June 3, 2016
TSG IntelBrief: The Geopolitics of Oil
The June 2 meeting of OPEC did not lead to any cuts in oil production, nor signal any imminent agreement with large non-OPEC producers such as Russia to freeze production at prior levels. The outcome of the meeting was precisely the one Saudi Arabia sought, demonstrating Saudi Arabia’s continued dominance within the organization. Three of Saudi Arabia’s Gulf Cooperation Council (GCC) allies—Kuwait, UAE, and Qatar—are among the 13 OPEC members (a 14th member, Gabon, was admitted at the Thursday meeting). Two other members are Sunni-led Arab states, Algeria and Libya—though Libya, in particular, is highly fractured politically. Iran—Saudi Arabia’s regional adversary—represents a rival pole within OPEC, but it has only one consistent political ally in the cartel; the Shi'a-dominated government of Iraq. Newly released from international sanctions, Iran is seeking to increase its revenue rapidly through production increases as well as hoped for price increases for its crude. Iran has advocated for an OPEC strategy that would immediately cause oil prices to rise—a strategy that attracts support from the poorer OPEC members such as Venezuela, which is suffering a severe economic crisis.
The June 2 meeting was not nearly as contentious as an April meeting in Qatar between OPEC and major non-OPEC producers, including Russia. That meeting was characterized by acrimony between Saudi Arabia and Iran, and the latter steadfastly refused to sign onto a draft agreement freezing production levels. Perceiving that longtime Saudi Oil Minister Ali Naimi sought compromise with Iran, Deputy Crown Prince Mohammad bin Salman Al Saud, architect of Saudi Arabia’s intervention in Yemen, subsequently replaced him with Saudi Aramco CEO Khalid al-Falih.
In the context of the June 2 OPEC meeting, Saudi Arabia argued that its strategy is working. After dipping below $30 per barrel in February, oil prices have recovered to nearly $50 per barrel. Saudi officials contend this represents a realization of their forecast that keeping production levels high would drive U.S. shale oil producers out of business and reduce investment in new production more broadly, restoring a supply and demand equilibrium. In the Saudi view, production cuts would not only reduce the Saudi market share, but also benefit Iran and Russia—the two main backers of Syrian President Bashar al-Assad. Iran’s oil exports have nearly returned to pre-sanction levels of about 2.3 million barrels per day, but low prices are limiting the revenue Iran earns from that oil.
Critics of the Saudi approach say that the strategy is hurting Saudi interests. Because of the low oil price, the Kingdom and its wealthy GCC allies have been forced to cut subsidies the governments depend on to maintain support, and have reduced their respective sovereign wealth fund balances. Saudi Arabia and its GCC allies are counting on their healthy reserves to ride out a period of low prices, but the International Monetary Fund (IMF) and other bodies estimate that the GCC states’ reserves will be exhausted within five years at the current rates of depletion. The depletion rate of Saudi Arabia’s reserves has been accelerated by heavy spending on efforts to oust Assad, combat the so-called Islamic State, push back Iran-supported Houthi rebels in Yemen, and purchase new U.S. arms to deter a resurgent Iran. In March, Qatar took the unprecedented step of tapping international credit markets to avoid drawing down its sovereign wealth fund. Saudi Arabia itself is contemplating selling shares of Saudi Aramco to replace lost reserves. No GCC state has diversified its economy to the point where it can remain economically healthy without substantial oil revenues.
Another Arab state reeling from the Saudi oil strategy is Iraq, which is dominated by Shi’a politicians long linked to Iran. Saudi Arabia has been at odds with the Iraqi government not only for its alliance with Iran, but also for its marginalization of Iraq’s Sunni Arab minority. Saudi Arabia accuses the Iraqi political establishment of setting conditions under which the Islamic State has flourished in central and northwestern Iraq. Yet, Saudi Arabia and Iraq are both partners in the U.S. effort to defeat the Islamic State in Iraq and in Syria—an effort that is dependent on the success of the Iraqi government. Iraq does not have a substantial sovereign wealth fund to help it maintain its expenditures, and instead has had to negotiate IMF loans to stabilize its finances. Iraq has also had to utilize U.S.-extended credit to continue to buy weaponry it needs for the battle against the Islamic State, including HELLFIRE missiles. Iraq’s autonomous Kurds, who are in the lead in pressuring the Islamic State around Mosul, have had to delay salary payments to their peshmerga forces because Kurdish oil revenues have shrunk dramatically. Low oil prices also have contributed to significant demonstrations in Baghdad that are distracting Prime Minister Haider al-Abadi and the Iraq Security Forces from the anti-Islamic State mission.
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