As a young man in 1980, I debated two career choices, the commodity business or law school. I went for commodities because I knew that every day would be different, and I would never get bored. The global nature of the business attracted me. After studying in Europe during college and traveling, I was keenly aware that the world extended far beyond my backyard in Brooklyn, New York.
I was lucky enough to work for the most influential physical commodities trading company in the world at the time, Philipp Brothers. I learned the raw material trading and logistics business from the bottom up.
Over the years, I was exposed to shipping experts, financiers, market analysts, and traders. I learned that price forecasting for the future was a compilation of many factors. Fundamental supply and demand in physical commodities is an important determinate of future prices. Understanding fundamentals can be a tedious exercise of data accumulation of supply, demand, and inventories. Technical analysis focuses on price patterns and momentum applying statistical tools to price charts. Governmental policy, rules, and regulations are other factors that can influence prices. Finally, geopolitical trends and shifts often have a tremendous impact on commodity prices. Having been involved in all aspects of the commodities business over the years has been an invaluable education in economics as well as world politics.
Each commodity has individual idiosyncratic characteristics. When it comes to crude oil, the fact is that more than half the world's reserves reside in one of the most turbulent regions of the world, the Middle East. Therefore, politics often trumps many other factors when it comes to the path of least resistance for the price of the energy commodity.
Another article brought up an interesting perspective
In an article written for Seeking Alpha on April 25, What The U.S. Position On Saudi Arabia Means For Oil Prices, author Robert Boslego argues that a low oil price is in the strategic interest of the world's largest producer. He states that "… low prices are in Saudis' security interest, and higher prices are in America's oil security interest. One would naturally assume that the Saudis would prefer higher oil prices, and the U.S. prefers lower oil prices. Higher prices mean more income to Saudi Arabia. Lower prices means less cost to an oil importer such as the United States.
But with lower oil prices, the Saudis get protection of their wealth, due to the continued dependence of the U.S. on imported oil. With higher oil prices, U.S. shale output would rise again, and the U.S. could meet all of its oil needs from domestic production of oil, sooner rather than later." I enjoyed Robert's piece; I thought he added a nice touch when he reviewed the history of the co-dependent relationship between the Saudis and America. While I agree with his conclusions, I felt there was more to say about the current state of the Saudi-U.S. relationship on crude oil. So this piece is not another view, rather it is a continuation of the examination of the politics, economics and historical ramifications that will eventually resolve themselves in a path of least resistance for the price of crude oil which I believe will continue to be as volatile as the Middle East.
Saudi isolationism is dangerous - double dealing comes at a price
Saudi Arabia's present King Salman took over the throne in January 2015 upon the death of King Abdullah. The rise of oil consumption in the world has brought great wealth to the Saudi Kingdom. Aside from being the most oil-rich nation in the world, Saudi Arabia is also the home to the two most holy sites in the Muslim world, Mecca and Medina. Mecca is the holiest site in Islam, an once-in-a-lifetime pilgrimage there is required by each able-bodied Muslim, who can afford to go. Medina is the second holiest city for the religion.
The modern day House of Saud has ruled the nation since 1932. There are approximately 15,000 members of the Royal Family, but only 2,000 hold considerable power and wealth. Over 31.6 million people live in the nation; the vast majority of the nation is Sunni Muslim as are the Royal Family. 10-15% of the nation is Shia. Saudi Arabia holds the position as the most influential member of the world oil cartel, OPEC. While the nation enjoys close relations and cooperation with the other Gulf States, its relationship with another OPEC member, Iran, has deteriorated over recent years.
Iran has a population of close to 80 million people. The theocracy in Iran is Shia - Sunni Muslims comprise only 9% of the nation. The U.S. has maintained a close relationship with the Saudis, particularly in the years following the 1979 hostage crisis and revolution in Iran. Saudi Arabia has had a tense relationship with the theocracy in Iran since the wake of the Islamic revolution as the Ayatollah promised to export the revolution throughout the Middle East.
During the Iraq-Iran war that lasted from 1980-1988, the United States gave support to Iraq. The Saudi government remained neutral while providing non-military aid to Iraq. As Boslego points out in his piece:
"The U.S. has done what was needed over the decades to keep KSA militarily defended for oil security. But the U.S. political winds have been shifting since the Presidents Bush, 41 and 43, have been in office".
U.S. policy has attempted to create a balance of power in the Middle East to protect the flow of crude oil. In 1990, when Saddam Hussein marched into Kuwait, the U.S. led a coalition that included Saudi Arabia pushing Iraq back over the border and liberating the oil-producing nation quickly. Military and economic ties between SA and the U.S. continued to be strong. Perhaps the most public Saudi member of the Royal Family to Americans is Prince Al-Waleed, who is worth over $20 billion and has vast business interests in the U.S. The Prince is a major shareholder of Citigroup (NYSE:C), News Corporation (NASDAQ:NWS) (NASDAQ:NWSA), Fox News (NASDAQ:FOX) (NASDAQ:FOXA), Motorola, AOL and many other U.S. companies.
The Saudi Royal Family has ruled its nation with a generous social welfare program for many decades to take care of its citizenry and quell any dissent that might threaten the stability in the nation. Meanwhile, dissent has been smoldering for decades. Osama bin Laden was a member of a wealthy Saudi family that made its money in construction. While his family had close ties with the Royals, Bin Laden denounced them. 15 of the 19 9/11 hijackers were Saudi nationals. The Saudi Royal Family has been walking a tightrope for decades, placating or paying off those who might oppose it while making nice with the U.S. and Western countries who they view as the addressable market for their crude oil.
The recent nuclear non-proliferation agreement with Iran was a blow to Saudi relations with the West and particularly with the United States. The Saudi government was steadfast in its opposition to the deal with the theocracy that did away with sanctions, provided the Iranians with $150 billion and most importantly planted seeds to increase Iranian influence in the Middle East. The only other nation that stood with the Saudis in opposition to the deal was Israel; both nations are clearly in the crosshairs of Iran.
Mr. Boslego made an excellent argument as to why a lower oil price fosters U.S. dependence on the Kingdom of Saudi Arabia. King Salman through Prince Mohammed has unveiled a program that will create a sovereign wealth fund of $2-3 trillion over coming years. With proceeds from an IPO of Aramco, the Saudis will look to make investments around the world to secure their vast wealth and diversify away from oil.
However, decades of double-dealing and playing both sides of the fence could be coming back to haunt the Saudis. Funding for terrorist organizations and specific involvement in the funding for 9/11 could turn public opinion in the U.S. and the world against the Kingdom quickly. Their initial response to a move in the U.S. Congress to allow families of 9/11 victims to sue SA as the result of a yet to be released 28 pages report was a threat by the Saudis to sell all U.S. debt holdings and "crush" the U.S. financial system. The threat was not the first time this year the Saudis have involved themselves in U.S. politics. Prince Al-Waleed recently weighed in on the current presidential election by saying the leading candidate on the Republican side was a "disgrace."
As a result of their oil riches, the Saudis have been able to play both sides of the fence around the world for decades. They have balanced dissent at home with payoffs to their non-royal populous. They have meddled in U.S. politics as well as in other areas around the world. The nation's tradition of double-dealing could present problems for investors in a publicly-traded Aramco in terms of their majority shareholdings. It could also present problems for those companies chosen as investments for the Saudi sovereign wealth fund. Meanwhile, the world has handled the oil powerhouse gingerly as the Saudi regime has used wealth to gain influence. Now, the power base in the Middle East is shifting, and Iran is gaining stature. The Saudis have quietly been cozying up with another nation in the region.
Marriages of convenience
Nothing creates the environment for a budding friendship like a common enemy. In the Middle East, Iran's stated enemies are Israel and Saudi Arabia. The anti-Israeli rhetoric out of Teheran since 1979 has been a constant. At the same time, the theocracy would like nothing more than to seize control of the holy sites in Saudi Arabia and rid the world of the Royal Family. The two nations are involved in a proxy war in bordering Yemen. Israel and Saudi Arabia view Iranian expansion as a threat to their existence, which is changing traditional relationships in the region. I would not be surprised if the Kingdom recognizes Israel and establishes formal diplomatic relations with the nation sooner rather than later. A warming of relations with other Gulf States close to SA could follow. To complicate matters, the U.S. was the major supporter of the agreement with Iran, and the theocracy continues to chant death to America.
The dynamics of the Middle East are changing rapidly. A lower oil price has put economic pressures on the Gulf nations and Saudi Arabia as Iran has found new wealth, power and stature. The new Saudi King and his henchman are doing everything they can to diversify away from oil. However, money is not everything in this world and the threat focused on Saudi Arabia is subversive, military and not economic. Other than warming to Israel in a relationship of convenience, they appear to have isolated themselves from other traditional allies.
Aside from recent problematic issues with the United States, the Saudis appear to have frustrated the Russians, the world's second-largest oil producer, in Doha on April 17. The Putin government worked hard to create the atmosphere for an oil production freeze acting as the front man for Iran. However, Saudi intransigence caused the hopes of any agreement to fall apart. As a result, the Kingdom is turning to improving relations with the two most populous nations in the world, China and India. However, both nations have good relations with their arch enemy, Iran. The Saudi Royal Family may become surrounded and backed into a corner as a result of decades of double-dealing.
The U.S. and crude - a slippery slope for Saudi Arabia
Over recent years, the United States as a result of technological advances in the energy sector has proved to the world that it can be oil independent, at a price. That is a much different situation than in the 1970s when an oil embargo caused a recession in the Unites States. At that time, the Saudis and the Middle East had what amounted to a choke-hold on the economy of the United States. It is one thing to pay more for a commodity like oil; it is another not to be able to source it at all.
Therefore, the slippery slope of crude oil supply for the United States has become less slippery as the technology to retrieve higher cost energy is now available. That could be bad news for Saudi Arabia in the long run. Given the Royal's current dilemma with Iran, whether it likes it or not, the Saudi Royal Family is more dependent on the U.S. support than ever before regardless of the price of oil. While Robert Boslego opines that a low oil price benefits Saudi Arabia in that it fosters U.S. dependence on the producer; that may not matter in the years ahead.
Crude oil technicals - shades of 2008?
As I wrote at the beginning of this treatise, geopolitical trends and shifts often have a tremendous impact on commodity prices. I have attempted to take Robert's piece one step further to explain the difficult issues facing the area of the world that is home to more than half the oil reserves of the world. That oil is low production cost oil. Oil is a boom and bust commodity. We saw that in 2008 when a global economic crisis caused the price to drop from over $147 per barrel to $32.48 in six months. As the monthly chart of NYMEX crude oil futures highlights, the recent move from $107 to $26 occurred over 20 months. Crude oil has a penchant for massive price volatility. In 1990, when Iraq invaded Kuwait, nearby crude oil doubled in a matter of hours. The incendiary political landscape in the Middle East caused by tensions between Iran and Saudi Arabia could result in a boiling oil price over the months and years ahead. The only given in this region is that uncertainty is ahead and that politics will continue to determine the path of least resistance and provide for occasional price shocks in the energy commodity. Active month June NYMEX crude oil futures settled on Friday, April 29 at $45.92 per barrel. That is an increase of over 76% from the low established less than three months ago.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.