Editor’s Note: Unbelievable oil headlines dominate the news today. So we turn to Casey Research Analyst and Editor Nick Giambruno to help make sense of them. Nick’s a master speculator who’s lived and invested all around the world. His experiences in the Middle East are especially insightful right now…
J. Reeves, editor, The Palm Beach Daily: Nick, Saudi Arabia continues to flood the global market with cheap oil. Why are they doing this right now?
Nick Giambruno, analyst and editor, Casey Research: The Saudis are flooding the market for a couple of reasons.
First, to hurt Russia’s and Iran’s economies. They both depend heavily on oil sales.
The Saudis want to hurt Russia for supporting their regional rival, Syrian President Bashar Al-Assad. They want to hurt Iran for the same reason. Iran is the Saudis’ age-old geopolitical rival in the region.
The Saudis have also declared war on the U.S. shale oil industry.
In the 1990s, the U.S. imported close to 25% of its oil from Saudi Arabia. Today—because of high U.S. shale oil production—we only import 5%.
By keeping the market saturated with oil, the Saudis are driving down the price. They hope to drive it down low enough and long enough to bankrupt the shale industry… since shale oil costs more than Saudi oil to produce.
This would knock out a major competitor and let the Saudis regain lost market share.
J.R.: Doesn’t this market oversaturation also hurt the Saudis?
Nick: It definitely hurts them. I think they’ve overplayed their hand… big time.
Oil makes up 90% of Saudi government revenue. So the price drop has been very painful. They’re bleeding through their reserves.
The market is putting more pressure on their currency peg than at any time in its history.
For over 30 years, Saudi Arabia has pegged its currency at 3.75 riyals per U.S. dollar. To maintain this, it needs a large stash of U.S. dollars. With its historically large reserves, this has never been a problem.
But now, the Saudi budget is under serious pressure. The government is only staying afloat by draining its foreign exchange reserves. This threatens Saudi Arabia’s ability to support its currency peg.
If the currency peg breaks—which is exactly what the current market expects—the riyal would be devalued. This would increase the cost of living for Saudis across the board.
It would also increase social unrest.
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J.R.: The Saudis are also hemorrhaging cash from their wars now, right?
Nick: Yes. The Saudis are losing billions underwriting foolhardy wars in Yemen and Syria.
The Saudis thought they could support armed Syrian rebels and topple the Assad government in a matter of months. They figured Assad would fall just as easily as Gadhafi did in Libya in 2011. It was a gross miscalculation.
There’s also the Saudi war in Yemen, its southern neighbor.
The Saudis launched the war in March 2015. They wanted to reinstate a Saudi-friendly government. The Saudis thought the intervention would last a few months, then they’d declare “mission accomplished” and go home. That’s not what happened.
The political and economic stars are aligning against the Saudis. It’s their most vulnerable moment since the kingdom was founded in 1932.
J.R.: So Russia, the U.S., Saudi Arabia, and Iran are all involved in proxy wars in the Mideast right now… but the price of oil hasn’t spiked throughout the turmoil. What does that tell you about the global oil market?
Nick: It’s strange. There’s so much conflict in the Middle East—but oil prices are falling.
And despite China’s economic slowdown… it still imported more oil in 2015 than in 2014. China is the world’s No. 2 oil consumer behind the U.S.
Turmoil plus demand says oil should be going up, not down. But the mystery’s explained by the Saudis’ oil war and their strategy of flooding the market to bankrupt competitors.
J.R.: The Saudis may succeed in bankrupting many U.S. shale oil producers this year. That will create crisis conditions in the sector. Will the crisis spread throughout the broader economy?
Nick: The Saudis are having some success. In the past year, at least 67 U.S. oil companies have filed for bankruptcy. Analysts estimate as many as 150 could follow. The shale oil industry is in “survival mode.”
And the crisis in the oil market could spread. That’s because many banks made big loans to these distressed shale oil companies. A wave of bankruptcies means those loans could go bad, which would be a huge threat to those banks.
It has the potential to trigger another meltdown in the financial system. The warning signs are there.
I wouldn’t own any bank that has big exposure to risky shale plays… nor keep my life savings there.
J.R.: Who do you see winning this “oil war?” And how can the average investor profit from the crisis?
Nick: The Saudis have damaged the U.S. shale oil industry. And they’ll continue to cause more damage. But they won’t bankrupt every producer.
The shale industry has more staying power than Saudi Arabia. Some producers now say they’re profitable with $40 oil. And their pace of innovation will drive that even lower. It will survive.
All the Saudis have done is create an existential crisis for themselves.
If the Saudis don’t stop flooding the market—and there are no signs they will—they won’t be shooting themselves in the foot… but in the head. Either Saudi Arabia will collapse or they’ll surrender—and stop flooding the market.
Either way, oil will eventually go a lot higher.
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There will be explosive profits once oil prices start recovering.
J.R.: Thanks for your time and insight, Nick.
Nick: My pleasure.
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