Wednesday, March 16, 2016

Blood & Oil - The New Emerging Petro-Landscape

Collectively the major oil producing countries that are highly dependent on oil export revenue are experiencing an unprecedented level of tumultuous upheaval. A seismic shift is taking place in world oil production with the addition of US shale-oil production and recent exports during a period of flat demand not to mention a strong US dollar - so much oil and nowhere to go. And because of the strong US dollar, even countries that are not under economic strain have shrewdly decided to limit their purchases of oil.

Each oil dependent country has unique economic handicaps and each with their own particular budgetary breakeven oil price requirement that makes it imperative for them to produce at an unsustainable, flat-out pace.

However the oil market share is directly linked to another type of market share: defending sovereign territory with the creation of buffer zones by arming proxy groups. Additionally they have a dearth of military experience in supporting or battling militants beyond their borders, made more challenging because these militants are battle-hardened, highly experienced and possess firepower that rivals those of sovereign states.

A factor rarely mentioned is that many of these oil producing countries’ economic difficulties are exacerbated by the high cost of these direct and/or indirect military entanglements. The security and armed forces of autocratic governments are established to defend against internal threats, rarely external ones. These counties are now battling a two-front war, internal and external, and as a result are stretched painfully thin.

In the past their purchases of advanced fighter jets and other ‘trophy’ weapons designed for external battles, were rarely used in combat and their costs were limited to the initial purchase price, crew training and general maintenance. Nowadays these trophy weapons are significantly more expensive to maintain when utilized on a daily basis which accelerates the ‘burn rate’ of their precious foreign reserves. Consequently these war-time military expenditures increase considerably the actual breakeven budgetary oil price point than the officially accepted published figures.

Even a rise in oil prices above their adjusted economic break-even point will only enable them to more comfortably finance their armed forces to defend territorial market share. Depressingly because of the continued existent of powerful non-states operating almost at will within failed states, military expenditures will remain unchanged. And at some future point when the region establishes a modicum of stability, these countries will maintain their elevated military expenditures because they reside in a region whose stability is always short-lived and tenuous at best.

In this region, market share in the oil is meaningless without military dominance because “checkbook diplomacy”, practiced to perfection by the Saudis, has been rendered outdated and ineffective. Economically countries can adjust accordingly to harsher circumstances but cannot recover easily militarily from the loss of sovereign or buffer territory, especially the loss of influence within their own territory to anti-government indigenous citizens.

Outside of the Middle East cauldron is Nigeria and Venezuela, major oil producing countries that have exclusively internal yet still potent challenges. Nigeria still struggles to pacify the militant group Boko Haram while Venezuela, at the cusp of economic default, a humanitarian crisis and civil unrest, has a political gridlock between President Maduro and the opposition’s legislative majority, an acidic confrontation that can spillover onto the streets and ignite this tinderbox.

The OPEC community continues to have divergent and competing interests which have created unusual and sometimes contradictory geopolitical cross-relationships. In one of a multitude of examples, Iran and Russia collaborate militarily in Syria because of decades-long mutual interests yet compete on energy matters including gas exports with sanctions lifted on Iran yet still in place for Russia.

Because of these conflicting interests it’s almost impossible for OPEC to agree upon a strong coordinated effort to reduce production to raise oil prices. Those countries best positioned to not only survive but thrive after the denouement of economic and military battles, are the ones who best utilize their resources. Based solely on economics the ones with the deepest pockets and access to credit are Iran and Saudi Arabia; those most vulnerable are Iraq, Russia, Venezuela, Nigeria, and Iraq.

Not surprisingly the recent non-binding production “freeze” agreement among OPEC and non-OPEC producers has no real impact on raising oil prices. The real objective of the agreement was that it provides an important political precedent: that OPEC and non-OPEC countries can agree collectively in establishing some kind of an agreement. The perception created is that OPEC and non-OPEC countries indeed continue to disagree, but now the lines of communication are established so that differences can be narrowed, perhaps even overcome, in future meetings. Weak agreements are better than no agreements.

The eventual denouement of these economic and military battles will shape the region for decades to come. These governments are well aware that these are extraordinary historic times which, whenever the sand settles, will determine a newly formed power dynamic in the Middle East whose future landscape may be unrecognizable from today. Their frenzied efforts economically and militarily for not only survival but dominance is justified because second best is not an option in this unforgiving region.

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