SAUDI: OIL PRICES DOWN
Saudi Arabia could be pushing for crude prices to fall to US$85 a barrel for years in a desperate attempt to stop the oil-fuelled rise of the Islamic State (ISIS) terror group by undermining its finances, said the Bank of America Merrill Lynch.
But the strategy would also inflict serious collateral damage on the economies of the kingdom's Middle East allies, Russia and Iran as well as threaten the US's recent oil boom, said the bank's report "Does Saudi want $85 oil?".
The bank credits Saudi policy for having helped kept crude oil prices steady at around US$100 in recent years. But ISIS's rapid emergence since June may have forced the kingdom to opt for much lower oil prices to reduce the terror group's main source of funding, said BoA.
ISIS has been selling crude and oil products seized from Iraq and Syria to finance its well-trained militia in its quest to overthrow governments across the Middle East.
ISIS prompting unlikely alliances
ISIS's recent advances in Syria and Iraq have disrupted Middle East politics as it threatens the existing order across the region, creating an incentive for local and global players to co-operate.
The North Atlantic Treaty Organization (NATO) and Australia have started discussions to form a military coalition to fight both ISIS and Russia. Regional players like Saudi Arabia, Iran and Qatar already have a meaningful local presence after having significantly expanded their military capabilities in the last 20 years.
All of them are threatened by ISIS, who under the self-proclaimed caliph al-Baghdhadi, rejects political divisions established by Western powers at the end of World War I.
Beneficiaries of lower oil prices
The bank identified several beneficiaries of sustained low oil prices: politically conservative Arab states, the West, consumers, and Saudi Arabia's oil industry.
In view of ISIS's emergence, the bank said Arab conservatives welcome a return and expansion of American military engagement in the region. What could Arab countries offer the West to help contain this threat?
"Lower oil prices," said BoA, which has the added benefits of slowing down US shale development while weakening Iran and ISIS financially.
"A delay in energy independence would keep the US engaged in the Middle East for longer."
For Saudi Arabia, even a temporary decline in crude oil prices to US$85 per barrel would slowdown upstream activities in North America.
The bank noted that the US has become the world's largest oil liquids supplier, thanks to the 3.6 million b/d crude oil production increase over the last four years.
"With production costs ranging from US$50 to US$75 per barrel at the well head, a decline in Brent crude oil prices to US$85 would likely be a major blow to US shale oil players and lead to a significant slowdown in investment," said the BoA.
With its energy independence postponed, the US would "inevitably" be forced back to engage the Middle East.
Europe's stricken economies along with consumers around the world will benefit from low oil prices amid the uncertain outlook for the global economy.
There is a historical pattern of oil prices trending lower in the run-up to the November mid-term election in the US.
"Since 1990, we estimate Brent crude oil prices have been, on average, 2% lower in the month preceding a US election (presidential and midterm) and 4% lower than usual in the election month itself," said the BoA.
For the West, sustained low oil prices are an additional means to weaken the threat posed by Russia, as was the case during the Cold War in the mid-1980s and the late 1990s.
BoA said Russia would come under greater pressure to de-escalate the Ukraine crisis with a bigger public sector deficit if it fails to achieve a budget breakeven Brent oil price of $105 per barrel.
Saudi Arabia's estimated loss from low oil prices
BoA estimates that Saudi Arabia stands to lose between US$35 and US$55 billion per year from keeping global crude oil prices hovering around US$85 per barrel.
"Since 2008, on average, a 10% drop in oil prices has historically led to a 1.5% reduction in Saudi production three months later, rising to 2% after six months," said the bank.
It estimates that the recent 10% drop in the oil price implies a Saudi supply cutback of 150,000 to 200,000 b/d within the next three months.
"Instead, Saudi Arabia has increased production by 2% since June. This could be a sign that Saudi in fact wants prices to drop below US$100," it said.
With an annual budget of US$230 billion, a running surplus of US$40 billion, and estimated net foreign assets above $1 trillion, the BoA said:
"Saudi Arabia could cope with US$85 per barrel oil for years. True, the strategy carries risks for Saudi, including a big ramp up in global demand and further turmoil in oil producing countries as prices decline. But the Islamic State may now pose a larger immediate threat."
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