Oil Prices: This Could Break the Energy Market in 2016

Oil Prices: This Could Break the Energy Market in 2016Will This Spell the End of OPEC?

The International Monetary Fund (IMF) fears that the increased oil supply resulting from the lifting of sanctions on Iran could put pressure on global oil prices, lowering these by anywhere from $5.00 to $15.00 a barrel.

Although, the futures market may have already accounted for the impact of Iran’s big return to the global oil market, a further decline in prices could materialize with the increase in exports from Iran. (Source: “Iran’s market return could sink oil prices by $5 to $15, IMF says,” Fuelfix, December 22, 2015.)

Regardless of how other OPEC (Organization of the Petroleum Exporting Countries) producers react, the fact that relations between Saudi Arabia and Iran are deteriorating rapidly suggests that their respective governments will fail to reach any mutually beneficial agreement. Rather, Tehran and Riyadh will be looking for ways to intensify the economic pain.

Iran has a far more diversified economy than Saudi Arabia; therefore, it is in a better position to withstand the pressure, should oil prices drop to $20.00 per barrel or lower. However, Saudi Arabia is facing increasing budget woes and the low oil price is intensifying political as well as economic risks.

A crisis in relations between the two strongest powers in the Persian Gulf, Saudi Arabia and Iran, would normally have sent oil prices several dollars higher. Rather, on the day after the two countries cut diplomatic ties in the context of a crisis, whose borders and potential effects are not even close to being defined, oil prices rose slightly, only to drop again. The current crisis has, among other things, raised a basic question: just what kind of crisis must occur to push oil prices higher?

Will a burning giant oil tanker in the Strait of Hormuz remind the world of the risks, and therefore the value, of crude oil? OPEC cannot seem to do it; Saudi Arabia has imposed its will on the organization in order to discourage shale and tar sands oil production in North America. The policy has not worked. Prices have fallen too low and the kingdom is too proud and too afraid to concede to a cut in production in order to boost oil prices, doing its regional rival (perhaps its main enemy), Iran, a favor.

All eyes are on Iran. During the presentation of the budget for 2016, Tehran has set its reference crude oil price at $35.00 a barrel. If the Islamic Republic can follow its ambitious production targets, establishing relationships with an extensive network of client countries, it could pose a serious threat to Saudi oil supremacy. In this respect, news that India would be ready to import a large share of its oil supply from Iran (China and South Korea have already agreed to do so) could change the structure in the Asian markets.

Indeed, the quickly growing diplomatic crisis between Saudi Arabia and Iran (whereby Iran has compared Saudi Arabia’s royal family directly to ISIS and is now affecting Bahrain directly as well) could have unforeseen implications for the price of oil and the future of OPEC. OPEC rivals Russia and the United States will surely follow the clash closely from geopolitical and economic perspectives.

Will OPEC Survive 2016?

As traditional oil price factors fail to behave as intended or predicted, there is a multitude of analyses and scenarios, but there are few certainties, with the latest one coming from the IMF, as noted above. What is certain is that 2016 will most likely be OPEC’s year of reckoning, as the very future of the transnational oil-producing countries’ cartel is in doubt.

OPEC has endured almost two years of intense struggle, a veritable civil war, because of Saudi Arabia’s policy to challenge U.S. energy policies. This has left Riyadh badly bruised and King Salman playing chicken with the throne he has inherited from Abdallah, who pursued a more diplomatic line with Iran. King Salman does not intend to reverse course.

Saudi Arabia has closed 2015 with a historically bad budget deficit of about $87.0 billion—unheard of in the kingdom. The country will be forced to cut public spending by some $224 billion. The latest data from the Saudi Ministry of Finance shows that revenues from the sale of crude oil, which account for 73% of the country’s revenue, will drop by 71% to about $115. billion.

Despite the risks, King Salman has not shown any signs of budging and it is hard to say just how many enemies he is willing to make. Saudi Arabia faces Russia’s blatant hostility despite attempts to reconcile, even in the context of Syria and the ongoing civil war. Moscow has tried in every way to smash the Saudis’ plans through its allies, Iran and Venezuela.

Recently, Russian Energy Minister Alexander Novak accused the Saudis of having deliberately destabilized the market by increasing production by 1.5 million barrels per day without consulting anyone, let alone OPEC. While countries whose economies are reliant on oil and gas production are either in or close to being in a recession, the hydrocarbon industry is essential for economic recovery.

Meanwhile, the international scenario and the effectiveness of Saudi policy remains complicated, fueling uncertainty. Indeed, the oil markets remain cloudy at best and the markets have lost all bearings when it comes to oil prices in 2016. Whereas, in 2015, oil companies abandoned major development projects in Alaska and the Bering Sea, generating hundreds of millions in damage, it is also true that the lifting on the export ban for American crude could turn out to be a weapon against Russia and OPEC itself.

Analysts Have Misunderstood Saudi Arabia

One of the main problems, trying to read the oil price tea leaves, is that analysts have misinterpreted Saudi Arabia’s motives. Saudi Arabia is far less concerned by American competition than by damaging Iran and its allies (especially Russia). The clash, as recent events in the Persian Gulf are making clear, is between the Sunni-led (in fact, Wahhabi-led) Saudi Arabia and the Iranian-led Shiite block, with the latter being backed by Russia.

The United States has not taken a clear position between the two fronts, harboring Russia while opening up to Iran on the matter of sanctions and the pursuit of nuclear energy capability. The strains between Iran and Saudi Arabia following the latter state’s execution of the Saudi Shiite cleric Nimr al-Nimr have already caused the break of diplomatic relations between Iran (Shiite and the third-largest producer in the Middle East) and Saudi Arabia (Sunni and the first oil producer in the world).

Moreover, Saudi Arabia’s population includes some 10%–15% Shiites; they are an angry lot, concerned by decades of discrimination and living mostly in the oil-rich Northeastern Province. That fact has failed to inspire the oil markets for the time being, but where there is smoke, there is fire.

Saudi Arabia is the country that actually has gained an ever more influential position within OPEC for the past 35 years, since the Islamic Revolution in Iran, which forced international sanctions on the Persian country. The return of Iran to the global oil markets threatens Saudi Arabia’s leadership (or dictatorship, as some might say) over the organization; this suggests the Saudis are less interested in making OPEC effective.

Iran wants a more balanced price based on lower production, higher prices, and higher earnings. Iran’s push for nuclear capability is related to its oil policy. The idea of using nuclear power plants—or perhaps solar or wind energy, if these ever become efficient—is intended to ensure Iran can produce less oil, so as to then be able to maximize extraction when the price rises, without having to produce electricity.

The execution of a Shiite cleric could trigger riots among the people of Saudi Arabia, which would be drowned in blood. In short, the risk, not yet clear, is that King Salman may have ignited a fuse that could set off a powder keg, which nobody knows how or where it could hit.  Saudi Arabia? Iraq? Bahrain? In addition, what of Pakistan, India, and the Islamic republics of Central Asia; how will Iran react?

The consequences are too horrible to ponder, but while economic indicators and common sense point to oil prices going lower, geopolitical risks suggest they could shoot unpredictably upwards in 2016, threatening oil prices and global peace.

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