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The Real Reason for the Oil Meltdown

Written By Briton Ryle

Posted January 28, 2015

The price of West Texas Intermediate light sweet crude oil rebounded slightly yesterday to close at $46.23, bouncing off of Monday’s low of $44.35 – its lowest level in nearly six years since April of 2009.

Why the optimism in the oil trading pits?

“There’s a bit more optimism in the markets based on the idea the Saudis may be doing something perhaps soon,” Carl Larry, a consultant at Frost & Sullivan in Houston, informed Market Watch. “Not a definite sign, but a hopeful sign.”

Larry was referencing Monday’s statement by Abdallah el-Badri, OPEC’s secretary-general, who indicated he believed “prices around $45 a barrel to $55 a barrel are likely the bottom for crude,” Market Watch noted.

Is Saudi Arabia – who until recently was adamant it would not reduce its oil output – having a change of heart? Might it and other OPEC nations cut their oil production to allow the oil price to stabilize and perhaps rebound higher from here?

Not a chance. There is good reason to expect oil prices to remain low for a few years more. What is that reason? It depends on to whom you listen. There is an official story that accounts for low oil prices, and then there is the conspiracy theory. Let’s start with the boring one first.

Story #1: Rift Between U.S. and Saudi Arabia

The official story behind the plunge in oil prices is all about an oversupply of oil and gas on the global market.

“The American Petroleum Institute (API)… said after the market’s close that U.S. oil stockpiles surged by nearly 13 million barrels last week,” reports Reuters. “Stockpiles rose by 4.1 million barrels, on average, in the week to Jan. 23. That would add to the previous week’s build of over 10 million barrels, the biggest in 14 years, which had already brought inventories to the highest level on record for this time of year.”

Oil traders were actually quite surprised at oil’s pop upward on Tuesday. “Given the expectations in supply, it’s kind of surprising to see the market pop this much today,” Andrew Lipow, president at Lipow Oil Associates in Texas, reacted to yesterday’s rise in oil futures prices. “There’s probably some short-covering after the extended selloff we’ve had for weeks now, but I don’t think fundamentally anything’s changed,” he explained to Reuters.

In its December 2014 monthly report, The International Energy Agency noted that “the outlook for global oil demand growth for 2015 has been cut by 230 kb/d to 0.9 mb/d”, and that “a strong dollar and the lifting of subsidies have so far limited supportive price effects on demand”.

In other words, where lower oil prices would normally cause oil demand to rise, the stronger U.S. dollar has been weakening the currencies of most nations around the world, slowing their economies and thus reducing oil demand. Making matters worse, oil exporting nations are no longer bringing-in as much revenue as before, and have been forced to reduce their fuel subsidies to their citizens, resulting in higher energy costs for some regions despite the falling market price of oil.

The IEA then draws the demand/supply imbalance for us from 2009 until the start of this year, showing continually rising stockpiles from the middle of 2013 until now (blue).

Oil supply and demand until 2015


Playing-up the oversupply explanation is the “apparent” disaccord between the U.S. and Saudi Arabia, who seem to be blaming each other for the oversupply.

“On Monday, Abdallah el-Badri, the Organization of the Petroleum Exporting Countries’ secretary-general, said oil at $200 a barrel would be possible if producers don’t invest in new supply,” Market Watch reported.

On the surface it would seem that Saudi Arabia is none too pleased with the extensive development of new oil fields in the American mid-west and Canadian prairies, with the row pitting Saudi Arabia and its OPEC brethren against the U.S., Canada, and other non-OPEC oil producers.

“The Saudis and OPEC have a vested interest in taking out higher-cost competitors, such as US shale oil producers, who will certainly be hurt by the lower price,” explains “OPEC’s refusal on Nov. 27 to cut production seemed like the baldest evidence yet that the oil price drop was really an oil price war between Saudi Arabia and the US.”

That, then, is the boring explanation for why oil prices have plummeted and why they will remain low for some time. The U.S., Canada and other non-OPEC oil producers have flooded the market with oil from their expensive shale and oil sands projects, and OPEC wants to squeeze them out of the market by keeping its oil taps turned on full blast to lower the oil price and knock-out its competitors.

Now let’s move on to the real story behind the low oil prices. It’s a classic case of “you scratch my back and I’ll scratch yours”.

Story #2: Collusion Between U.S. and Saudi Arabia

The premise is really quite simple: the U.S. and Europe have serious economic problems on their hands, and Saudi Arabia and other OPEC nations have serious political problems on their hands. So a deal was struck between the two sides to help each other out by flooding the market with oil and suppressing the oil price.

What are these economic problems in the West? Europe, for one, has been stagnating, with negative GDP growth (recession) from Q1 of 2012 to Q2 of 2013, and anaemic GDP growth below 1.5% since then. Inflation in Europe has recently turned negative, with prices now deflating, causing an erosion of wealth for its governments, corporation, home owners and all its citizens. As a result, the European Central Bank has been forced to implement stimulus measures amounting to over €1 trillion over the next 18 months to stimulate growth.

The U.S. may be fairing a little better than Europe, but is now being adversely affected by a strong dollar which lowers the demand for its goods and services, on top of already weak demand from slowdowns in China, India, Latin America and Europe. And though unemployment is falling on paper, in reality the participation rate is falling too, resulting in persistently high unemployment above 8% on a total-workforce basis.

The U.S. is thus in need of stimulating its economy further, but doesn’t have any “magic bullets” left to use. Interest rates are already near zero, and can’t be lowered any further. Re-introducing a monthly bond buying program after just having terminated the last one could spook the markets into a massive sell-off. Besides, the U.S. central bank already has $4.5 trillion of debt on its balance sheet, and can’t afford to take on more.

A drop in oil and energy prices is the next best solution to stimulate the economy. It acts as something of a “tax break” of sorts, helping stimulate growth by reducing business expenses and saving consumers a great deal of money – which they can then spend at their local malls and keep consumerism alive.

What, then, are the political problems that Saudi Arabia and other OPEC nations are contending with? Losing power in the Middle East to the likes of Iran, Syria, Islamic State and other factions in Lebanon and elsewhere, who are together attempting to consolidate their control over swaths of oil rich territories in Iraq and elsewhere.

As explains, “Proponents of this theory point to a Sept. 11, 2014 meeting between US Secretary of State John Kerry and Saudi King Abdullah at his palace on the Red Sea. According to an article in the Wall Street Journal, it was during that meeting that a deal was hammered out between Kerry and Abdullah. In it, the Saudis would support Syrian airstrikes against Islamic State (ISIS), in exchange for Washington backing the Saudis in toppling Assad.”

Why does Saudi Arabia want to topple the government of Syrian president Assad?

Since 2011, Iran, Syria, and Iranian-friendly officials in Iraq had been attempting to strike a deal with Turkey for pipelines that would deliver Iran’s, Iraq’s and Syria’s oil and gas through Turkey and on into Europe. Of course, Saudi Arabia wasn’t thrilled with the idea of competitors having direct and cheap access to European markets.

“The Iran-Iraq-Syria pipeline – if it’s ever built – would solidify a predominantly Shi’ite axis through an economic, steel umbilical cord,” Asia Times illustrated the threat to Sunni Muslim Saudi Arabia.

“The conflict is now a full-blown proxy war between Iran and Saudi Arabia, which is playing out across the region,” Reuters reiterated. “Both sides increasingly see their rivalry as a winner-take-all conflict: if the Shi’ite Hezbollah gains an upper hand in Lebanon, then the Sunnis of Lebanon—and by extension, their Saudi patrons—lose a round to Iran. If a Shi’ite-led government solidifies its control of Iraq, then Iran will have won another round.”

Hence the deal between the Saudi Arabia and the U.S. to keep oil prices down. As summerized:

“The Saudis know the Iranians are vulnerable on the oil price. Experts say the country needs $140 a barrel oil to balance its budget. At sub-$60 prices, the Saudis succeed in pressuring Iran’s supreme leader, Ayatollah Ali Khamanei, to possibly containing its nuclear ambitions and making the country more pliable to the West, which has the power to reduce or lift sanctions if Iran cooperates.”

Low Oil Here to Stay

Hence, a low oil price would help the West stimulate its economies, while also helping its OPEC allies to suppress the might of Iran, Syria, Islamic State and others who depend on oil to finance their expansionist and nuclear ambitions.

Which story do you subscribe to? Is the low oil price simply a result of oversupply? Or is there some secret pact between the West and allied members of OPEC to keep certain “trouble makers” like Iran, Syria and Russia economically suppressed?

Russia too? Yes, Russia too:

“What is the reason for the United States and some U.S. allies wanting to drive down the price of oil?” Venezuelan President Nicolas Maduro asked rhetorically in October. “To harm Russia.” – cites Remember that Russia is still occupying eastern Ukraine, and Europe wants it to get out.

Regardless of which story you opt into, the result is undeniable: oil prices will not return to their +$100 levels for several years. But while investment opportunities may be shutting in some areas of the economy, they will be opening up in others, such as their airlines and other heavy consumers of oil and fuel. Not to mention the broader market indices in general, as corporations slowly begin benefitting from energy cost savings.

Joseph Cafariello