For many, any discussion about crude oil seems irrelevant, “so 1970s”: gas station lines, oil cartels, J.R. Ewing. Today we live in an era of wind and solar, electric-powered cars, George Jetson, right? Not exactly. By the way, and no offense to the “Millennials” and younger, how do we produce the vast majority of electricity in this country? Fossil fuels. Moving on…
On September 14th a major oil processing plant and oil field in Saudi Arabia were attacked with pin-point precision by cruise missiles and aerial drones. The perpetrator has not been definitively identified, but evidence points to Iran.
The attack, described by Secretary of State Mike Pompeo as “an unprecedented attack on the world’s energy supply,” could have far-reaching economic and geopolitical implications. Saudi Arabia is one of the world’s largest oil exporters. The attacks took out 5.7 million barrels per day of production, which equates to one-half of Saudi Arabia’s daily exports and over 5% of global crude production.
In the wake of the attack, the international crude oil benchmark, Brent Crude, spiked 15% higher to US$69, the largest one-day percentage move on record. (The US crude benchmark, West Texas Intermediate, made a similar percentage jump.) Nevertheless, global oil prices remain well below their multi-year highs. Daily closing prices of Brent Crude:
Oil prices have fallen victim to a supply-demand imbalance. Thanks in large part to rapid technological
advances, the US has re-taken its place as the world’s largest producer of oil – for the first time since 1973 – and has re-asserted its energy independence. Other energy producing countries are benefiting as well. These new sources of supply are overwhelming a global market that is suffering from declining demand due to economic slowdown and, at the margin, adoption of alternative energy sources.Assuming Iran’s guilt, what would be their motivation? As with many things, follow the money. Countries like Iran and Saudi Arabia are heavily-dependent on oil production to support their economies. Year-to-date Brent Crude has averaged US$65/barrel. According to the International Monetary Fund, the estimated fiscal breakeven price of a barrel of oil for Iran and Saudi Arabia are US$126 and US$85, respectively.
Persistently low oil prices have wreaked havoc with these economies. Saudi Arabia, the world’s largest oil exporter, has seen its foreign exchange reserves fall from $750 billion to $500 billion in three years. It has had to tap into global debt markets, liquidate assets from its sovereign wealth fund and pursue a privatization of the state-run oil company, Saudi Aramco, to plug growing budget deficits, estimated to be 17% of gross domestic product in 2019. Add to that the estimated cost of the attack in terms of lost production: $300 million/day. What happens to an oppressed populace that isn’t fed their proverbial cake?!
The situation in Iran is magnitudes worse. Iran’s economy has been crippled by US-imposed economic sanctions, compelling it to sell oil in the black market. Iran’s calculus in stirring up trouble in the region may be to force renegotiations to end the sanctions. Once sanctions are lifted Iran can freely export oil to countries like France and China, the world’s largest oil and gas importer. Also, Iran and China recently signed a 25-year strategic partnership that includes a $280 billion+ Chinese investment in Iranian oil and gas infrastructure, to include the positioning of military security forces.
This may not be the 1970s, but “black gold” still powers the world. This latest event is a reminder that the 
struggle for control of fossil fuels and their means of delivery portends political tension and military conflict. (That’s been the case for over 100 years.) It is in our country’s strategic and military interest for both the U.S. and its allies to cut dependence on fossil fuels sourced from geopolitical hotspots, like the Middle East, and hostile actors, such as Russia and Iran. Perhaps even China, whose economic slowdown is only worsened by a spike in oil prices, could see the benefit in working with the U.S. on this front. “Drill, baby, drill!”
Sincerely,
Jack E. Ditt, Jr. William L. McCollum
