The Saudi-Iran Oil Crisis

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If you've ever felt intellectually superior to members of Congress (and who hasn't?) you'll have even more of a high ground to stand on after reading this article.  That's because a shocking proportion of our elected officials don't know the difference between a Sunni and a Shia Muslim, despite the fact that they draw paychecks from taxpayers to determine Middle East policy.  If you're unsure of the difference, worry not -- since you likely don't get paid to determine foreign policy -- and read on, for the issue that will affect the price of oil most strongly in the upcoming weeks will be this religious rivalry, 1400 years old, that is playing out between Saudi Arabia and Iran today.

A Split In Time

The Bible states that Christ made no bones about the spiritual successor to His legacy: Christ nominated St. Peter to be the rock of His church, from which the succession of Catholic popes have dictated Christian policy for the past two thousand years.  The succession of authority from the Islamic Prophet Muhammad, however, proved a much thornier matter upon his death.  Stories of the prophet's life, known as hadith, record him speaking to an audience and appointing his son-in-law Ali as the successor of the movement.  Yet Ali died in a power struggle, leaving the authority of Islam under the guidance of the caliphs who would rule the Middle East for the next 600 years until Mongol tribesmen decided to ride on through.  Sunni Muslims believe the authority of Ali to be misguided, holding that the hadith refers to the principle of belief rather than the principle of authority.  Shia Muslims say the opposite, believing Ali to be a martyr to their cause.  The Middle East is split between Sunni and Shia today, with two states -- Saudi Arabia and Iran, respectively -- acting as the patrons of either side of the great schism.  While Christianity's wars between Catholicism and Protestantism died out centuries ago, Muslims still shed blood in the name of their preferred sect.

Playing With Fire

Today, Shias who live in Sunni regions often are regarded as second-class citizens.  Famously, Saddam Hussein engineered horrific treatment of Shia Muslims despite the fact that Iraq is about 70% Shia.  In Saudi Arabia, small pockets of Shia clerics must tread carefully lest they step on the toes of the Kingdom, who treats dissent about as favorably as they do competitors.  Saudi Arabia made global headlines last week with the execution of Nimr al-Nimr, a Shia cleric outspoken about the quality of life under the rule of the Saud family.  The execution -- one of 47 to ring in the new year -- shows not only that the Saudis are trying to keep an iron grip on their populace as King Salman approaches retirement at age 80, but that the country is not willing to shed its dogged traditionalism even as oil drops to a precarious price of $35 per barrel.  Killing al-Nimr predictably enraged the Iranian government, who considers itself a protector of Shia minorities throughout the Middle East despite also being a closer partner to the Saudis through OPEC.  A riot broke out in the streets of Tehran, resulting in the burning of the Saudi embassy.  King Salman, never a close friend to Ayatollah Khamenei, reacted by breaking diplomatic ties and cutting all trade and flights to and from rival Iran.  With the failures of diplomacy come also the failure of an OPEC agreement -- one that looked like it could be the savior the oil industry needs so badly.

Delay Until Death

The prior month, OPEC officials met in Vienna to discuss caps on oil exports.  Such caps are badly needed by struggling economies, such as Venezuela and Libya, who have almost nothing else to sell to the world except petroleum.  At the same time, the Saudis want to keep the taps flowing in order to bankrupt a laundry list of competition that includes American fracking, Canadian tar sands, Russian North Sea drilling, and Norwegian offshore production.  Iran wants to push our more oil as well: not to drive down their rivals, but to re-start an economy that has been blunted by sanctions over the past decade.  The world currently produces about 1.5 million more barrels per day than we consume, a major reason why the price of oil has fallen by almost $80 per barrel in just the past two years.  The Vienna talks, perhaps predictably, went nowhere even as oil dropped to 11-year lows.  Complicating the matter are the allies on each side: majority-Shia Iraq will back the Iranian side while Kuwait and the United Arab Emirates are firmly on the side of the Saudis.  This stalemate between two fiercely angry sides in the Middle East threatens to further destabilize the region, not in the least because Iran backs Bashar al-Assad in Syra against US-supplied rebels and ISIS. 

  • The Takeaway: without any hope of moderation between Sunni Saudis and Shia Iranians, OPEC lacks the quorum needed to put caps on oil production and reduce the output to drive up prices.  No other coalition influences the price of petroleum like this junta, and a failure to reach agreement means that oil is set to take yet another hit on the chin.  Investors should not waste time to short-sell oil over the course of the next six to twelve months, as both Iran and Saudi Arabia rush to pump out more and more crude with little care for the resulting economic collapse. 
  • In addition to commodity prices, the news is particularly bad for stock markets.  ExxonMobil and Royal Dutch Shell will likely take in on the chin once Iran pumps out more crude, making them appealing choices for short-sell.  Just like it's hard to see a recovery date for oil, it's hard to see energy companies pick up momentum and head back into the black any time in 2016.

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