Oiling political & economic wheels

As restrictions are removed on trade with Iran, David Watts examines the changes afoot for the global economy and the Middle East’s volatile political situation.

With the lifting of sanctions permitting Iran to start exporting one and a half million barrels of oil into an already glutted market this month, the new oil war is set to re-shape the world economy and Middle East regional politics in ways unimaginable.

Under sanctions, Iran was producing 1.2million barrels of oil a day and expects to boost that to 2.3million barrels by the end of the month now sanctions are lifted. Tehran will, at a stroke, more than double the amount of excess oil on the world market.

CRITICAL CLASH: In a modern-day version of the Gunfight at the OK Corral, this is a contest none of the protagonists can afford to lose
CRITICAL CLASH: In a modern-day version of the Gunfight at the OK Corral, this is a contest none of the protagonists can afford to lose

Historically, oil price wars have been between the West and the Organisation of Petroleum Exporting Countries (OPEC) as the latter fought to get a better deal for their invaluable product while the West used its collective purchasing power to hold back OPEC’s demands. For the most part, OPEC won the crucial oil wars of the 1970s. At the start of the decade oil was below $3:50 a barrel but the supplier boycott of the West at the time of the 1973 war between Israel and the Arabs launched it on its trajectory to the $100 mark.

Today, OPEC is a busted flush as Middle East oil producers go their own way and the lead producer, Saudi Arabia, pursues a new aggressive and high risk strategy of maintaining high production levels in a market so glutted that several tankers—in mid-transit from the Middle East—have been turned around and sent back to their countries of origin because there was no storage space in the United States for the oil that they were carrying. The growing number of tankers in limbo off American ports such as Galveston is also testament to the state of the world market. Current daily rates for tanker rentals have risen to $76,000 as a result, nearly three times the rate being charged last year, while US oil stocks are at a level not seen for 80 years.

The Saudi strategy is to keep the volume of oil on the market high, the price low and its market share high so that new entrants and re-entrants such as Iran, and especially the shale industry in the United States, are not economic to operate. Already a number of US shale companies have gone out of business and more are expected to succumb in 2016. Most require the price to stay close to the $100 per barrel mark to be viable, while the current world price is hovering around $30 and dipping even lower on occasion.

STATE BENEFIT: Three million of Saudi Arabia’s 5.5millionworkforce are employed by the government
STATE BENEFIT: Three million of
Saudi Arabia’s 5.5millionworkforce are
employed by the government

A key target is also Iran. The Saudis are determined to try and make investment by the West in Iran uneconomic. To do that, it’s estimated that they need to bring the oil price down to $35 a barrel and to hold it there for some time.

In a modern-day version of the Gunfight at the OK Corral, this is a contest that none of the protagonists can afford to lose: the US is determined that the development of its domestic industry must continue to rid it of dependence on the unstable Middle East for its supplies, which the Saudis are equally determined, under a new royal dispensation, to maintain their position as the world’s premier producer and to hold back the re-emergence of their Shia rival Iran.

The scale of the Saudi operation and its impact can be gauged from the reality that none of the world’s top 12 oil producers is currently operating anywhere near break-even point. As the year closed, Kuwait was nearest the mark with $52 a barrel production costs, Libya was well wide of it at $208 and Saudi Arabia itself was producing at $96.

Saudi drivers got an unpleasant reminder of the country’s financial state when they pulled up at the pumps in late December to find that petrol prices had jumped 40 per cent. But with the nation’s heavy government subsidies in place, they were still only paying just over $4 a litre, a fraction of the consumer cost overseas. Still, with pump prices falling in other countries all around the world, it must have come as a particular shock in a country whose citizens are used to being mollycoddled, with even domestic electricity bills being only ten dollars a month even if the air-conditioning is run 24 hours a day.

But reality has now dawned and with oil yielding much reduced revenues the budget can no longer stand the strain of big, new military expenditures, the cost of the war in Yemen and the intervention in Syria, along with 88 billion riyals in generous gifts to citizens to grease the path of the new monarch King Salman. It is estimated that $360 billion has been wiped off Gulf-wide export earnings over the past year and the prospects are poor.

Three million of Saudi Arabia’s 5.5millionworkforce are employed by the government. All received an extra two months’ salary, as did students, soldiers and pensioners, to mark the coronation.

Many of them must now be looking back bitterly at the regal tweet that followed such largesse: ‘Dear People, you deserve more and whatever I do I will not be able to give you what you deserve.’ Much of that extra cash will no doubt now be taken up by paying routine bills as the finance ministry has warned that over the next five years, more and more subsidies will be withdrawn and more government activities taken into the private sector.

But the Saudi populace has come to take for granted such largesse: during the Arab Spring Salman’s predecessor, King Abdullah, gave away almost 500 billion riyals to placate citizens bereft of a say in the running of their country and to secure the continued loyalty of the religious elite.

Thus last year’s deficit ballooned to $97.9 billion, or 15 percent of gross domestic product, as oil revenues fell 23 per cent to $118 billion.

As well as the increase in petrol prices, wealthier citizens will face an immediate rise in electricity prices, an overall increase in water prices and changes to power charges for industrial users. The government is also going to try and implement a plan for a sales tax throughout the Gulf states.

This sudden turnaround in the kingdom’s financial fortunes, after a decade of easy money and easy profits in which governments did not have to worry about the effect on the national exchequer of big payments to keep the national polity calm, comes at a particularly delicate time for the government which is already facing rising incidences of Islamist insurrection in the country with some reports of increasing support for Islamic State.

It comes also at a time when there are increased demands on the kingdom’s budget because of the more adventurous foreign policy of the new government, with its concomitant financial burdens. That includes substantial financial support for the Sisi regime in Egypt, which recently received another $8 billion tranche of assistance.

With the breakdown of the ceasefire in Yemen it is clear that this is one burden that will continue, if not increase, and the war in Syria likewise, with growing pressure likely from Iran’s allies in the contest.

But the biggest financial unknown is the fallout from the newly-heightened tension with Tehran following the execution of Sheikh Nimr al-Nimr, the leading Shia cleric in the kingdom. The breach of diplomatic relations alone is likely to bring extra costs for the kingdom, not to mention potential costs arising from securing the pressure points in the Gulf, where Tehran is likely to make its displeasure felt.

What is remarkable is the reality that the government continues to take on new responsibilities abroad when there are so many pressing problems that need urgent attention at home: already people under 25 make up more than half the population and the forthcoming demographic bulge, according to the consultants McKinsey, predicts that more than 4.5million working-age Saudis will enter the workforce, requiring jobs to be created at three times the current rate.

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