Weaponized Oil

The Fuel and the Fury

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The plunging price of oil is changing global politics.
  • Why it matters

    Why it matters

    The low price of oil means once-powerful oil-rich nations face a loss of power, changing the balance of global politics.

  • Facts

    Facts

    • Tumbling oil prices could create economic disaster in countries such as Russia, where economists estimate a per barrel cost of $100 is needed for the country to meet current budget obligations.
    • Low prices for oil are bruising the currencies of oil-producing countries, especially in Russia, where the value of the ruble has dropped by 40 percent in recent months.
    • Conspiracy theorists believe the U.S. and Saudi Arabia are working together to punish other oil rich nations.
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    Audio

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Saudi Arabia’s King Feisal was not normally one to receive unannounced visitors at his palace in Riyadh. But he made an exception for Anwar El Sadat, who was on a secret mission when he visited the king on August 23, 1973.

The Egyptian president was planning a surprise attack on Israel and sought assurances the Saudis would support his war effort, not with tanks or troops, but by turning off the oil supplies for Israel’s allies, first and foremost the United States.

Saudi Arabia not only transferred half a billion dollars into Sadat’s war chest, but the king also promised to keep the West under constant pressure with the power of his oil.

Two oil crises followed, leading to the realization that the elixir of life to the world economy was also one of its most dangerous weapons.

“That changed the world,” former U.S. Secretary of State Henry Kissinger said. “If you control the oil, you control the nations.”

Forty years on, the circumstances are reversed. This time, the weapon is the collapse in oil prices.

Now, Saudi Arabia and the United States are acting in unison, at least partially, and are primarily hurting other oil producers.

U.S. President Barack Obama and the Saudi sheiks allied against political rivals like Russian President Vladimir Putin? It’s a conspiracy theory that has reached European political leaders. Europe and especially Germany are profiting from the steep decline in energy prices.

“The Saudis are using oil to put political rivals under pressure, like in 1973,” says Mohammad Bazzi, a Middle East expert at the New York Council on Foreign relations. “Only this time, they are not driving the prices up, but the opposite.”

It’s a shock, even for rich Persian Gulf states like Oman. “We had hoped to keep politics and energy apart,” said Oman’s Oil Minister Mohammed al-Rumhy. “But it has become a nightmare.”

The price of oil has plummeted by more than half since September 2014, to under $50 per barrel. The price had generally been stable for the previous three years, hovering around $100. Now, oil exporters are absorbing enormous losses in revenues, forcing them to cut back on government services.

 

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The old order is up in flames. Source: Polaris

 

Energy experts believe, for example, that Russia needs an oil price of about $100 to fulfill its current budget obligations.

Iran is even more heavily dependent on oil prices since sanctions by the West have worn down the country’s economy over the past years. Ten cargo ships reportedly have been waiting for weeks to unload in the southern Iranian port of Bandar Abbas because exporters want to be assured of payment before offloading the goods. Last year, the government in Tehran needed oil at $120 per barrel to avoid budgetary red ink, but this week Oil Minister Bijan Namdar Zanganeh claimed Iran currently needs just $72 per barrel for a balanced budget, largely because of low production costs of just $25. “We will also survive considerably lower prices,” he declared.

Oil producing countries are paying a steep price for their dependence on oil in other ways. Currencies are softening and economies are slipping into crisis.

Ultimately, it is the average citizens who feel the impact. The value of the Russian ruble has plunged by some 40 percent while the Iranian rial has also lost a massive amount of its value against the dollar in past weeks.

The International Monetary Fund, or IMF, now predicts a recession for Russia. Economic performance stagnated in 2014 and is expected to drop by three percent this year, putting Mr. Putin and his country under even more pressure as the economy is weakened further by sanctions imposed after Russian troops marched into the Crimea. The Russian economy needs its oil and natural gas revenues like a junkie needs a fix.

It’s a tough situation for the Russian president to explain and one that is feeding fears of a conspiracy against Russia. Mr. Putin attributes the fall in oil prices not simply to market forces of oversupply and lower demand, but to a political plot.

“Could it be the agreement between the U.S. and Saudi Arabia to punish Iran and damage the economies of Russia and Venezuela?” he recently asked. “It could.” He noted prophetically in October that oil prices are being manipulated by flooding the marketplace with much more oil than is needed.

Additionally, Mr. Putin fears history could repeat itself. Many Russian economists believe the United States, aided by Saudi Arabia, pushed oil prices below $10 in the 1980s, accelerating the demise of the communist regime of the former Soviet Union. When oil revenues collapsed back then, Mikhail Gorbachev, then-Soviet leader who was fighting to save the U.S.S.R. with reforms, was unable to even import more soap for his striking miners. The rest, as they say, is history, and it is now becoming a similar nightmare for Mr. Putin.

The Russian president isn’t alone in harboring suspicions. Venezuela President Nicolás Maduro also sees sinister forces at work and says America and its allies are forcing down oil prices to cause economic damage to Russia and his nation.

 

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Bleak times? Source: Mauritius

 

No one in Washington confirms such conspiracy theories, of course. However, Barack Obama makes no secret of the fact that he welcomes the plunging oil prices: “Russia is isolated, its economy is in ruins,” the U.S. president said coolly in his State of the Union address last Tuesday.

Political commentators such as the conservative historian Arthur L. Herman from the Hudson Institute think tank are openly demanding that the United States use oil as a “weapon” to promote its geopolitical goals.

In other words, troublemakers like Mr. Putin and the nuclear bomb-seeking mullahs in Iran should be attacked indirectly. Wolfgang Ischinger, Germany’s former ambassador to Washington and the director of the Munich Security Conference, also believes that such a strategy could work.

“In the short term, the low oil price strengthens the impact of Western sanctions on Russia. Putin’s options would certainly be less limited if the price of oil was a lot higher,” he said.

On the other hand, the plunging price of oil was just as much of a surprise to Washington and the rest of the world. President Obama didn’t achieve a geopolitical coup but is profiting from a fortunate foreign policy coincidence.

But it’s also true that the drop in oil prices has tipped the balance of power in favor of America. The conditions for U.S. foreign policy have vastly improved, as have Mr. Obama’s opinion poll ratings. Cheap oil is the soothing balm against America’s fears of decline.

 

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Happy days for drivers. Source: DPA

 

These days, U.S. drivers pay just over $2 per gallon of gasoline and the U.S. economy is gaining speed. Each American has roughly an extra $750 each year in his or her pocket thanks to the low energy prices.

The IMF reckons that falling oil prices could push global growth 0.7 percent higher in the coming years, with oil-importing economies profiting the most. “The winners are all those countries that need a lot of oil relative to their gross domestic product and don’t produce any themselves,” said István Zsoldos, chief economist of the Hungarian oil and gas firm MOL.

But the drop in oil also has a downside for America: Its previously booming fracking industry, which has squeezed ever-more oil and gas from shale deposits in recent years, faces ruin if oil drops much below $50 a barrel. And that’s a development welcomed by the Saudi oil sheikhs. The Saudis have refused to cut production so far, fuelling speculation that they are also using their oil as a weapon. Fracking has allowed the United States to become a production rival.

The new technology might have a questionable impact on the environment but it has freed Americans from decades of dependency on foreign oil. North America is on track to eliminate the need for energy imports by the end of the decade and become an oil producing “titan of unprecedented size,” according to a forecast by the International Energy Agency.

The United States has raised its oil production by half from 2008 to 2013, which is why there is an estimated oil surplus of 1.5 to 2 million barrels globally each day. That is depressing prices – and Saudi Arabians.

But it’s possible that the Arabs are playing a double power game with their cheap oil: On the one hand they hope to force their archrival Iran along with its ally Russia to their knees, while simultaneously destroying the U.S. fracking competition.

The cost of victory could be high: As OPEC’s largest producer, Saudi Arabia is also suffering from the oil glut. But the sheikhs have the advantage of being able to pump oil from their sandy country for a mere $6 a barrel. They also had hefty currency reserves of around $900 billion at the end of 2014.

In the short term, the low oil price strengthens the impact of Western sanctions on Russia.

In other words: Riyadh can afford an oil war and at the same time hope to gain market share. Because the business is still driven by simple market mechanisms, demand and supply.

“No one expected supply to expand to this extent,” said Daniel Yergin, a U.S. energy expert. The hike comes at a time when the global economy is struggling. Mr. Yergin said conspiracy theories that Saudi Arabia and the U.S. are working together to push down the oil price to hurt Russia are unrealistic. Rather, he said, the plunge in the oil price is partly due to stagnating growth in China and Europe. The IMF recently reduced its  growth forecast for 2015 to 3.5 percent – despite the cheap oil flood.

Meanwhile on the demand side, fracking, fueled by new technologies, has catapulted the United States to the top of the list of worldwide oil producers. In 2013, the United States still came in second after Saudi Arabia. American soil yields 11 million barrels per day now.

In addition, the civil wars in Libya and Iraq have affected local oil production far less than expected. So it’s not surprising that the oil price is plummeting in the face of fundamental oversupply.

What is surprising, however, is how fast and far it has plunged. Conspiracy theories are almost as popular as oil itself.

The same was true during the first oil crisis, when on October 17, 1973, six Arab oil producers hiked the quote for one barrel by 70 percent overnight while curbing their output. A year later, the oil price doubled again. Since then, other oil producers like Iran, Russia and Venezuela have used the power of commodity time and again to put pressure on Europe and the United States.

In 2007, at an OPEC meeting in Vienna, Iran’s then President Mahmoud Ahmadinejad and  Venezuela’s Hugo Chávez wanted to close the oil tap. Their plan fell through because of resistance from the Saudis, who did not want a new oil shock. In return, the European Union put an embargo on Iranian oil in 2012 to pressure Tehran in the dispute over the country’s nuclear capabilities.

Such tit-for-tat gestures have rarely had a lasting effect on the global market – this still requires Saudi Arabia. But according to Ali al-Naimi, Saudi Arabia’s oil minister, the country prefers prices which are “predictable and fair.” After all, using oil prices as a weapon can work both ways.

After the two oil crises, Western countries started tapping new sources in the North Sea and the Gulf of Mexico, minimizing their dependence on the sheiks. What followed was an expansion of nuclear energy and a boom of renewable power sources like wind, water and solar energy. Saving energy has also become increasingly popular in the West – and a worry in the Middle East.

The Saudis depend on the high and rising revenues from oil to maintain their domestic regimes and resource deliveries. “If the oil price stays low in the long term, some oil-producing countries may face pressure to consider redistribution in order to maintain political stability,” said ex-diplomat Mr. Ischinger.

It is not the first time that the supply of oil outweighs demand. In the past, though, OPEC member states curbed production to stabilize prices. This time, the Saudis protested. “It isn’t in the interest of OPEC states to reduce production,” Saudi Arabian oil minister Mr. Al-Naimi said in November. According to him, it doesn’t matter “whether the price falls to $20, $40, $50 or $60.”

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The ensuing price slump may even strengthen Saudi Arabia’s position in the long term as a much-needed commodity supplier for the industrialized world. “The new strategy chosen by Saudi Arabia includes accepting low oil prices in the short term in order to benefit from higher oil prices in the future – with the goal to not have to surrender any market share to non-OPEC countries,” said Hannes Loacker, an energy expert working for Austrian Raiffeisen Bank International (RBI).

Mr. Loacker said such a strategy is not calculated in weeks and months, but in years and decades, which is part of the nature of a monarchist dictatorship. “It’s a risky strategy, but it might succeed in the end,” he said.

That is why Riyadh decided to maintain a constant output of 30 million barrels per day at last November’s OPEC conference in Vienna.

On the face of it, everything seemed the same as ever at that fateful Vienna meeting: the security cordons, the limousines, the oil ministers.

What had changed was the atmosphere. Gone were the smiles, the poses for photographs, the backslapping. Instead, people were preparing for a showdown. But Saudi Arabia’s Mr. al-Naimi managed to achieve the impossible. OPEC said it would not curb its output – no matter how much the price for the barrel was going to slip. Nobody dared to veto Mr. al-Naimi, who has been holding the powerful ministerial position with the world’s largest oil-producing country for two decades. The other OPEC member states gave in, after all, the Saudis still set the tone in the cartel with their daily output of 10 million barrels.

After the meeting, the oil price continued to plummet. Christopher Bellew of the London investment bank Jefferies said he expects it to fall below $40. It is a long way from $115, the price of a barrel half a year ago.

“In the industry, it's generally accepted that we're in the middle of a price war between the U.S. shale gas producers and OPEC.”

Roland Vetter, Chief analyst, CF Partners

One reason for the tip in demand and supply is a technical revolution nobody dreamed of a few years ago. Fracking has enabled the U.S. to become the world’s largest producer of oil so fast. “In the industry, it’s generally accepted that we’re in the middle of a price war between the U.S. shale gas producers and OPEC,” said Roland Vetter, chief analyst and energy market specialist at CF Partners in London. “Of course, OPEC has an interest in shutting down shale gas.”

The problem with fracking is that it is still expensive compared to oil production in the Saudi Arabian desert. The production methods involved in fracking become too expensive above a certain oil price, despite the latest advances in the technology. But nobody is quite clear on what that threshold is: some say at $60 to $70, others say $50 or $40. Nobody knows for sure yet – but the price slump is the first serious test for America’s young shale gas industry.

The industry is dominated by relatively small companies which will face difficulties if prices stay low, as many expanded during the summer, financed by credit. According to Bloomberg, smaller U.S. oil companies’ debt has doubled to $260 billion since 2009.

Experts call this a global pricing war that was initiated by Saudi Arabia and used by the United States to fight enemies such as Iran and Russia.

“The Saudis, who have low production costs, are deliberately trying to exclude oil producers with higher costs from the market, reducing investment into shale gas and deep-water offshore subsidies,” said Richard Buxton, manager of Old Mutual U.K. Alpha Funds.

It is unclear how this battle will play out.

“Saudi Arabia thinks it can win any price war with the American shale gas producers,” said Seth Kleinman, analyst at Citi investment bank. But U.S. production will continue through 2015 and 2016, meaning Saudi Arabia will keep paying a high price for this war, too. Shale gas companies’ share prices are falling, but OPEC governments need oil money, too.

“They can deal with a low oil price for a while, but definitely not forever,” Mr. Kleinman said.

Biggest Oil Users-01

 

The United States’ new status as an oil power has consequences for the powers in the Middle East – they face the potential loss of a major buyer and a guarantor of order in one of the world’s most dangerous regions. As a country surrounded by failed states such as Syria, Iraq and Yemen, Saudi Arabia is interested in its long-term partner, the United States, maintaining stability in the region.

The Saudi royal family faces two worlds – a modern one which they project to the outside world and a traditional one inside the country where everyday life is ruled by Shariah law.

Without the support of the United States, Saudi Arabia would be alone in its rivalry with Iran, the second-largest oil power in the Gulf and protector of the Shia community. The countries are arch rivals.

Saudi Arabia is in a stronger position, thanks to currency reserves and enormous investment by the Saudi Arabian Monetary Agency. But the king has invested billions of dollars in building industrial cities, modern hospitals, universities and apartment buildings after the Arab Spring in 2009. He also initiated construction of the world’s largest skyscraper – Kingdom Tower in Jeddah.

To maintain such luxury for everybody, Riyadh needs a balanced budget, which requires an oil price of $101, experts say. That puts pressure on Mr. al-Naimi, Saudi Arabia’s oil minister. The public oil company, Saudi Aramco, has already stopped a $530 million Shoaiba power plant project. Other projects are also being reconsidered.

These should only be minor interruptions in the modernization of the Gulf States, according to John Sfakianakis of British investment group Ashmore. He doesn’t expect Saudi Arabia’s modernization path to stop any time soon.

“Saudi Arabia is just like Qatar, Kuwait and the United Arab Emirates – it can live with a low oil price in the medium term. We don’t expect any mega projects to stop,” he said.

Nonetheless, in Saudi Arabia, there are hopes that the oil price will rise again soon. This is possible. It is still a limited resource, said Fatih Birol, chief economist of the International Energy Agency after the release of the latest World Energy Outlook in London.

OPEC’s general secretary Abdalla el-Badri believes strongly that the oil price will change. “The price will not drop to $25 or $20,” he said. “We have seen this several times. Prices fall quickly and rise slowly.”

Claudio Descalzi, chief executive office at the Italian energy firm Eni, thinks the oil price may soon rocket following the present low phase and that it could reach up to $200. This would be a new oil shock, he said, which would shift geopolitical power again, bringing older and newer powers back into business. Europeans would lose out in this game.

 

Handelsblatt’s Mathias Brüggmann, Carsten Herz, Till Hoppe, Moritz Koch, Torsten Riecke, Hans-Peter Siebenhaar all contributed to this article. To contact the authors: brueggmann@handelsblatt.com, hoppe@handelsblatt.com, koch@handelsblatt.com, riecke@handelsblatt.com and siebenhaar@handelsblatt.com.

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