It is no secret that the international order is currently rife with conflict; between the Ebola outbreak, the ongoing situation in the Ukraine, and the fight against the Islamic State, it seems like there are crises emerging from every corner of the world.  Unfortunately, these “sexier” conflicts have overshadowed another recent development that has critical geopolitical implications. Namely, the price of oil has fallen by a dramatic 25 per cent in the past three months alone.

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Image courtesy of US Navy, ©2006, some rights reserved.

 

This steep decline in prices can be traced largely to slower-than-expected economic growth in China and Europe, as well as the miraculous success of the hydraulic fracturing (“fracking”) industry in the United States.  Decreased demand from sluggish growth paired with an oil-exporting America has led to a glut of oil on the market.  And if those two factors were not enough, Saudi Arabia, the de-facto leader of OPEC, just decided to maintain its current production levels and aggressively cut prices, guaranteeing a further decline in prices.  This decision has shocked many of the world’s largest oil producers including many of its OPEC partners.  Part of this surprise stems from the fact that Saudi Arabia’s decision is a complete reversal of its traditional oil policy.  In the 1980s, Saudi Arabia responded to falling prices by slowing their production levels and thereby raising the price of oil artificially.

So why did the Saudis reverse their standard policy?  Two major narratives have emerged which seek to answer that question.

The most interesting narrative that has gained momentum is the argument that Saudi Arabia’s decision is a part of a joint power play with the United States to pressure Russia and Iran.  Given the geopolitical implications of cheap oil, the development of this narrative is not that shocking.  The idea that the United States and Saudi Arabia would want to pressure both Iran and Russia is intuitive.  The United States has made it clear that it seeks to punish Putin for his alleged interference in Ukraine.  As for Iran, the United States has spearheaded the sanction movement intended to stymie its continued efforts to develop a nuclear program.  Similarly, Saudi Arabia has grievances with both countries.  The Saudis resent Russia for its continued support of al-Assad in Syria, and views Iran as their main competitor in the Arab and Muslim world.

Unsurprisingly, this conspiracy theory-esque narrative has been articulated mostly in those countries that are feeling the squeeze from cheaper oil.  State-controlled newspapers and oil companies in Russia have claimed that the Saudis and the Americans are intentionally manipulating market conditions in order to collapse the domestic economy.  On the other side of the world, Rafael Ramirez, Venezuela’s foreign minister, also claimed that the two states were conspiring to undermine major oil-producing countries [1].  It is worth noting that this view is not solely limited to the West, in fact, the influential journalist Thomas Friedman recently weighed in and labeled the Saudi move as a part of the new “global oil war” [2].  Yet, for the most part this view is strongest in those countries impacted negatively by cheap oil.

The strength of this narrative has been supported by the realities that cheap oil has imposed on major oil producers like Russia and Iran.  While Saudi Arabia has the large cash reserves to withstand low prices in the short term, other producers are not in good standing.  Oil revenues account for 60 per cent of Iran’s government revenue and over half of Russia’s, and neither have reserves to the same degree as Saudi Arabia [3].  If the move is indeed a political one, it certainly has been successful thus far.  Morgan Stanley estimated that for every $10 fall in the oil price the Russian government loses about 1.6 per cent of its GDP or $19 billion in government budget revenues.  According to these numbers, the recent fall has wiped out almost $60 billion in government budget revenues [4].  The severity of those kinds of losses has not escaped Putin, who recently admitted that the government might need to reconsider its budget due to the disappointing export revenue.  Unlike Western sanctions imposed after Putin’s activities in Ukraine, which were characterized as an “annoyance”, the implications of declining oil prices have been treated with an unexpected degree of seriousness.

Interestingly, the other major narrative explaining Saudi Arabia’s decision sees it as an antagonistic move against the United States, rather than a cooperative one.  Instead of joint action aimed at Russia and Iran, some see Saudi Arabia’s decision as a means to discipline OPEC and weaken the burgeoning shale gas industry in North America.  Badr H. Jafar, the president of Crescent Petroleum, a United Arabs Emirates-based oil and gas company, argues that Saudi Arabia’s immediate strategy is to discourage new “fracking” projects in the United States and Canada [5].  The basic logic is this; hydraulic fracturing is an expensive process and therefore requires high prices in order to be profitable.  Saudi Arabia could be forcing low prices in an attempt to slow down the growing industry.  It is unknown exactly how low prices would need to go in order to prevent new projects, with some industry analysts arguing that the price would have to drop as low as $60 per barrel.  While Saudi Arabia might be able to temporarily handle prices that low, it is doubtful whether the rest of OPEC would.  Certainly, this narrative makes sense given the threat that the American shale “revolution” poses to Saudi Arabia; however, the major issue with this storyline is that both Saudi Arabia and Kuwait have indicated that they do not plan on cutting production after OPEC meets in late November.

As in all things, the truth behind Saudi Arabia’s motivations likely lies in the middle of these differing accounts.  In a sense, the decision makes sense from both of the angles isolated above.  Maintaining current production levels to force prices down is a sound economic decision that has convenient political ramifications. In one simple move, Saudi Arabia manages to put significant pressure on key rivals while simultaneously challenging the American shale market.