Conspiracy theories bring down oil prices
Last updated: Saturday, October 11, 2014 7:03 PM
Syed Rashid Husain
As oil prices go down, conspiracy theories flourish.
When Saudi Arabia announced cutting its Official Selling Price (OSP) recently - and not output - pundits went overboard - underlining the ensuing battle for market share.
Other crude producers were not too far behind. Iran dropped its OSP to Asia for Iranian Light to a premium of 18 cents/bbl to the average of Oman and Dubai crude in October, down from $3.96 in January and the lowest since November 2010. Iraq’s October OSP to Asia was a discount of $2.50/bbl to the same crudes, the lowest level since January 2009. Other OPEC members have also been cutting their OSPs as Brent fell.
And conspiracy theorists are not far behind. As markets went into a free fall many theories kept making rounds -and for obvious reasons. Typically, oil prices start to rise at the sign of the slightest trouble in the Middle East. Not this time!
The entire energy rich Middle East is in turmoil. Iraq, Syria, Yemen, all are in chaos. The very threat of ISIS has already helped galvanize an international coalition. A war is on and the battleground is energy- rich Middle East. The US in close association with its Gulf allies is bombing ISIS hideouts in Syria and Iraq. This would also impact output from areas under ISIS influence. The ISIS has captured oilfields in Syria and Iraq. It is estimated that ISIS earns around $3 million from oil sales. By driving down price, this earning can be driven down as well.
But despite the scary scenario, crude market prices are going down and not up. Why?
One theory circulating says it is in the interest of both the United States as well as Saudi Arabia to let oil prices go lower.
Melting markets could force President Putin - their common foe at the moment - to rethink and lower his geopolitical ambitions. An average oil price of $90 a barrel, close to where prices are now, would already give Russia a budget deficit of 1.2 percent of GDP next year, Sberbank CIB, the investment bank of Russia’s biggest lender, said. Russia will require an oil price of about $104 to balance its budget in 2015.
Oil prices having already plunged to a 27-month low are inflicting damage on Russian economy already contending with escalating sanctions from the US and the European Union. Russia may have to cut spending if oil falls below $80 and stays there, Vladimir Pantyushin, chief strategist at Sberbank says. And that would be difficult for a Moscow with global ambitions.
There is also a convergence of interest between Riyadh and Washington in making Moscow retreat from its offensive on the geopolitical chessboard and change its policy on Syria, Iran and other points of conflagration in the Middle East. Lower oil price also helps the United States and other Western powers neutralize Russia in Ukraine. Many thus see a collusion between Washington and Riyadh on the score.
ISIS which makes $3 million a day out of oil sales could also be another target. A Bank of America-Merrill Lynch report: “Does Saudi want $85 oil” says the recent advances by the Islamic State in Syria and Iraq are leading to a situation where Saudi Arabia is cooperating with the United States to keep oil prices down. Cutting down the funding of ISIS, through oil sales, could well be an objective of the international coalition against the emerging threat.
Falling oil prices are also hurting Tehran, considerably more than other regional producers. Among the Gulf producers, Iran has the highest fiscal break-even price for its budget at over $130 per barrel of Brent, compared with the UAE at around $70 per barrel and Saudi Arabia at about $90, a Deutsche Bank report recently said.
And both Washington and Riyadh have a common interest in holding Iranian nuclear ambitions in check. Fall in oil prices could help them achieve the goal, some now insist.
An added bonus for the OPEC producers could be that a sustained slump in the price of oil could put many drillers and others working the US “tight” oil sector in a tough spot, curtailing production.
A Bank of America-Merrill Lynch analysts was quoted in the media as saying: “With production costs ranging from $50 to $75/bbl at the well head, a decline in Brent crude oil prices to $85 would likely be a major blow to US shale oil players and lead to a significant slowdown in investment.”
A Deutsche Bank analysis says, “tight oil” in North America is unlikely to attract investment at a cost of $90 per barrel. The German investment bank estimates that if OPEC fails to cut production in response to the current trend in falling oil prices then around 9pc of US “tight oil” output would be immediately rendered uneconomic at a level of $90 per barrel. This figure would rise to 39pc should prices slump as low as $80 per barrel.
Indeed the cost of unconventional barrels are considerable higher than the conventional crude barrel in the region. Saudi Arabia is known to incur the lowest cost per barrel, as compared to most of its competitors.
However, conspiracy theorists seem missing out the changed scenario. We are not in the 80s. The cash requirements of Saudi Arabia and the rest of Gulf are going up and not down. Post-Arab spring, public spending too has gone up considerably and all these oil based economies need cash flow - in terms of petrodollars - to sustain the elevated spending.
The IMF is already out with the first warning shots. As oil markets cool, the Kingdom risks falling into a budget deficit next year and may have to tap its reserves, the International Monetary Fund (IMF) warned, in its recent annual consultation paper.
One sign that Saudi Arabia is in danger of dipping into deficit is its “break-even oil price” – the price oil needed for the country to balance its budget. IMF underlined that Saudi Arabia’s breakeven price has risen to $89 a barrel in 2013 from $78 a barrel in 2012.
“This expenditure path and lower oil revenues lead to an overall fiscal deficit in 2015, which is expected to deteriorate further to almost 7.5 percent of GDP by 2019,” the fund, the 54-page dossier said.
Riyadh could not be oblivious to all this.
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