If Oil Prices Don't Rise, the Middle East Will Sink

 | Aug 13, 2016 | 12:00 PM EDT
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The ongoing collapse in oil prices that began two years ago is setting the stage for a catastrophic situation in the Middle East if it continues. That catastrophe could come in three stages of war: civil war within the boundaries of each sovereign; war between sovereign states; and most broadly, for the intra-Islamic fight between the Sunnis and Shias to devolve into a war of finality between them, with one side vanquishing, conquering and perhaps even attempting to extinguish the other. 

I first addressed the potential for oil prices to be caught in a secular decline and its implications shortly after the collapse in prices began in 2014 in the column, "Oil and the Limits to Growth." 

Although the process I laid out has largely occurred over the past two years, one part of that process has glaringly not occurred, and has enormous implications for what happens from this point forward. 

That issue is that U.S. alternative oil producers have not been driven out of business to the extent I envisioned was probable; not even close. 

As I discussed in the column, "The Biggest Current Threat to the Markets" last November, my expectation was that as the Saudis held oil prices down, the U.S. alternative producers would have to severely reduce production, loan defaults would spike, bankruptcies requiring the transfer of assets would follow, and the time it would take for all of this action to play out legally would preclude the ability of the U.S. alternative E&P industry from raising capital to restart production, even as the Saudis allowed oil prices to begin increasing again. 

It would have been a temporary situation but would have provided an immediate reprieve of the fiscal issues facing all the OPEC countries, and in the process relieve the social tensions caused by the lack of economic activity in the region. 

That hasn't happened and economic activity throughout the Middle East has plunged as a result. 

The most daunting aspect of this is that the Saudis are running the largest fiscal budget deficit of all the OPEC members, with the exception of Libya, and as a result must produce oil, regardless of OPEC-mandated limits, in order to meet fiscal budget requirements. 

The fiscal spending is required to fund the social welfare programs the citizens have come to rely upon. The government is fearful that reducing these programs could lead to social unrest and even civil war. 

However, this is causing the other countries to suffer economically and raising the possibility of social unrest and civil war in them. 

I don't know how the U.S. alternative oil sector has been able to achieve the financial efficiencies allowing companies not only to continue to produce for the past two years but with many of them experiencing big rebounds in their stock prices. 

Year to date, Continental Resources (CLR) is up by 100%, EOG Resources (EOG) 30%, Hess (HES) 17%, Marathon Oil (MRO) 13% and Statoil ASA (STO) 17%. 

The only one of this group that's down is Whiting Petroleum (WLL) , by 19%, which is also by far the smallest of them. 

I don't know if it is possible for the alternative producers to continue operating with oil prices at these levels, but it is beginning to appear that they are the marginal producers of oil globally, which means they, not the Saudis, are the group with the capacity to determine the price of oil. 

If that is the case, it is probable that oil prices will never again move above the fiscal break-even prices required to allow OPEC to continue to function or for the member countries to avoid fiscal, economic and social crises. 

The research I've read pertaining to the viability of the alternative oil sector to continue operating falls in two basic categories. One group insists that technological and financial efficiencies achieved over just the past two years have allowed the industry to become the marginal producer, displacing Saudi Arabia permanently. 

The other group insists that the efficiencies are illusionary, have been achieved by way of temporary reductions in capital investment, and will disappear as the industry is forced to make those investments or reduce production. 

I don't know which is right, perhaps there is a bit of truth in both. 

The one thing that appears certain, however, is the Middle East is on a path toward social upheaval that will make the Arab Spring pale in comparison, if oil prices don't at least start rising toward where they were before the collapse began two years ago.

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