The Next Oil War May Be Nearer Than You Think

Last month, Saudi King Abdullah (1924 – 2015) passed away, aged 90. The late King’s successor is his half-brother, former crown prince Salman, aged 79. Oil markets are calm for now; but for how long? That’s an investable question.

Saudi Succession Moves Markets… Nowhere

What does Saudi succession mean for energy investors? The short version is that we’ll likely enjoy low-cost oil, for a little while — my hunch is about six months or so. But, by this coming summer, stand by for petroleum drama, because risk factors are rising every day. Oil prices are headed back up by mid-year.

Oil prices popped up initially, on news of Abdullah’s passing. When leadership changes in the world’s largest oil exporting nation, traders buy. Later though, oil traded down, following broad trends of the past six months. Here’s that chart.

Evidently, it takes more to move markets than a deceased Saudi king. In another age, not long past, any hint of uncertainty about Saudi leadership would prompt traders to bid up oil. Not anymore; there’s a deep shift in trader and market psychology. What’s going on?

First, Abdullah’s death was not unexpected. Abdullah was elderly, and in poor health. He entered hospital on December 31, with pneumonia. You probably know how these things go. The big surprise would’ve been if the Saudi royal had walked out healthy; but nature took its course. Oil markets saw this coming, I’m sure.

Second, a new Saudi king — above-noted Salman — promptly took over. He’s been around for a while, and is a known quantity. Immediately, Salman stated, “We will continue adhering to the correct policies which Saudi Arabia has followed since its establishment.”

It’s a vague statement, to be sure. Still, the message is one of Saudi unity and policy continuity, at least until further notice. That’s exactly what oil markets wanted to hear. In fact, with the late King Abdullah being ill for much of the past few years, Salman has been a big player in political councils.

Overall, oil markets wanted reassurance, and Salman gave it to them. Price-wise, Salman reassured Saudi oil customers, and a global army of traders, that he would make no sudden, abrupt changes to Saudi oil policy, one way or another. No boat-rocking. Steady as she goes, right?

Now comes the hard part. The new Saudi king has much on his plate. Begin with the issue that, according to the Economist magazine, 79-year old king Salman had a stroke a few years ago; and he suffers from dementia. Hmmm… what could go wrong?

Meanwhile, Saudi is surrounded by enemies that want to take the place down. In that event, all hell will break loose across the global energy complex (more on that below.)

Here’s the takeaway from the new Saudi king. Looking ahead over the short term, low oil prices will persist as long as Saudi policy within OPEC is not to reduce output. And not reducing output — which keeps oil prices down — is the Saudi policy for now.

When Will Low Oil Prices Begin to Rise?

I said “for now,” and I mean it. For NOW!

In other words, enjoy low oil and fuel prices while they last, which will be for about half of 2015. The next six months of global oil supply/demand — and pricing — are pretty much baked into the cake, what with wells flowing, pipelines pumping and tankers sailing. By summer, though, I believe oil prices will begin to rise; it’s a question of how far and how fast. Why do I say that?

Well, many things could move oil prices; and a change in current Saudi oil policy is certainly on the table. What Saudi giveth, Saudi can taketh away, so to speak. In other words, don’t discount the possibility of Saudi policymakers quietly — or openly — tightening the valves to export channels, and firming-up oil prices.

Understand that the people who really run Saudi oil policy aren’t sitting on thrones. Kings don’t micromanage wellhead settings, pipeline flows and tanker loadings from the royal palace. Indeed, when you peek behind the curtain of Saudi oil policy, it’s clear that the bosses are a power bloc all their own.

The current Saudi Petroleum Minister is Ali al Naimi, born 1935. He’s well-educated — PhD from Stanford in economic geology — and well-traveled, savvy and in strong control. Beyond some royal arm-waving, oil policy is al Naimi’s call.

For example, Saudi could run the world oil price back up towards $100 in a big hurry, if its policymakers chose to do so. Markets could shift profoundly in a few days with one very terse, simple announcement from al Naimi… of a million, or 1.5 or even 2 million barrel per day reduction in output.

In that case, oil prices would spike up from the sub-$50 range to $60, $70 and more almost immediately, I suspect. Then move upwards, as the news flowed through. But that’s not Saudi’s agenda; it’s not happening… not yet.

Saudi is running this show, for now; and Saudi’s script is to keep oil markets where they are, through at least mid-year. The new Saudi king won’t change policies that he helped set under the old Saudi king; that’s one of the things that Salman surely told Pres. Obama during the U.S. leader’s brief visit to the Kingdom — to express “condolences.”

I can’t emphasize enough, though, that Saudi oil policies are formed deep within the bowels of that nation’s oil and national security bureaucracy. Mere kings don’t make big, important calls like that. Then, outwardly and publicly, Minister al Naimi says things like, “Let the markets work.”

Yes, of course, “markets.” In oil. I laugh when I hear that, because there are other agendas in play.

Why Did Saudi Drop Oil Prices?

This gets us to the question of what’s behind Saudi leading the charge to lower oil prices in 2014? It’s a combination of factors, all meeting-up at the same time.

  • At the same time, Saudi sends a message of production discipline to other OPEC members. That is, most OPEC players cheat on production quotas, selling “extra” oil — on or off the books — to raise cash. Saudi’s message is that OPEC nations have to get their house in order, and play the cartel-game.
  • Saudi wants to protect its oil industry market share. I believe the Saudis when they say this. Oil from foreign sources — fracking, oil sands and increased output in Libya/Iraq — was taking markets away from Saudi oil. Thus Saudi is waging a low-price oil war to protect its long-term markets and market share.
  • Related to that, Saudi is testing the economics of fracking and oil sands. Saudi will likely keep oil prices down until U.S./Canadian output levels off or begins to decline. If it takes a year — or two — then so be it; but Saudi’s problem is that the nation may not have a year or two. Sure, Saudi has acted to push prices down; but other players are reacting in this great game, as I’ll discuss in a moment.
  • If low oil prices serve to hamstring the economics of Iran (and its nuclear bomb program); Russia (and its support for the Syria regime); ISIS (which has designs on Saudi); and other rogue nations such as Venezuela (a close ally of both Iran and Russia)… then it’s a good day at the office for Saudi policymakers.

Saudi Surrounded

Here in OI, one long-term theme is the “Oil Wars” scenario. That is, Saudi is located in a very tough neighborhood, filled with tribal, ethnic and deep-seated religious rivalries. So while Saudi appears to have everything under control, there are outside forces at work.

Indeed, last week as the late King Abdullah went to his grave, Iranian-backed rebels took over Yemen, directly south of Saudi. Now Saudi is surrounded. Here’s the map.

This map terrifies Saudis. You should worry, too.

That is, Saudi’s long-time rival Iran is directly across the Gulf, to the northeast. Iran is deeply involved in Iraq, to the north; and of course Iran is engaged in Syria and Lebanon. Now there’s trouble with Yemen.

Everything is NOT Fine in Saudi

The bottom line is that, for as much as Saudi wants to transmit a message to the world that everything is fine, the country’s enemies have beach-heads at every frontier. Iran has worked diligently against Saudi for a long, long time. There’s no love lost. Now Iran is setting up for the next phase, which is to destabilize Saudi’s ruling regime.

Meanwhile, much of Iraq and Syria is under control of ISIS, whose leaders are on record as wishing to chop off the heads of Saudi’s royal family. To Saudi’s west, Egypt barely managed to get rid of the hard-line Muslim Brotherhood; yet that movement is still active, working underground.

When push comes to shove in Saudi, the ruling regime will pull out all stops. Everything is expendable in order to preserve the existing ruling class, to include “modernity” and the price of oil.

Right now, as Saudi leadership transitions, enhanced vigilance is the order of the day. For example, last week, Saudi border guards received orders to “shoot to kill” unauthorized entrants along the troubled lines of control with Iraq and Yemen.

As I discussed above, Saudi oil policy is intended to keep up an appearance of stability. Thus, we’ll likely enjoy low oil prices through this winter and spring. But by summer?

Well, as the next six months unfold, more events will occur at Saudi’s periphery that are beyond Saudi political or military control. This is especially the case with old rivalries with Iran. At the rate things are going, it’s going to be a long, hot summer in the oil trading pits.

Best wishes,

Byron W. King
for The Daily Reckoning

P.S. Ever wonder how you can make a lot of money from oil without owning a well? Or whether or not you should buy gold and silver? Or is fracking just a flash in the pan? Get insight, insider scoops and actionable investment tips twice a week with Daily Resource Hunter? Just click here for a FREE subscription!

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Byron King

A Harvard-trained geologist and former aide to the United States Chief of Naval Operations, Byron King is our resident gold and mining expert, and we are proud to have him on board as the managing editor of Whiskey & Gunpowder.

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