Comment | Iran, Saudi Arabia, and a Global Game of Risk
by ANDREW SCOTT COOPER
31 May 2012 03:31
Looming Saudi decision on its stockpiled oil pivotal to U.S., Iranian economies.
A year ago, a senior member of the Saudi royal family threatened to drop a financial super bomb on Iran's economy. Prince Turki al-Faisal, former chief of Saudi intelligence, explained to NATO officials that if "dysfunctional" Iran tried to take advantage of unrest in the Middle East and persisted with its uranium enrichment program, the Saudis were prepared to take decisive action. The Iranian regime's "hold on power is only possible if it is able, as it barely is now, to maintain a level of economic prosperity that is just enough to pacify its people." Flooding world oil markets with surplus Saudi crude would drive oil prices down and deny Tehran the billions required to balance its budget, finance its nuclear ambitions, and maintain social harmony.
Fast forward to May 2012 and oil is still priced at over $100 per barrel, Iran's nuclear program is moving forward, and the Saudis have not moved against the oil markets. Was Prince Turki serious when he delivered his threat, or was it intended as a bluff in an increasingly dangerous game of high-stakes strategic poker? Are the Saudis biding their time, waiting to flood the market when the Iranians least expect it? Regardless of his motives, Prince Turki may have unintentionally exposed serious shortcomings in the Desert Kingdom's much vaunted petro-power.
With petroleum responsible for 80 percent of income from exports, there is no doubt that Iran's economy is perilously exposed to unexpected price fluctuations in the oil markets. On at least four separate occasions in recent decades the Saudis have used their preeminent status as OPEC's "swing producer" to saturate oil markets, deliver price relief to Western consumers, and hammer their neighbor's economy.
The first occasion was until recently shrouded in secrecy. According to declassified U.S. government documents, in 1976 President Gerald Ford concluded a grand bargain with King Khalid of Saudi Arabia to lower oil prices, break the Organization of Petroleum Exporting Countries (OPEC) from the inside, and deliver the cartel into "moderate" Saudi hands. At that time Iran, and not Saudi Arabia, was OPEC's preeminent power broker. Although the Shah was a U.S. ally, he had antagonized Washington by engineering the 1973 oil shock that led to the swamping of Western economies with debt, unemployment, and inflation, and sparked fears of banking collapses and the bankruptcy of NATO allies in southern Europe. The U.S.-Saudi intervention in the oil markets, though well intentioned, had dramatic and unintended consequences elsewhere when Iran suffered a sudden and unexpected loss of oil revenues. A shortfall in state finances destabilized the economy and weakened Mohammad Reza Shah Pahlavi's rule at precisely the time when the Shah's religious and secular critics were preparing to mobilize against him.
Still, 1976 provided a model for future interventions. The Saudis stepped in a second time in 1985. Again, they sought to restrain Iran, which at the time was embroiled in a brutal war of attrition with its Arab neighbor, Iraq. Ironically, the Saudis' third intervention in the oil markets was directed against Iraq. Saddam Hussein's 1990 invasion of Kuwait jolted world oil markets. The Saudis opened the spigots to prevent a global oil shock.
The fourth and most recent intervention occurred in early 2008. King Abdullah responded to appeals from the Bush administration to lower oil prices lest they trigger a financial crisis. In hindsight, there were problems even then with the sluggish Saudi response. The initial Saudi effort to ease supply faltered. Instead, oil surged in price from around $80 per barrel in January to a staggering $147 per barrel at midyear. The price decline in the second half of the year (from $147 to $32 per barrel) can be attributed to Saudi over-production but also to frozen credit lines, the near-collapse of financial markets, and a dramatic fall in business confidence, industrial output and demand for imported fuel.
Since then, but particularly this year, oil industry analysts have questioned Saudi Arabia's ability to deliver on its claim to be the "swing producer" to the world economy. In a recent opinion piece published in the Wall Street Journal, author James Krane pronounced the end of the Saudi "safety net" that, since 1977, has allowed the United States to meet its foreign policy objectives in the Middle East while keeping gas prices low at home. Analyst Cyrus Sanati, writing in Fortune, explained that the Saudis have essentially lost control of the oil markets and are no longer in a position to offer price relief as they used to.
One of the most intriguing clues to Saudi oil production came in the wake of the WikiLeaks release of sensitive U.S. State Department cables a year and a half ago. According to cable traffic, a senior Saudi oil official confided his view that the national oil company had overstated reserves by 300 billion barrels, or nearly 40 percent of total reserves. "In his view once 50% of original proven reserves has been reached...a steady output in decline will ensue and no amount of effort will be able to stop it." The Saudi official was described as "no doomsday theorist. His pedigree, experience and outlook demand that his predictions be thoughtfully considered." American diplomats concluded that Saudi assurances to hold oil prices in line should henceforth be viewed with caution.
Two unrelated factors are also in play.
The first is Saudi Arabia's pattern of domestic energy consumption, which can only be described as reckless and short-sighted. The kingdom is now one of the world's biggest gas guzzlers, so much so that "its ability to pay a stabilizing role in world oil markets is at stake." Untrammeled economic growth, high birth rates, and expensive outlays for industrial enterprise and the military are soaking up the country's fuel reserves. And according to a recent analysis by Chatham House, the country's energy consumption is set to double in a decade: "On a 'business as usual' projection, this would jeopardize the country's ability to export to global markets. Given its reliance on oil export revenues, the inability to expand exports would have a dramatic effect on the economy and the government's ability to spend on domestic welfare and services."
The exorbitant costs of those state subsidies are also a focus of concern. In the wake of the Arab Spring unrest across the Middle East, the Saudi government announced that it planned to increase state spending by at least one third and pump more than $130 billion back into the domestic economy. This raises the risks of monetary overheating and inflation. An estimated $6 billion will be spent on foreign study scholarships alone. Anxious to stabilize the emerging regional order, the Saudis have poured at least $5 billion in loans and grants into Egypt to prop up that country's foreign currency and military government. Billions more are being spent to combat Iran's vaulting ambitions in Lebanon and Iraq. Then there is the $60 billion arms deal concluded with the U.S. in 2010 -- the biggest of its kind.
Who will pay for the billions in welfare subsidies and high-tech weapons?
Americans will. It wasn't too long ago that the Saudi budget was balanced on $42 per barrel of oil. Those days may be gone for good. According to the Institute of International Finance, this year's 31 percent increase in government spending means that Saudi government finances can break even only if oil sells at an average $88 per barrel (and $110 per barrel in 2015). That translates into a $20 increase from last year. Saudi Finance Minister Ibrahim al-Assaf avers that the kingdom can balance its books if oil sells at just under $80 per barrel. This helps explain recent statements by Saudi officials that they would prefer oil prices to hover at around $100 per barrel -- they are allowing for a modest financial cushion if demand for Gulf oil falls back to 2008-09 levels.
These unfavorable trends have not gone unnoticed in Tehran. Last month, Iranian Oil Minister Rostam Ghasemi dismissed Saudi Arabia's claim that it was prepared to step in to replace Iranian oil lost due to new sanctions. "Saudi production may be temporary, and it definitely cannot continue," he predicted. The Iranians are gambling that Saudi production, though at full capacity, will not make a dent in the oil markets. The implication is that the Saudis don't really want to -- or perhaps can't afford to -- bring prices down. The Iranians had better hope they are right.
As I noted in my column earlier this month, the Saudis are not only producing oil at full capacity, they are also stockpiling much of their surplus production. Until they decide whether to hold on to it or flood the market with it, the Saudi oil sword remains sheathed for now and the global game of risk continues.
Iran has been at the epicenter of every oil shock since 1973. In my next column, I will look at how oil prices have historically contributed to geopolitical and financial instability, and why any decision to flood the market this year may turn not on Iran's nuclear program but on events in Europe and President Obama's prospects for reelection.
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