competition from US shale oil and maintain its share of the US market. Keeping prices below $100 a barrel will put pressure on higher cost US shale producers and will prevent further erosion of OPEC’s position in the Americas.”


I disagree with the conventional wisdom.  Yes, falling oil prices will slow U.S. exploration in marginal or expensive areas (including deep water and the arctic) and take some lower producing fracking wells off line.  But due to improvements in production technology most U.S. shale oil is still profitable at $60 a barrel.  Wails of pain will issue from sectors of the U.S. economy which have placed bets on continued high oil prices.  Too bad.

Here is the new normal: the U.S. now produces more crude oil per day than any other country in the world.  This isn’t the sour, sulphurous sludge that oozes into Gulf Coast refineries from Venezuela and Mexico.  Much of America’s new oil is the light, sweet, easy to refine stuff that comes from North Dakota’s Baaken formation.  This oil has put the U.S. well on its way to oil independence. The Saudis know it.  I don’t think they’re trying to claw back share in a market they know they’ve already lost.

No, I think the Saudis very much want oil prices to crater—but for strategic reasons. They needed to wait until the U.S. produced enough oil to make their price play stick.  The Saudis can afford to wait out a period of low oil prices.  They are sitting comfortably on foreign exchange savings of about $757 billion (the stolid Norwegians have squirrelled away $800 billion of their North Sea oil revenue).  And the Saudis are relishing every minute of the economic pressure cheap oil is putting on two very troublesome, recalcitrant countries—Iran and Russia.

Oil producing countries that are most vulnerable to substantially cheaper oil are those with a combination of (1) inefficient or high-cost production; and (2) an unhealthy budgetary reliance on oil revenue. Because they have failed to diversify their economies and sock away a big chunk of their oil earnings, some countries need oil in the $90-130 a barrel range for their national budgets simply to balance. According to the Wall Street Journal, Iran needs a barrel of benchmark crude to price at an improbable $130.70 to balance its budget; Nigeria needs $122.70 and Venezuela, $117.50. Oil at today’s $60 a barrel is catastrophic for all of these countries–even for Russia, which breaks even at a mere $98.

Russia, whom Sen. John McCain famously—and correctly–called “a gas station masquerading as a country” has three big problems: cheap oil, Western economic sanctions, and a kleptocratic, oligarchic government that abuses its regulatory authority to plunder businesses and punish successful entrepreneurship. It is rapidly burning through its large cash reserves in a failed bid to prop up the free-falling rouble.

Venezuela—a badly behaved, poorly governed exporter of oil, regional instability and baseball players—comes close behind Russia and Iran in the trouble-maker category. But today, and thanks in part to Venezuela’s swoon, cheap oil gave the world its very first foreign policy breakthrough: the announced normalization of diplomatic ties between Cuba and the U.S.  You see, when oil was at $130 a barrel Cuba could count on the support of Venezuela, even Russia.  But with its two patrons headed toward recession and possible default, Cuba realizes that the game has changed.

And while we are on the topic of badly governed oil producers, resource rich Nigeria has recently passed South Africa to become the largest economy in Africa.  But it is, sadly, one of the continent’s worst governed countries. Like Venezuela, cheap oil will drag Nigeria down into an economic and political abyss.

But let’s focus on the Saudi’s game, because that is what the cheap oil is all about.

Mind you, the Saudis like to make money on their abundant oil. But there is one thing that the Saudis like even less than cheap oil: Iran. Iran is trying to make a bomb, which threatens Saudi Arabia and its neighboring Sunni monarchies and emirates–to say nothing of Israel’s strong views on the matter. When Iran, a country with the world’s fourth largest petroleum reserves, isn’t vigorously—and ridiculously–asserting its right to have nuclear power (and the bomb), it stirs the pot in an already tension filled region. They’ll support Shiite movements in Arab countries, send missiles and aid to Hezbollah and Hamas, and fund Shiite militias in Iraq. Iran, in the view of most of the world—and certainly the Gulf’s conservative monarchies and emirates–throws its weight around constantly and unhelpfully.

But to the Saudis, Iran’s most egregious conduct is its support for the murderous Alawi regime of Syria’s Bashar Assad. The bestial, interminable struggle in Syria has become a proxy war between Saudi Arabia (and its Gulf allies) and Iran.

And Russia, which is where we return to the plot.

Assad has survived because Iran and Russia provide him weapons and money. Russia has many reasons to support Assad. First, Russia needs friends and arms customers in the region. Egypt and Iraq, once Soviet allies, are now in the U.S. sphere. Second, Russia’s only naval base in the Mediterranean is in Tartus, Syria. And while it still has money to pay, Syria is one of Russia’s biggest arms customers–at a time when Russia needs non-oil export revenue.

The Saudis made their move at the November 27 OPEC meeting. They successfully blocked attempts to cut production despite a world-wide glut of oil caused by increased U.S. production and weakened demand from a cooling Chinese economy. Venezuela pleaded for production cuts. Russia, which is not an OPEC member, sent their energy minister to the meeting to urge production cuts—to no avail. Prices, which had already dropped $30 from their June apex, fell immediately and haven’t found their bottom yet.

So, while Americans get at least a winter of cheap gas for their SUV’s, far bigger things will happen.

Russia, smarting from low oil prices and the bite of economic sanctions put in place after Putin’s expensive Crimea and Ukraine adventures, is desperately–and unsuccessfully—trying everything from currency intervention to interest rate hikes to stop the rouble’s free-fall. Capital is fleeing Russia at a breathtaking rate. Russian banks and corporations need to refinance their debt but can’t because EU sanctions cut off access to European capital markets. Many will default.

One ponders Putin’s options for lifting sanctions, while saving face domestically (his Crimea and Ukraine moves are both wildly popular at home). I am certain that his continued support for Assad is now one of the few openly displayed cards on his table of diplomacy.

As for Iran, low oil prices worsen an already teetering economy and devalued national currency. Life becomes even more difficult for the average Iranian. Iran has one of the region’s youngest populations. If the Arab Spring taught us anything it is that lots of unemployed Internet-connected young people milling about without an economic future is not conducive to political stability. What the Iranians want is jobs, growth and an end to their isolation, and they know that only a lifting of sanctions and access to long-frozen assets will get them there.

Perhaps they will re-assess their costly support for terrorist clients in Gaza and Lebanon. Most importantly, Iran may be at the point where, in exchange for the lifting of sanctions, it ends a decades-long game of nuclear lies and delay–before a very unsympathetic, incoming Republican congress whacks them with yet more sanctions.

And as with Russia, I am certain that Iran’s support for Assad, the butcher of Syria (which incidentally isn’t winning Iran any friends in Turkey or anywhere in the Arab world) is on the table.

Assad should be very nervous, pondering various exit strategies. Getting rid of Assad merely begins the process of dealing with the threat of ISIS and the rebuilding of war-ravaged Syria. This may include (to forestall slaughter at the hands of the majority Sunni Syrians) a partition of Syria’s Alawite northwest under UN supervision.

So, by the middle of 2015, I reckon we’ll be able to chalk one up for the Saudis. Another story that hasn’t been written will be what John Kerry and the U.S. State Department did with the Saudis and their Gulf friends to make all of this happen in the most natural sort of way.

And as for Russia, Iran and all the rest, it couldn’t happen to a likelier pack of rogues.


Duncan McCampbell