Saudi cannot be pumping crude oil forever as in
the distance future it will be pump more water than oil . This will not be
known the outside world because it maybe happening already and must be also a
reason for Aramco IPO.
How does OPEC work?
OPEC (Organization
of the Petroleum Exporting Countries) is a consortium of thirteen countries,
headquartered in Vienna. Together, these countries account for about 40% of oil
production and more than 70% of world's proven oil reserves. For the past four
decades OPEC has had a wide range of influence on the oil sector, and thus on
the energy scene of the world. Simply put, OPEC is a cartel whose goal, since
its creation in 1960, has been to coordinate oil
prices in order to
ensure that oil producers received a steady stream of income. The mechanism
used by OPEC to control oil prices has been fairly straightforward; in
technical parlance it's a "hysteresis cycle", the same logic used by
a thermostat to control room temperature.
That is, if oil prices climb too high,
OPEC decides to sell a little bit more of oil in the open market so that the oil prices go down. This
is to avoid slowing first-world economies which would cause them to import less
oil. In other words, it takes the sting off its tail.
On the other hand, if oil prices fall too low,
OPEC reduces oil production so that oil prices spurt. With cut in supplies,
demand rises, after all. This way OPEC wrestles to keep oil prices high enough
to maximize profits. This hysteresis cycle started in the 70s itself when
reduction in oil production by the cartel led to immediate spike in oil prices.
In the eighties, OPEC started to set production targets to streamline the oil
price. In April 2001, OPEC reduced production by one million barrels, whose
effect as oil price increase was felt in the US, almost immediately. And, in
November 2006, it reduced production by 1.7 million barrels so as not to sledge
off the prices below the $50 per barrel mark. You see, the cartel had clout.
Now the scene moves to Saudi Arabia. The
kingdom being the largest producer (and exporter of oil) of OPEC, has become
the de-facto leader that few OPEC members dared oppose. During its first 54
year history, this mechanism worked great for OPEC, so why upset the apple
cart, opined the rest of the OPEC members. After all, the said mechanism
guaranteed a steady oil supply which, in turn, fuelled economic exchanges and
progress during the last half-century with an unprecedented increase in
prosperity worldwide.
Meanwhile thanks to new unconventional
methods, the American oil revolution was well underway and when in 2014 the US
passed Saudi Arabia as the first oil producer, Saudi Arabia, naturally, did not
like it. Clearly, it was used to everyone bowing to its tune. And so Saudi
Arabia decided to deal with US oil producers like the dictatorship usually
deals with its opponents: a public beheading for everyone to see. Unexpected to
everyone, the Saudis forced OPEC to increase production. It calculated that oil
prices would plummet and the US producers would be priced out of the market. The
logic was sound as fracking remains an expensive
process. This move from Saudi Arabia was, of course, historical.
No-one could have predicted nor anticipated. Not even Warren Buffett, usually right, but who
recently admitted of his mistake in investing in Conoco Phillips because of the
whole "peak oil" thing.
And, here's the rub, it worked. The
string of bankruptcies which ensued rivalled the size of the telecom bust.
Close to 70 oil and gas companies in the US filed for bankruptcy in the US so
far, with more to come. The scheme set in motion by Saudi Arabia was gaining
momentum.
Saudi Arabia pays the price for its actions
1.
Saudi Arabia lost its grip on OPEC
2.
OPEC lost grip on oil prices
3.
Riyadh lost its most precious political
ally, the US oil industry
4.
US came clean on its relations with the
Saudi Kingdom, lifting the veil of secrecy
5.
Western democracies took note of Saudi
Arabia's increasing arrogance and now perceive Saudi Arabia in a negative light
6.
Saudi Arabia is on track to run out of
cash with no plan to survive low oil prices
Now, for the details.
The day OPEC lost grip on oil prices
Respectable leaders lead by example and
by breaking the golden rule of 'supply control' and by demanding others to
obey, 'leader' Saudi Arabia not only harmed other OPEC member countries, but
also lost all its credibility. And, reputation is one that is difficult to
salvage once lost. Saudi Arabia did what it did, but the effect was felt by
all. Breaking the rules of OPEC caused extreme hardships for other OPEC
members. For example, Venezuela and Nigeria's oil payments contribute more than
90 percent of their total revenue from exports. Now, after Saudi's ill timed
move, both countries are not only crumbling under massive revenue loss because
of low oil prices but are also on the brink of famine and civil war.
Ever since then, OPEC hasn't been able
to act in a cohesive coordinated way. So much so, OPEC meetings nowadays beget
mayhem as members don't respect quotas any longer and are just happy to 'get
something' for their oil. OPEC's clout has crumbled.
The cartel has lost the cohesion that once made it strong.
SA lost key political allies
Evidently, harming the American Oil revolution cost Saudi Arabia support from US oil
lobby. For decades, the Saudis and the US oil industry was a match made in
heaven. It was a honeymoon phase all along. Generous oil contracts were handed
to US oil companies to develop the Kingdom's vast oil resources. Saudi Arabia
hired lobbyists to curry favour in the political arena too. After all, US oil
companies are political heavy weights. Understandably many past US presidents
from both parties had dubbed Saudis a key ally in the region.
However, the numerous oil bankruptcies
in the US built resentment throughout the US oil industry. It turned out
harming the US oil industry to be was an ill-fated political move by Saudi
Arabia which lost its most influential ally in Washington. Also, it's an
election year in the US and politicians, both Republicans and Democrats, do not
want to be seen courting Saudi Arabia.
Take the case in point: Republican front
runner Donald Trump has been an outspoken critic of Islamic fundamentalism and
Saudi Arabia. Trump even made the declaration that he would stop purchasing oil
from Saudi Arabia if it did not provide troops to fight ISIS. And, he had the
choicest expletives for Prince Alwaleed Talal nicknaming him as "the dopey
Prince". Let's keep in mind that these apparently candid retorts and all
statements on the campaign trail are indeed carefully crafted by image
consultants; in the case aforementioned this is meant to achieve the following
end-goals:
§ Being outspoken against Islam gathered huge popular support
at a time when acts of terror like the Orlando nightclub shooting are on the
rise. Any politician, in a democracy, needs votes to get elected first and
foremost.
§ Denouncing Saudi donations to US politicians loud and clear
sends a loud and clear message to Riyadh that its days of Washington coziness
are over.
§ It sets the context of openness and transparency for
discourse, where freedom of speech is not muffled by the fear of offending a
religious group.
This is a definite departure from the
Republican's previous attitude towards Saudi Arabia. The Bush family's snugness
to the Saudi regime has been a thorn in the side of Republicans since 9/11 and
a detached outsider such as Trump brings a clean slate, signalling a clear
break with previous allegiances.
Sadly on the Democrat side, much energy
is spent on tiptoeing around the issue in an effort to court Islamic voters, in
a manner identical to Europe's socialist parties, at the expense of other
minorities. This betrayal of values has also been such a thorn in the side of
the Democrats that Hillary Clinton broke the party line and joined Donald Trump
in criticizing Saudi Arabia for funding terror. Expect political one-upmanship
all the way to election day in denouncing Saudi funding - which ironically both
parties have gladly accepted for years.
It will never be the same in Washington
for Saudi Arabia, ever again.
Still, until the election, Washington
had to do something and it did. It turned its back on the Kingdom by
re-kindling relations with Iran, Saudi Arabia's arch enemy cum rival. Sanctions
on Iranian oil were lifted officially in January and a nuclear deal was inked
last summer. As a result, Iran has become a key player in OPEC's stalemate.
Not stopping there, the US also did just
what Saudi Arabia feared the most: it started a motion to open its previously
secret dealings with Saudi Arabia to public scrutiny.
Lifting the veil of secrecy
Secrecy chapter between the US and
Riyadh has been a long time affair. During the 1973 oil crisis, Saudi Arabia
forced OPEC members to cut oil supplies to the US in retaliation for its
support of Israel in the Yom Kippur war. The oil prices went up, as did
inflation and OPEC realized its power. So much so, the then President Nixon
sent in Henry Kissinger, the secretary of State to cut a deal. With the
assistance of US Treasury Secretary William Simon, a deal was made with the
Saudis: they would buy US debt (bonds) with petrodollars to finance consumer
debt and trade deficit of the US. Of course, there was a catch. The amount of
US debt owned by Saudi Arabia would never be made public but rather published
as a bundled figure for Middle-Eastern state. This way Saudi Arabia's influence
would remain concealed from public scrutiny. By 1974, the petrodollar was in
rage with many oil producing countries wanting a way in. Come 1975, all the
OPEC countries agreed to price oil in dollars. The petrodollar was born, key
contributor to the American economic hegemony.
This historical secret agreement worked
great for both the US and Saudi Arabia. Neatly, the US was able to outspend
Russia throughout the eighties while Saudi Arabia funnelled Islamic fighters
including Osama bin laden to oppose Russia in Afghanistan. By 1991 the USSR
which could not keep up with US spending collapsed. The cold war was over.
This agreement was kept secret for over
40 years. This is the key to Saudi Arabian foreign policy: to cut secret deals
with heads of states, away from the populace. Secrecy is the key for Saudi
Arabia. That is, until now.
The whole thing came to a crescendo as
it was made public thanks to the US freedom-of-information act. Well, this
release of information was "helped" because US/Saudi relations were
deteriorating rapidly. Earlier, a bill went to congress Justice Against
Sponsors of Terrorism Act (JASTA), that will, if passed, allow the families
affected by the 9/11 terrorist acts to sue the Saudi Government (15 of the 19
hijackers were Saudi nationals). Enraged Saudi Arabia resorted to extortion by
threatening to liquidate its US bonds if the bill were to be passed.
Until now, no-one seemed to know for
sure how much of the US was "owned" by Saudi Arabia. Now the data is
public: a mere $117 billion. Significantly less than 10% of either China's 1.25
trillion and Japan's 1.13 trillion. In fact, Saudi Arabia doesn't even make it
the top 10 creditors. Lifting the shroud of secrecy is America's way of telling
Saudi Arabia publicly: "look, we don't have any reason to fear you. Because
you have no game."
SA unpopularity grows in the west
It's an intricate web of a complex story
but in layman terms - Saudi Arabia funded the Muslim brotherhood to impose
Sunni control over Middle East. When the Muslim brotherhood spun out of
control, the Saudis retracted and washed their hands off. The same happened in
Syria. Saudis funded the insurgent groups in Iraq and Syria including ISIS.
When ISIS got arrogant, the
Saudi regime withdrew into its shell again like a tortoise. Saudi Arabia funded
the war in Yemen which is still ongoing. Last year, unsurprisingly, Saudi
Arabia became the world's largest military spender at a time where western
weapon system increasingly fall in the hands of terrorist groups. The world has
slowly woken up to the fact that it was Saudi Arabia's insistence to fund
overthrow of Assad over the Qatar-Turkey pipeline to control oil to Europe that caused
the migrant crisis.
In a nutshell, the migrant crisis and
the surge in home-grown terror, routinely threatening European capitals, can be
attributed to Saudi ideological exports. As a result, Western democracies have
taken note of Saudi Arabia's agenda and now perceive Saudi Arabia in an
extremely negative light.
Of late, terror attacks in Paris and Orlando have awakened Western
democracies to the perils of Saudi Arabia's cultural export. After 40 years of
Wahhabist influence, fundamentalist Islam is alive and well, even standard on
European soil. As things go, since the fall of communism, fundamentalist Islam
exported by Saudi Arabia is unequivocally acknowledged as the number one threat
to western way of life.
Increasingly, with the string of
investigative reports, lot more people are aware of Saudi Arabia's role and
Saudi Arabia is being blamed for using oil revenues for destructive purposes.
Thankfully Europeans and Americans can elect their own leaders who value
transparency and reflect their own values. This is a central topic on the US
campaign trail as well as in Europe.
Saudi Arabia flinching
With drastic cuts in public spending,
Saudi Arabia is already feeling the pinch of falling oil prices.
Saudi Arabia has already spent 1/5 or $140B of cash reserves, since the oil
prices crashed, to maintain its heavily subsidized social system. The kingdom
needs the oil prices at $89 or higher to break even, whereas today it sells a
barrel of crude for exactly half that price. At the present rate the Kingdom
will become insolvent within 4 years.
It would be an understatement to say
that Saudi Arabia relies on high oil prices. Oil
accounts for about 92.5% of state revenue and represents 55% of GDP. This
problem is compounded by the fact that Saudi Arabia cannot levy taxes on its
citizenry for two reasons: first, tax payers universally demand the right to
vote on how money is spent. Voting implies choosing rulers and this is
unacceptable for a theocracy founded on writings unchanged since the 6th
century. Second, the Kingdom's workforce legendary low rate of productivity
renders it nearly unemployable, so much so that 93% of its private sector is
staffed by foreigners. So Saudi Arabia is left to auction off Saudi Aramco in
an attempt to attract foreign capital and delay the inevitable.
In addition, liquidating US assets may
be the only choice left for Saudi Arabia. If convicted of assisting terrorists
by an American court, the US can and will seize Saudi assets held in US
dollars. Which, it has to be pointed out, would abruptly accelerate the
timeline to default. Understandably, few financial institutions want to run the
risk of being associated with a rogue state on its way to bankruptcy.
Consequently Saudi Arabia's debt rating was cut to A2 by Moody's in May. This
is the second cut in a few months following S&P's cut to A+ .
The smart money is noticing that Saudi
Arabia is faltering and has no plan B to survive low oil prices. Not only
are politicians turning their backs on Saudi oil, so are financial
institutions.
What does it all mean for oil prices going forward?
Saudi Arabia's former might hinged on
the respect it received from OPEC members, which gave it control over OPEC
outputs - and de-facto control of 40% of world oil output, way more than its
share. Now that OPEC members have lost trust in Saudi Arabia, its leadership
has evaporated. We are transitioning to a time where open trading on world markets has
more impact on oil prices than
artificial supply control by OPEC.
Further, thanks to new advances in oil
production we can extract oil from unthinkable locations at competitive prices.
More importantly American ingenuity can do that on
short notice and on
such a massive scale that it turns the oil market on its head. Dependence on
Saudi crude is declining every day. Finally, Saudi Arabia has found its match.
If it thought that Iran was its rival, it has found a more portent one in the
West.
Sure oil prices plummeted to $26 and caused turmoil in the industry.
Yet, as usual, markets self-regulated and prices are now stabilizing at around
$50. In the long term, this is far more reliable than the old
"cartel-controlled" oil market because it is more transparent and
self-regulating.
Market dynamics function efficiently for
all other commodities (such as corn or steel) without a cartel to artificially
create scarcity. In essence, taking the OPEC cartel out of the picture
increases market efficiency. It is straightforward: the money that is no longer
retained by OPEC sheiks to buy Ferraris and ship Imams to the US and Europe is
instead allocated to productive endeavours such as funding medical research. It
makes the world a better place.
Let's face it. Many (if not most) Middle
Eastern rulers were either deposed or hand-picked with "assistance"
from western powers. Recently Egypt's democratically elected Muslim Brotherhood
was replaced by the Egyptian army, second largest recipient of US military aid
behind Israel. Saddam Hussein came to power with US assistance but was
overthrown in 2003 after planning to trade oil in Euros instead of dollars.
Iran's democratic government which intended to nationalize oil fields was
overthrown and replaced in 1953 with the Shah backed by the US and UK. Examples
galore. Each time a change of leadership took place it was because western
interests tied to oil were threatened by a ruling body which got a little too
bold.
It seems a page is about to be turned in
the history of the Kingdom, sometime between now and 2020. Given the strategic
importance of its (albeit overestimated) oil reserves, one needs to tread
carefully in order to avoid a replay of Iraq. In post-Saddam Iraq a leadership
vacuum caused fundamentalists to rise to power after a period of unrest, and
this should be shunned at all cost in favor of a smoother, more legitimate
transition. Thankfully more than 15,000 Saudi princes call the Kingdom home and
just as an oversupply of oil created a buyer's market, there is no shortage of
candidates to turn things around for the greater good.
based in Mali, haven't
taken the oil potential of Mali under consideration (think Canada, France) and
so their analysis have remained over Islam and insurgency, only-you need to
know.)
Predictably
a confrontation with the West over said resources and fundamental cultural
differences was bound to happen. This is likely the start of something bigger,
a new world paradigm where former colonial powers return not as oppressors but
as liberators and protectors of freedom and liberty.
