Saudi Cut In Oil Price for US May Lead To Price War
Posted on November 6, 2014 by Yves Smith
Yves here. We pointed out last month that the US was on the list of Saudi targets when it made clear it was not supporting oil prices at a level higher than $80 a barrel. Some readers rejected the idea that Riyadh would launch a price war to undermine the US, when in fact the desert kingdom has been mightily unhappy with US policies in the Middle East for some time (in case you managed to miss it, ISIS started out as Prince Bandar’s private army and odds are high that it continues to get Saudi support).
--- It is critical to remember that the Saudis have no compunction about imposing costs on other nations to maximize the value of their oil resource long term and hence the power they derive from it. The 1970s oil shock produced a nasty recession in the US and most other advanced economies and gave a further impetus to inflation, which was already hard to manage and dampened growth by discouraging investment.
The current alignment of factors gives the Saudis the opportunity to make life miserable for a long list of parties they would like to discipline, including the US.
The sharp rise in the dollar means that lowering the price of oil in dollar terms is unlikely to leave the desert kingdom worse off in local currency terms. But it undermines US energy development, both fracking and development in the Bakken, as well as more development by the majors, who were regularly criticized by analysts for how much they were spending on exploration when the math didn’t pencil out well at over $100 a barrel. Countries whose oil is output is mainly heavy, sour crude, like Iran and Venezuela, find it hard to sell their oil when prices are below $100 a barrel (or at least when the dollar was weaker, but the $80 price point, even with a strong dollar, may be low enough to cause discomfort).
Now admittedly some pet targets may not be hurt as badly as hoped. Russia will suffer more of an opportunity loss than an actual cost from the price reduction, since the ruble has fallen significantly against the dollar. The Saudis may hope to partially displace Russia as a supplier of oil to Europe (now roughly 1/3 of the total) but refineries would need to be retooled to refine the Saudi’s light crude, so it isn’t clear whether even what amounts to bargain prices will offset this cost (and readers point out that Russian crude may also produced a better mix of distillates for European use, since they are much heavier users of diesel fuel than the US).
But aside from the not-inconsiderable economic impact, the surprise Saudi step looks to be an even bigger geopolitical winner. The US and Riyadh have been at odds for over a year; the Saudis were particularly unhappy over the US failure to try to topple Assad last summer (you may recall the intensity of the Administration warmongering versus the dubious US interest; even Congress showed an unexpected amount of backbone and made its lack of support for Syrian adventurism clear). The Saudis have also long been less than happy with the US refusal to attack Iran (which is a rare case of the US acting as a responsible hegemon and curbing a putative ally with a bad case of blood lust). That unhappiness has ben compounded by the US now effectively helping the Assad regime and working in as distanced a manner as possible with Iran in targeting ISIS.
-- Cutting prices will make it far harder for Iraq’s Shia led government to invest in the fight against ISIL. So long as Western sanctions continue, it will destabilize Iran significantly, not only making it a lot harder for Iran to help Iraq and Syria, but also undermining the government that has chosen to deal with the US. The cuts will also destabilize Iran’s allies in Venezuela and Ecuador. Oligarchic forces have been trying to foment a coup in the former country for some time and this may well help to do so…The Saudis have been trying to undercut Russia for some time and — to the extent the ruble exchange with the dollar doesn’t shelter Russia from these changes [Update: though see Mark Adomanis on how this is hurting Russian consumers] — this price cut will hurt Russia too.
Ultimately, though, I suspect the US is just as much the target of this move as Iran and Russia are. Since the US refused to take out Assad last year and inched forward with its Iran deal, the Saudis have been worried about having Shia Iran and Iraq take over its role as the swing producer in the world, mirroring what happened in 1976 when the US replaced Iran’s Shah with the Saudis. By destabilizing the government in negotiations with the US, the price cut will make it a lot harder to achieve such a deal.
Just as importantly, the US is now a petro-state. And this price cut will make fracking (and deepwater drilling) unprofitable. We’ve been fracking largely to give ourselves some breathing room from the Saudis; cutting the price will make it far harder for us to sustain that effort (and will make some renewables uncompetitive).
To me, then, this move looks like part of an effort to force the outcome the Saudis have been chasing for a decade and even more aggressively since the Arab Spring: to paralyze Shia governments just as the chaos of ISIL threatens to remap the Middle East.
The Saudis may well claim to be supporting our fight against ISIL, but the long-term commitment to dropping oil prices, looks more like an effort to undercut it. -- ---
With that as background, OilPrice reports on the latest skirmish in the oil price war.
Saudi Arabia’s move to cut the cost of its oil to US customers has injected fear into the oil markets, bringing the price of OPEC crude below $80 and suggesting to some observers that the cartel is preparing for a global price war.
OPEC production has remained level despite worldwide demand, and as a result, on Nov. 5, the cartel reported that its basket price .. http://www.bloomberg.com/news/2014-11-05/opec-oil-basket-price-falls-below-80-to-least-in-4-years.html – the average price of its leading grades of crude oil – had dropped to $78.67 a barrel the day before, the lowest in about four years. And US production has reached its highest level in more than three decades, creating a buyer’s market for oil.
Saudi Arabia cut its price for US customers on Nov. 3. Meanwhile, along with Saudi Arabia, Iraq and Iran, two other major OPEC producers, also are cutting prices to Asian customers this month.
The reason for the Saudi move is a matter of some dispute. Some observers of the global oil market view the Saudi price cut to US customers as an effort to undermine the boom in American production of oil from shale.
“The market reacted to it very negatively, thinking, ‘Here we go, we’re going to have a price war in the United States,’ ” Anthony Lerner, a senior vice president of industrial commodities at brokerage R.J. O’Brien & Associates LLC, told The Wall Street Journal .. http://online.wsj.com/articles/saudi-oil-price-cut-upends-market-1415063053 .
But another person familiar with the Saudi decision, whose name was not disclosed, told the newspaper that the aim was merely to lure US refiners to buy cheaper oil from Saudi Arabia and thus increase their profits.
Whatever the Saudi motivation, industry insiders and observers from OPEC officials to oil price news services view these actions as leading to a price war. In Baghdad, for example, Iraqi Oil Minister Adel Abdul Mahdi told parliament on Oct. 30 that the struggle is internal in OPEC, with members fighting one another to hold on to their shares of the petroleum market.
Meanwhile, the Oil Price Information Service (OPIS) .. http://www.opisnet.com/ , which reports extensively on the oil trade, said in a Nov. 4 report that the Saudi move had caused a “panic” in the market.
As frightening, or at least chaotic, as all this may sound, however, there are positive signs.
AAA, the US auto club, said Nov. 4 that the national average for regular gasoline had fallen to $2.97, down 6 cents from the previous week and 33 cents from the same date in October. And industrial customers including hotels, restaurants, railroads and airlines also are likely to benefit from lower fuel costs.
For now, the only losers are the oil and natural gas industries. They’ve been enjoying a kind of windfall in the past few years as they’ve increased exploration and production of shale oil. Now, though, their share prices are falling for fear that their profits will begin eroding.
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