The Threat of Oil

As sanctions against Iranian oil are ready to begin to disappear, market analysts wonder how low the price per barrel will go.  Some say that the mid-$20 range is likely, but some calls go as low as $10 a barrel.  The price has already breached the $30 firewall, dropping to $29.73 for a time before rebounding to $31.  Iranian oil could send prices much lower, which is a threat to the economies not only of Middle Eastern countries but also producers as far away as Latin America.

Iran is desperate for the capital at any price, and thus is committed to selling its oil even if it has a ruinous effect on other economies.  But the dropping price of oil is as much a strategy of Iran’s enemies as it is a consequence of Iran’s own weak economic situation.  Saudi Arabia in particular has much to gain in its regional conflict with Iran by riding out low oil prices, which work against Iran’s weaknesses.

The fact is, Saudi Arabia is at a disadvantage when it comes to a military showdown with Iran…. While the Saudi economy is more heavily reliant on oil than Iran’s, its foreign exchange reserves are far higher and its sovereign wealth fund owns far more assets. It also still has the untapped option of issuing bonds — it has the world’s lowest GDP-to-debt ratio (under 2 percent) and a high credit rating. Most importantly, Riyadh is already taking steps to inject more funds into government coffers…

Iran, on the other hand, does not have as many options. It’s already in the midst of a subsidy reform plan and, unlike Saudi Arabia, already taxes its citizens. Raising taxes is difficult when inflation is high (16.2 percent) and unemployment is in the double digits (10.4 percent). The oil price necessary to balance Iran’s budget is much higher than the price needed to balance the Saudi budget; the Iranian oil sector is in need of development after more than a decade of sanctions.

The Saudi strategy is nevertheless going to play hell with the fringe members of OPEC.  The core Middle East producers are backing the Saudi play, which CNN describes as a strategy to pursue “market share over prices.”  In fact, it is a cold war strategy designed to cripple a would-be regional hegemon that is a danger to the internal stability of all of these core Middle Eastern producers.  Nations are nearly always willing to accept costs in exchange for victory in war.  To understand the economic strategy in mere market terms is thus to miss the main action that is driving this move by Saudi Arabia and the core producers.

The destabilizing effects of this strategy, made necessary by the Iran deal’s inflation of Iran’s regional ambitions, will be felt across the globe.   Not only will the strategy seek to curb or even cripple the Iranian economic recovery imagined by the Iran deal proponents, it will further damage an oil market already suffering from a Chinese economic slowdown.

Low oil prices are hurting Latin America’s exporters. Mexico’s state-owned oil company Pemex has… borne the brunt of government spending cutbacks. And the much-anticipated first auction of Mexico’s offshore oil resources following a historic liberalization of its energy sector produced disappointing results, as low oil prices scared away bidders.

Brazil has fared worse. Compounded by a colossal corruption scandal, Brazil’s Petrobras is drowning in debt as oil prices have plummeted….

But no oil producer is in deeper trouble than Venezuela. The Maduro government needs oil prices well over $100 per barrel for its budget to break even… Venezuela is suffering from the highest inflation in the world, a crime rate that could be the worst in the Americas, and ordinary people are struggling to find basic foodstuffs and household items.

Even at the high end of the price point scale being suggested by analysts, Venezuela will be getting only a fourth of the price it needs for its oil economy to break even — not to make a profit.  The effect of ending sanctions on Iran may well be the economic collapse of already suffering nations in the Americas.

If so, there is little doubt that Iran will make use of the chaos it has created.  By blaming the low oil prices on Saudi Arabia rather than on its own glutting of the market, Iran can leverage anger in Latin America to further expand its infiltration.  Iran’s Quds Force has already developed ties in Venezuela, and has been seeking deeper ties with Mexican cartels.  The ending of sanctions is widely expected to lead to an increase in terror funding by Iran, including in Latin America.

The oil strategy by OPEC’s core Middle Eastern producers may have the effect of restraining Iran somewhat closer to home, but increasing its danger abroad.  Especially in the Americas, the introduction of Iranian oil to world markets promises to be dangerous and destabilizing.