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Trading Lessons

Why Overpriced Crude Oil Failed

Commodities / Crude Oil Oct 11, 2014 - 12:14 PM GMT

By: Andrew_McKillop

Commodities

Forget the Secret Deals
US-Saudi petrodollar recycling or the "Secret Deal" between the USA and Saudi Arabia dating from the early 1970s and heavily associated with Richard Nixon, Henry Kissinger, the US Treasury  Dept and US Federal Reserve was anything but a secret deal, and public domain information on this system is easily available. Ultra basically, petrodollar recycling worked best with high oil prices. The long slump of oil prices through 1986-2002, was basically engineered, at its beginnings, by Saudi Arabia with full US support to deny revenues to Khomenei's Iran in its 1980-88 war against Saddam Hussein's Iraq, seen by the Sunni-dominated Gulf States as holding back the Islamic revolutionary Shia of Iran. Saudi Arabia certainly did not profit from low oil prices and after the period of 1974-86, it consistently reduced its deposits of "windfall gain" petrodollars in the US Fed Reserve system.


Times changed for petrodollar recycling, and they certainnly changed for the national budgets of major oil exporters. This certainly includes Russia which is not shown in the table, below, but certainly and surely needs oil prices "north of $90 a barrel". US shale oil producers likewise need oil prices well above $75 a baarrel for guratnteed profitability and production sustainability.


Other US-Saudi secret deals are much more recent, and we can particularly highlight the Syrian civil war and the attempt to overthrow the government of Bashr al Assad. Whn or if the Assad regime falls, there would be a classic "power vacuum" allowing Saudi Arabia, Qatar, UAE, Kuwait, Jordan and/or Turkey to divide spoils of war as they saw fit and were able to arrange between themselves – probably with renewed fighting on the ground. Regional wid cards are rampant, including Kurds, Iranians, Azeris, Armenians and others. Power struggles in the region are hard-wired and traditional – the post 1918 frontiers are merely a Wordl War I colonial legacy.

Back to 1986 - Back to the Future
The betting right now is that KSA is for the moment and at present making a carbon copy of its actions in and from 1986, which slashed oil prices by two-thirds or 67% in 6 months.

KSA calculated, and calculated wrong, that slashing oil prices would cripply Khomenei's Iran. The blowback included Saddam Hussein's demand for higher oil prries to pay war damage to Iraq. When Hussein didnt get that, he invaded Kuwait, possibly with an amber light if not a green light from the US.
The KSA shock tactic with oil prices, using its vaunted "swing producer role" continued right through the 1990s decade, to the extent that OPEC was heavily compromised, even fractured as a cartel-type entity able to limit production to bolster prices. Iran is still the bogey man for KSA, now joined by Russia – both of them seen as vulnerable to a serious and sustained dip in prices by perhaps 33%-45% from recent prices near $100 a barrel.
The present KSA-USA oil price lever policy could or might work on Iran – although it did not work in the past – but is even less likely to work on Russia. Given little or no media attention, Russia has both de-dollarized and cut its public debt at a fast rate in 2014 to date.

Russia has drasrtically trimmed its capital outflows, most radically in the last 6 months and since September has net capital inflows, or a  current account surplus, mainly due to increased trade with non-G7 countries of the G20 group. In 2014 to date, Russia has paid down a massive $52.8 billion in foreign debt, cutting its external debt to the lowest since 2012.

 Recent infromation out of KSA (eg. from the the Riyadh-based Saudi Arabia Oil Policies and Strategic Expectations Center) says that Riyadh will sell oil at prices as low as $50 to $60 per barrel in the Asian markets, Europe and North America.  The claimed objective of this cheap oil strategy is "to attract new clients" but this fools few persons. KSA believes that cheap oil can sufficient harm Iran and Russia to  to limit Iran's nuclear energy expansion, and to make Russia change its position of support for the Assad government in Syria.

As in the long period of cheap oil from 1986, the Organization of Petroleum Exporting Countries, will certainly suffer internal splits and quot-excess production, as OPEC producers increase outtput to try compensating lower baarrel prices, in a fundamentally weak global oil market. The future of low-priced oil looks provisionally assured!

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2014 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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