By Paul Sterne:
Every seasoned oilman knows that supply is more important than demand. Supply can be controlled; demand cannot. Throughout history, the oil industry has swung violently from glut to dearth as supply and demand have oscillated around the market equilibrium. At its core, today’s glut is due to the new technology. Fracking has opened up new fields and increased the reserves of existing fields. Plus improvements in deep sea drilling and oil sands extraction have exacerbated the oversupply.
In the past, OPEC would have solved the problem. OPEC, whose members control 81% of worldwide oil reserves, would have cut production and brought supply back into equilibrium to support higher prices. Last year, to the surprise of all participants in the industry, Saudi Arabia, the swing factor in the OPEC, refused to cut production and caused global prices to collapse from a high of $110 per barrel in February 2014 to the current price of $37 per barrel, a decline of 66%. Talk about the great short!
Incredibly, no billionaire has stepped forward to boast that he saw it coming and profited from it. This lack of prescience is attributable to the fact that Saudi Arabia acted irrationally – and it is impossible to predict irrational behavior. To protect its long-term market share, Saudi Arabia decided to let oil prices collapse even though they as the world’s largest exporter would suffer the greatest loss. The effect of lower oil prices has been so pronounced on Saudi Arabia that the kingdom has had to liquidate a material portion of its foreign currency reserves and sovereign fund assets as well reduce subsidiaries on domestic gasoline to cover its fiscal deficit.
Saudi Arabia’s behavior – its refusal to cut production again at the December OPEC meeting – has opened the door for another ‘swing producer’ to take leadership of the global oil industry. There are only two possibilities: the United States or Russia. Due to the fragmented structure of the US oil industry – 47% of production is by small uncontrollable independents – the United States is not in the position to lead. Only Russia with its state monopolies could replace Saudi Arabia.
Russia is also well positioned to wrestle control of the oil market from Saudi Arabia because of its Shiite alliances. Russia has aligned itself in the Middle East with Shiite powers – Iran, Iraq, Syria and, by extrapolation, Hezbollah in Southern Lebanon. If Russia were to coordinate its efforts with these major oil producers (who together represent about 20% of global production), it would not be difficult for this collective to cut production by the 2-3 million barrels per day needed to bring global production back in line with demand. Giving up 2-3 million barrels of market share seems a reason “give” to “get” a substantial increase in global oil prices as well as take control of the world’s most important commodity.
If Russia were to make this move, it would mark the end to the Age of Saud — the period since the first oil embargo in the 1973 in which Saudi Arabia with its oil power and riches has dominated global geopolitics. The consequence of such a move would be far-reaching and probably lead to a major conflict in the Middle East between the old Cold War, pre-9/11 “East and West”.
I tested this idea on a friend who is knowledgeable about the inner working of the Russian oil industry. He agreed that forming a Russ-Shiite OPEC made sense, but cautioned the Vladimir Putin may not actually have the power to cut Russian oil production for the sake of geopolitical power.
— Article first published in The Ground Report