Is the World Poised for an Economic Tailspin? – The Saudi Purge and the Saudi Iran Conflict

Saudi Crown Prince Mohammed bin Salman, Masayoshi Son, SoftBank Group Corp. Chairman and CEO, and Christine Lagarde, International Monetary Fund (IMF) Managing Director, attend the Future Investment Initiative conference in Riyadh, Saudi Arabia October 24, 2017. REUTERS/Faisal Al Nasser

The Saudi Purge

Saudi Arabia arrested 11 princes, including a prominent billionaire, and dozens of current and former ministers, in a sweeping crackdown as the kingdom’s Crown Prince Mohammed bin Salman consolidates power.  The crackdown was reported immediately after a new anti-corruption commission, headed by Crown Prince Mohammed bin Salman, was established by royal decree.

Though Saudi Arabia no longer dominates the oil market to the extent that it did in the 1970s and 1980s – oil production in the US and in Russia is roughly comparable – disruption of production in such an important producer would unavoidably have huge consequences for oil prices.

Most analysts aren’t expecting any major shifts in the price of oil in the near future, given that Salman backed the kingdom’s oil policy. However, the purge has sent oil prices surging to its highest levels since July of 2015, and that trend may continue.

Prince Salman’s concern has been to support a higher and more stable oil price and the IMF estimates that oil prices may rise from the current $62.50 per barrel to $70 per barrel in 2018.

The growth in US oil rigs this year – indicating a production increase by the world’s third largest producer – has muted the recovery of the oil prices hoped for by OPEC and several other producers including Russia, but the number of rigs plateaued in August – making the recent Saudi purge more likely to affect US and world oil prices.

Joseph McMonigle, senior energy policy analyst at HedgeEye, said the uncertainty in Saudi Arabia compounded issues in other oil-producing regions.

Oil markets were already facing major geopolitical risks with Iraq’s response to the Kurdistan independence bid, potential new US sanctions on Iran and an economic and political collapse in Venezuela.

“Now we can add an unsettled Saudi political environment and attempted Houthi-Iran missile attack on Riyadh to the mix. Geopolitical risks have just spiked and oil prices are heading higher,” he said.

And What of the Petrodollar?

The key reason why the US dollar continues to be the world’s reserve currency despite the fact that in terms of purchase power parity the US economy has been overtaken in size by China’s is because of a longstanding agreement between the US and the Saudi monarchy that Saudi Arabia will accept payment for its oil in US dollars.

A prolonged political crisis in Saudi Arabia or a political breakdown there could call that arrangement into question, with massive implications for the global position of the dollar and of the US.

It is unlikely for the moment that the situation in Saudi Arabia will spur armed intervention by the US. For the time being the crisis within Saudi Arabia is confined to a power-struggle within the Saudi Royal Family.

Saudi Iran Conflict

Saudi foreign minister Adel Jubair said a missile fired at Riyadh from Yemen over the weekend was an “act of war” and put the blame for the action with Tehran.

Dr. Hossein Askari, a professor at The George Washington University stated, “If there is a war confronting Iran and Saudi Arabia, oil could overnight go to above $250, but decline [back] down to the $100 level. If they attack each other’s loading facilities, then we could see oil spike to over $500 and stay around there for some time depending on the extent of the damage”.

While not impossible, war is speculative at this point. Also, $250 and $500 per barrel are numbers pulled out of thin air, and may seem a bit sensationalist. But despite the glut in global oil production – somewhere around 1 mb/d – the margin from excess to shortage is thinner than most people think. Even though it remains a remote possibility, direct military confrontation between Saudi Arabia and Iran could well put oil back into triple-digit territory in short order.

Oil and natural gas prices translate to cost of living, and increases in oil and gas prices create a domino affect of increased costs for food, energy costs, and of course an increase at the gas pumps.

While the conflicts in the Middle East appear to be mostly stable, the situation is most certainly fluid; and the outcome could reverberate throughout already struggling economies around the world.

References:

Oil climbs after Saudi Arabia detains princes and dozens of former officials

Oil price rises to two-year high after Saudi Arabia purge

Crude Oil Prices Soar On Saudi Purge, Iran War Worries

War Between Saudi Arabia And Iran Could Send Oil Prices To $250