Oil To Fall Further? Saudi Seeks To Checkmate Iran and Russia

London, UK - 23rd June 2012, 18:35 GMT

Dear ATCA Open & Philanthropia Friends

[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

Forget the plunge to $80 a barrel, there are new predictions emerging that oil could fall further to between $60 and $40 per barrel by this autumn. Why? There are many factors at work and Saudi Arabia is one of them. Saudi oil minister Ali al-Naimi has made no secret of his desire to curb high oil prices in order to provide a "stimulus" for the stalling global economies. If the price of oil continues to fall that is obviously great news for motorists around the world but this is not so good for Russia and Iran because their budget trajectories don't balance below $100+ a barrel. Countering the threat from those two countries is very important to the Kingdom of Saudi Arabia because:

1. Russia is not only stalling the efforts to halt excessive violence in Syria but it appears to be stoking the fire by supplying armaments and military assistance; and
2. In parallel, Iran is refusing to give up its lofty nuclear ambitions which not only threaten Israel but are particularly threatening to the Gulf Co-operation Council (GCC) kingdoms.

Mercurial: Oil Price Decline

Saudi is carrying out aggressive actions to lower oil prices by not only pumping some 10 million barrels a day but also leveraging its extensive energy trading networks. All this might seem counter-productive given Riyadh's economic stake in the oil game and keeping the oil prices high. However, the Saudi rationale is clear, and entirely consistent with the kingdom's traditional long game. The Saudis think that lower oil prices will produce a more reasonable attitude from both Russia and Iran in order to bargain with them. In addition, Saudi is terrified of a current US boom in shale oil and natural gas. It is hoping that lower oil prices will disincentivise further costly drilling efforts in North Dakota's Bakken Shale, which deploys controversial fracking technology, and Canada's oil sands in Alberta.

Impact on the US Presidential Elections via Lowered Fuel and Food Prices

Let us not forget that the incumbent president in the US will also benefit tremendously in the upcoming November elections if the price of gasoline falls dramatically. Although the US presidential elections are likely to be fought on the primary issue of jobs, if the American people feel that their day-to-day cash flow has improved because they are spending less on fuel and food, this would enhance the chances of the incumbent dramatically. Food prices are also likely to fall because they are highly correlated with the price of fuel: given the costs of fuel-intensive land preparation, plantation, irrigation, fertilizers, mechanised harvesting, processing, packaging, animal husbandry, refrigeration and distribution.

Severe Oil Price Correction

Given the long game that the Saudis are now playing, there is a rising likelihood that oil prices could undergo a severe oil price correction. Energy markets are historically mercurial: they overshoot when one is trying only to fine-tune them, as the Saudis and other members of OPEC have discovered over and over and again. Let us not be surprised if oil goes to $40-a-barrel by this autumn. To the degree that such fire-sale prices are long-lived, they could have many unintended consequences. Chief amongst them is the likelihood of causing mayhem amongst petrocracies. Yet the Saudis in association with the rest of the GCC are willing to suffer the consequences, knowing that their joint financial reserves -- in trillions of dollars -- are sufficient to close the gap of any potential deficit to the detriment of both Iran and Russia.

Perfect Storm

In parallel, there is a perfect storm brewing which is likely to cause a massive correction in oil prices anyway, regardless of Saudi's extra efforts. Why is the price of oil going to correct further given that it has already fallen by more than 25% from its recent peak and now stands at around $80 per barrel?

1. The Eurozone crisis is paralysing strategic business decisions and consumers are increasingly going on a buyers' strike as unemployment rises;
2. The swift slowdown in the GDP growth of China, India and Brazil is curtailing aggregate demand for oil from the most important emerging economies; and
3. The decline in US oil consumption with a simultaneous rise in domestic natural gas and oil production and supply means the high price of oil is no longer sustainable.

Key Questions

I. What happens if the oil price drops by another $20 to $40 a barrel for an extended length of time and oil trades in the range of $40 to $60 by this autumn?

II. What about the world's petro-rulers, who are watching the price of oil plunge at a rate they have not experienced since 2008 when world growth and trade fell considerably in the aftermath of the Lehman Brothers' crisis?

III. If the oil price continues to fall, could there be a fresh round of Arab Spring unrest or will the falling price of food, in tandem with fuel, mitigate the chances of insurrection?

IV. Could there be unpalatable nightmare scenarios unfolding for those who run petrocracies in the Arab world, Iran, Russia and perhaps Venezuela as budget deficits increase and extensive social welfare programmes are cut?

V. What happens to the viability of the green industry including bio-fuels and alternative power solutions such as solar, wind and tidal power given that they are mostly in-profit above $75-a-barrel of oil?

[STOPS]

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[ENDS]

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