December 21, 2014

Sinking oil: Saudi Schadenfreude

Sinking oil: Saudi Schadenfreude

Saturday, 20 December 2014 | Rohit Pattnaik | in Oped

Using lowering oil prices as a tool, the Saudis are seeking to arm-twist Russia and Iran for their support of Bashar Assad's regime in the Syrian conflict

Daily Pioneer: Leading News paper 

Many oil exporting states across the globe that had built their budgets on visions of perennially high oil prices are beginning to press the panic button as oil prices continue to remain well below the fiscal break-even for many of these countries. Many Governments in oil exporting countries will face a difficult time in financing the populist programmes that they need to maintain public support, hence there will be pressure from many OPEC members to curtail production to arrest the decline of oil prices.

In the game of oil roulette, the Saudis are unlikely to cut oil production for the simple fact that in the 1980s when they cut production as part of the OPEC cartel, they lost a huge portion of their market share, without affecting global oil prices. It is the past precedent that has probably resulted in less confidence that production cuts by the Saudis, the largest oil exporter in OPEC, would have a desired impact. With global demand slowing, it is highly unlikely that OPEC could cut production for the near-term.

There are reports that Saudi Arabia and OPEC are trying to squeeze US Shale oil producers who require higher prices to remain competitive vis-a-vis conventional producers out of the market. New exploration techniques have allowed America to surpass all but Saudi Arabia in crude oil production. Lower prices put the viability of higher cost oil wells in jeopardy and many weaker firms are likely to stop production or even exit. Such a ploy could be foolhardy and boomerang badly on OPEC as recent report has emerged that with greater technological prowess, US Shale oil production for many producers is likely to remain viable at $50 per barrel.

Saudi Arabia and its oil exporting West Asian allies differ from other global producers in the cost of extraction for many of their wells, which is low even at current prices, meaning that they will be able to produce profitability at current or even lower prices. It is estimated that Saudi Arabia needs oil prices at $99 for break-even, but it has a $750 billion reserve along with non-existent debt. The Saudi budget is laden with big infrastructure projects which could be cut if necessary. It is clear that it can weather low oil prices and wait for new market dynamics to emerge. Iran and Iraq, according to an IMF report, need oil prices over $100 per barrel to balance their budgets. Iran has been facing declining production on account of sanctions and so declining oil prices impacts it more.

Previously, high oil prices ensured that the Arab monarchies were fortunate in keeping at bay the political turmoil that affected many of the countries in North Africa and West Asia by increasing public spending significantly. Although it has significant reserves, Saudi Arabia will be keeping a close eye to prevent any social spillover due to low oil prices in neighbouring Bahrain. Any financial difficulties notably among its dynastic neighbours could lead to political instability across the region. While currently all appear to be in good financial health, the strain of low oil prices could begin to emerge in a year and as the Arab Spring events demonstrated, a small problem could easily turn into a significant trouble for the political system. A further decline in crude prices could have global ramifications, though it is Venezuela and not any West Asian nation that could be impacted first.

Aware of the instability that low oil prices mean for the region, the recently held Gulf Cooperation Council (GCC) meet also sought to underline greater unity among the Arab monarchies amid the emergence of ISIS and other jehadi organisations coupled with the impact of declining oil prices on national budgets. A decline in public spending could erode support for the Government and give ISIS more opportunities for growth in a region racked by extremism.

Despite the decline in oil prices, the Saudi-led GCC will extend political and monetary support to stabilise Egypt and Libya, two countries that are threatened by Islamists. It is highly likely that the GCC will become increasingly involved if the security situation in Egypt and Libya deteriorates further. Air strikes conducted by UAE against forces allied to the extremist Fajr Libya, which is opposed to the al Thinni government, are an indicator. In a significant move the GCC has announced the formation of a regional police force and naval force. The GCC security meet also highlighted state meddling in the GCC by neighbouring powers such as Iran and Turkey, which clearly is likely to ratchet up tension in a highly combustible environment. Even a meeting of the Saudi Crown Prince and the Iranian President to settle a host of issues ranging from oil prices to the fight against ISIS did not achieve much, due to Saudi distrust of Iran's nuclear ambition.

In a law of unintended consequences, the declining oil prices have given Saudi Arabia some leverage in the shadow jousting between itself and Iran across West Asia, even as both battle a common foe — ISIS. Beneath the veneer of fighting ISIS, there appears to be a game of supremacy between Iran and Saudi Arabia in the region. After the US invasion of Iraq in 2003, Iranian power has been on the ascendancy across West Asia. The Arab states across West Asia have been watching warily Iran's nuclear ambition, its control over Iraq, its alliance with Syria and its leverage over Hamas and Hezbollah. Saudi actions in ensuring low oil prices have meant that Iran will take an economic hit as it currently remains under sanctions. Using lower oil prices as a tool, the Saudis are seeking to arm-twist Russia and Iran for their support of Bashar al-Assad's regime in the Syrian conflict. While Saudi Arabia and its Arab allies armed many of the Syrian rebels, Iran and to a minor extent Russia, by providing weapons and funding, have kept Assad in power. It is clear that the Saudis are perfectly content to see Iran and Russia struggle domestically on account of declining oil prices. Saudi Arabia would prefer the current status quo, in which it has gained greater leverage rather than do a course correction, by cutting oil production and aim to raise crude price.

Lower oil prices are likely to have significant ramification across West Asia as it means that GCC will have to take on greater responsibility to ensure that the fiscal woes of the weaker monarchies does not lead to political instability. Declining oil prices are unlikely to lead to a divergence in Iranian policies, but careful calibration between Saudi and Iran could ensure that jehadis do not gain traction as national budgets are pruned across the region, even as both play Weiqi in the region.

(The writer is a commentator on West Asia)

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