Oil Weapon

You might have been pleasantly surprised when you last pulled into the gas station to top-up your tank. Yes, oil prices are falling and that is good news for businesses moving people or things and consumers alike.

The global economy isn't growing at the rate that was anticipated at the start of 2014, so that could be a contributing factor to a correction in the recent oil price. But surely, that can't be the only reason for such a sharp correction, bearing in mind energy hungry China and India, which economies are still growing at enviable rates, would most likely mop up any excess supply.

So what could be behind the sharp fall in the oil price?

Could history give us a clue? Cast your mind back to the time when Michael Jackson's “Beat it” was the rage and the old Soviet Union was dubbed “The Evil Empire” by the then US President Ronald Reagan, way back in 1983. Do you remember what happened to the Soviet Union? It disappeared into a mountain of debts in 1991. Sure, the deception of the century, the fictional star-wars project so masterly spun-out by Reagan(a former actor) that duped the Russians into overspending on their military was a major factor in contributing to the demise of the Soviet Union.

However, there was also another factor at play. Oil prices during that decade also tumbled. Back then, as is the case now, the Soviet Union was highly dependent on oil exports for its economy. So when the oil prices collapsed, falling to the equivalent of more than 100 (today's) dollars per barrel in 1980 to about 30 (today's) dollars and stayed low for more than a decade Soviet Union income was sharply reduced. So burdened with military expenditure and falling export earnings, for oil exports, it was a one two knockout blow for the Soviet economy, financial ruin was inevitable.

Legend has it that at the time a secret agreement took place between the US and the House of Saud conspiring to engineer the collapse of the Soviet Union by flooding the market with Saudi oil, thereby bringing down the oil price. Several decades on and there is no proof that such an agreement did exist. Moreover, if we look at a breakdown of the supply of oil, during that period, from the major producing countries, OPEC, it becomes apparent that the Saudis actually cut their supply

In other words, the Saudis did everything possible to try and prop-up the oil prices.

So it would be unreal to assume that a number of oil dons, with a few US senior officials, filled a smoky room and plotted to financially ruin the Soviet Union.

However, what did cause oil prices to drop, and contribute indirectly to the financial ruin of the Soviet Union was newly discovered oil fields starting their production phase, mainly in Alaska and in the North Sea.

But with no new discovery of oil fields today, could the latest push by the Saudis to aggressively flood the market with supply have an agenda. A recent article in the Wall Street journal entitled, Saudis Make Aggressive Oil Push in Europe, October 12, “The kingdom is taking the unusual step of asking buyers to commit to maximum shipments if they want to get its crude”.

“The Saudi push is not just in Asia. It’s a global phenomenon,” one oil trader said. “They are using very aggressive tactics” in Europe too, the trader added.”

After cutting its November prices there, Saudi Aramco is also asking refiners to commit to full, fixed deliveries in talks to renew contracts for next year, the traders say. They say the Saudi oil company had previously offered a formula allowing flexibility of more or less 10% of contracted volumes, the most commonly used in the industry.

So oil prices are falling sharply because the Saudis are flooding the market with oil.

Why would the Saudis act in a way that is not in their commercial interests, unless their arms were being twisted by the US. Maybe this time a secret US/Saudi deal is for real.

The motives are clear; lower oil prices are benefiting US consumers in a midterm election and crushing Russian revenues.

From the Saudi's perspective what they are losing in revenue from the lower oil prices they make up in volume sales. They are saying to their customers buy more or we won't sell you another drop of oil.

“They are threatening buyers” to discontinue sales if they don’t agree with the fixed deliveries, another trader said.

This is not going to go down well with some struggling EU economies, which are already running huge deficits.

So while the Saudi's are dumping oil on the market, probably spurred on by the US, the Russians are dumping US dollars. during the third quarter ending in September Russia has paid off a near record 53 billion US dollars in foreign debt, and sold off dollars to use as capital to stabilize their declining currency, and to protect their primary resource industry from the deflation.

Whether, secret US/Saudi deal is for real this time, who knows. But one thing for certain is that a commodity dependent economy is its Achilles heel when the price of those commodities fall. There would we strong motives for this kind of US/Saudi deal, bearing in mind the current trade war raging between the two states. If this were the case we would again be seeing geopolitics rather than economics as being a leading factor in determining prices.