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Politics Will Dictate Higher Oil Prices
With world oil markets showing increasing volatility over the first few months of 1998, investors around the world have been left frustrated in their seemingly futile attempts to predict the future price of oil. One needs only to look as far as the world of international politics for a glimpse into what the future holds for the world oil market. Analysts worldwide have looked at many factors when considering oil prices, but have overlooked the involvement of both domestic and international politics in the equation. When OPEC members, and other cooperating nations such as Mexico, announced they would work together to reduce world oil supplies, the markets reacted positively and oil prices rose sharply. Since this event, oil prices have fallen back amid concerns that cooperation will be difficult and oil production may not be cut back enough to cause prices to rise substantially. The debate surrounding the issue continues to rage on, yet no one seems to be able to develop a hypothesis that can predict the future movement of oil predictions. By using an analysis of domestic political issues, such a hypothesis can be formed and the future of oil prices can become much more apparent.
The political situation within several key OPEC members will dictate higher oil prices in the future. One important thing to remember when studying the politics of oil is the fact that OPEC members are a cartel. They have, and will continue to work for, common goals and mutual interest. The collapse of oil prices can be largely attributed to the breakdown of this cartel. When members begin overproducing and selling oil at reduced rates, the cooperative nature of the cartel is diminished, and the strength of the group is considerably lessened. Predicting a turnaround in the mentality that has led to this breakdown in cooperation, and the subsequent breakdown of oil prices, can be an insurmountable task. It is true, however, that this task can be accomplished with an analysis of the factors that will cause this turnaround. An analysis of the situation in OPEC member countries will provide the background information for our prediction of higher oil prices.
SAUDI ARABIA
Saudi Arabia will lead the move towards higher oil prices. With its standing as OPEC's most powerful member, the political leadership in Saudi Arabia has come to grips with the fact that their domestic political situation, as stable as it may seem, cannot afford the shock of prolonged weak oil prices. For years the kingdom has enjoyed oil revenues which have provided a cushion against the economic realities of the outside world. The massive oil revenues have allowed for many government-subsidized jobs and an economic system that is built on oil and little else. There are two main factors that will provide strong motivation for the Saudis to do everything in their power to raise oil prices. Firstly, the health of King Fahd, despite reports to the contrary, appears to be declining rapidly. His brother, Crown Prince Abdullah, has recently assumed control. This development, often overlooked by analysts, is a key one. The Crown Prince is banking on a smooth power transition should King Fahd pass away. The decline in oil prices has crippled the Saudi government and its heavily subsidized economy. Should the government cut services, jobs, education and other services, the likely source of criticism for this action would be Crown Price Abdullah. The Crown price could be faced with civil unrest and declining popularity should oil prices remain where they are. This could be devastating to his political goals and his political legitimacy. The second domestic factor, which will motivate the Saudis to raise oil prices, is the combination of a population boom and a sagging non-oil economy. The population of Saudi Arabia is expected to double in the next few decades and with an under-performing non-oil economy, the possible economic disaster that could be forthcoming is clear. The government needs increased oil revenues now, not only to service the needs of the population, but to ensure their market reforms are successful in establishing an economy that can create enough jobs, outside the oil sector, to meet the needs of the nation. With oil accounting for nearly 40% of the nations Gross Domestic Product, the Saudis must act soon to raise oil prices, or be faced with hardship both now and in the future. As well, increasing tensions among its citizens who are accustomed to high standards of living and services provided by their leaders must also be considered as a motivating factor.
INDONESIA
The situation in Indonesia is perhaps the most grim of all the OPEC nations. If there is a source of political will for higher oil prices, it will be Indonesia. The headlines of world newspapers have shown the devastation caused by both the decimation of rupiah and the decline of oil prices. With budget and IMF reform conditions based on a target of $16 dollars a barrel for oil, the conditions in Indonesia are declining further with each drop in oil revenue. Already, reports of political unrest, attacks on foreigners, riots, and looting of foreign businesses are making headlines. Recent United Nations reports have also shown that starvation and famine are also becoming a concern in Indonesia. The only good to come from this misery is that it will provide the political will needed to force Indonesia to work with OPEC members to slash oil production. President Suharto will most likely use any means at his disposal to gain the support of his allies within OPEC to make immediate production cuts. Again, the cartel mentality of OPEC should provide the support required so that a key member does not lose complete control of their nation and economy. Investors should look for other OPEC members to be in discussions with Indonesia as they look for a solution to low oil prices, which would save Suharto and the Indonesian government from revolt or civil war.
VENEZUELA
The effects of low oil prices in Venezuela, combined with the wrath of El Nino, have left the Venezuelan economy in dire need of assistance. El Nino has hurt Venezuela in two ways. The weather phenomenon has provided much warmer winter temperatures throughout North America, which is a Venezuela's key export market for oil. This winter, United States used approximately 500,000 fewer barrels of oil a day than they normally would. El Nino has also crippled agricultural production throughout Latin America. This devastation has been felt particularly in Peru and Ecuador, but its effects have been seen throughout the region. The weather phenomenon has caused a decrease in agricultural output, and an increase in prices for the goods that are being produced. The overall effect has been a severe downturn in the economy. The government, as many other OPEC nations have, based their economic plans on oil prices that were at $16 dollars per barrel. The realities of current prices have forced the government to make drastic spending cuts just to maintain their fragile economic goals. This year alone the government had to cut almost 400 million dollars from the national budget simply due to losses incurred from low oil prices. The reality is that the government will be spiraled back into a situation of high inflation and runaway debt, which it fought so hard to control over the last five years, if oil prices do not rise. There will be considerable political will in Venezuela in the near future, which will drive the government into real cooperation with OPEC and drive a cutback in oil production in Venezuela, as the long- term health and stability of the nation depends on this.
OTHER KEY NATIONS
Other less-powerful nations may also provide some of the political will that will cement the deal to cut oil production. Nations such as Kuwait and Iran will also face domestic political turmoil should oil prices continue to sag. The reality in Kuwait is that the government depends on oil revenue for 90 percent of government income. The national budget in Kuwait has been cut by a devastating 25 percent. Most nations would be destroyed by such an income loss. Kuwaiti oil has sold for around $10-11 per barrel, compared to prices of $17 dollars a barrel in November. The pressure put on OPEC members to cut production and raise prices will be key in brokering a deal.
The Iranians are also looking to put pressure on major OPEC powers to stabilize prices and help their economy. Iran loses almost $1 billion dollars in national revenue for each dollar the price of oil declines. With an already fragile economy and less than stabile political support for new President Khatami, Iran could headed for more domestic political turmoil. The government has taken measures such as doubling the tariffs on imported goods as a means of saving their economy. The already weak Iranian economy has been forced to come to a grinding halt, thus nixing any plans for an economic resurgence and reintegration into the world economy. One factor that is encouraging for investor is that President Khatami has enjoyed good relations with Crown Prince Abdullah, who is much more "pro-Arab" than his brother King Fahd. The result could be an avenue for Iranian voices to be heard by the leader of OPEC. The urgency in Iraq should help facilitate political will in Saudi Arabia.
CONCLUSION
The upward trend in oil prices should begin very soon. The main problem with OPEC discussion on cutting output has centered on the fact that there has been little political will among members to accomplish this task. There is a desire to see higher prices and cut production, but there has been little done to back these intentions with political actions. The result has been a series of promises, ideas, proposals and commitments, without any concrete action. This has led speculators to believe that it will be difficult for OPEC members to cooperate and find a solution to weak oil prices. As the cuts in services, funding for major projects, healthcare and rising unemployment become more and more evident in OPEC nations, so will the political will to work together on the crisis at hand. Often in politics, real political will does not kick in until the eleventh hour, when the crisis reaches a boiling point. One need only look back at the recent crisis in the Middle East between Iraq and the United States. Very little action to solve the problem was taken until the bombs were ready to drop. Once it became very clear to all involved that the crisis was reaching a head, the political will to solve the problem came through. The low-level negotiations between Iraq and the United Nations stopped and so did the futile efforts of the Russian diplomats. Instead, Secretary of State Madeleine Albright began visiting Arab nations personally, and high level negotiations backed by tremendous amounts of political will, were used to avert a possible military conflict. Investors will soon see much more powerful political figures from OPEC nations meeting to discuss the crisis as more and more devastation befalls their economies. This will lead to definitive action on oil production cuts and a real up-trend in oil prices towards the middle to end of 1998.
Dennis |
