December 15, 2015
TSG IntelBrief: OPEC, the Oil Market, and Middle East Crises
Saudi Arabia prevailed at the December 4 meeting of the Organization of Petroleum Exporting Countries (OPEC), engineering a decision not to rein in the cartel’s crude oil production targets. The decision disappointed OPEC’s 'price hawks,' such as Venezuela, Algeria, Ecuador, and Iran, all of which are reeling from the 60% drop in crude oil prices since mid-2014. Saudi Arabia’s key regional rival, Iran, is particularly affected due to the 2014 interim nuclear agreement between Iran and the P5+1 (United States, Britain, France, Russia, China, and Germany) that keeps in place international sanctions that have capped its oil exports at 1.1 million barrels per day. Iran, therefore, cannot recoup a price drop through increased export volumes. Prices fell further after the OPEC meeting to seven-year lows, well below $40 per barrel.
The Saudi refusal to reduce production reflects a strategic decision to let prices fall and hopefully drive fledgling U.S. shale oil producers out of business. These producers require oil prices of nearly $50 per barrel to remain viable and have access to credit. The Saudis are calculating that a price drop now will drive U.S. producers out of business, at which point U.S. oil production would not be a major factor when worldwide demand increases and prices start to recover. The Saudi strategy appears intended to acquire as much market share as possible for Saudi Arabia and its GCC allies before Iran returns to the oil export market full force early in 2016 as sanctions are lifted under the P5+1-Iran nuclear deal (Joint Comprehensive Plan of Action, JCPOA). Iran’s oil exports will no longer be capped as of 'Implementation Day' of the JCPOA—the point at which Iran is deemed to have complied with its main JCPOA nuclear commitments. The GCC countries have relatively small populations and large foreign exchange reserves, enabling them to ride out a prolonged oil price downturn much better than can the much larger Iran or non-OPEC producer Russia.
However, the International Monetary Fund has warned in recent reports that Saudi Arabia, Kuwait, and, to a lesser extent, the UAE and Qatar (the four GCC countries that are OPEC members) could be miscalculating. All have large foreign exchange reserves of well over $600 billion each, but all are nearly entirely dependent on oil energy exports and all are running significant budget deficits. The IMF estimates that Saudi Arabia, whose financial reserves are decreasing particularly rapidly, might exhaust its reserve funds within five years unless it reduces expenditures and diversifies its economy.
Saudi decisions are not based purely on economics but also on regional strategy. The anticipated oil price declines are intended not only to hurt U.S. shale producers but to strategically weaken two key Saudi rivals—Iran and Russia. Both are militarily supporting President Bashar al-Assad of Syria, who Saudi Arabia insists must leave office as part of a political transition to end the country’s civil conflict. Iran is estimated to be spending about $1 billion per month to support Assad, a very large amount given the enormous effect international sanctions have had on its economy. Russia’s economy—which has failed to diversify significantly from energy and material exports, and which is also affected by sanctions stemming from its intervention in Ukraine—cannot indefinitely afford the large expenditures Russia is making in its direct military intervention in Syria. Further price declines could, in the Saudi view, cause Iran and Russia to accept that Assad cannot be part of a political transition in Syria. Assad’s departure would, in the U.S. view, pave the way for the formation of a unified Syrian government and military that could partner with the U.S.-led coalition against the so-called Islamic State. The Saudi strategy for Syria is predicated not only on harming Iran and Russia economically, but also on keeping non-Islamic State rebel groups amply supplied with U.S.-made TOW anti-tank weaponry that has proved devastating against the forces of Assad, Iran, and Iranian-supported forces such as Lebanese Hizballah and Iraqi Shi’a militia fighters. Saudi oil strategy could also be intended to weaken Iran’s influence on the government of Iraq, which, like Saudi Arabia, has been increasing its market share of crude oil exports. The Shi’a-dominated government in Baghdad is a U.S. partner against the Islamic State, but it faces growing political pressure from Iranian-supplied Shi’a militias and their commanders to ally more closely with Tehran and Moscow.
Weakening Iran’s economy is also intended to help Saudi Arabia prevail in another key conflict—this time in Yemen. There, Saudi Arabia is leading an Arab coalition, logistically supported by the United States, against Zaydi Shi’a Houthi forces that are armed but not necessarily controlled by Iran. The introduction of Arab ground troops against the Houthis has pushed them back and apparently paved the way for talks between the Houthis and the government of Abd Rabbuh Mansur al-Hadi. The two sides agreed to a one-week ceasefire beginning Monday December 14, ahead of talks to begin next week.
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