The Saudi Arabian Oil Conspiracy and What It Might Mean for Your Portfolio

With oil prices now trading at nearly six-year lows, investors in oil related stocks have suffered mightily in the last six months. 

WTI Crude Oil Spot Price data by YCharts

Much has been written about why oil prices have collapsed, and what it might take for them to recover. The key player in both explanations remains OPEC and Saudi Arabia, which produce about 33% and 9% of the world's oil, respectively. 

Most oil analysts agree that OPEC's recent decision to hold the line on production despite sinking oil prices is part of a price war designed to squeeze higher production cost U.S. shale producers in a bid to reclaim market share. However, there are also several reasons I think Saudi Arabia, the world's largest swing producer, may drag this oil pricing war out far longer than most people expect. This in turn might prove incredibly important to the potential future returns of your portfolio.

The great Saudi Arabian oil conspiracy
On Sept. 11, 2014, Secretary of State John Kerry met with Saudi King Abdullah bin Abdulaziz to discuss how the U.S. and Saudi governments could work together to counter the growing threat of ISIS, or the Islamic State of Iraq and Greater Syria, the fundamentalist Muslim organization that has managed to seize control over large areas of Syria and Iraq.

In the effort to dismantle ISIS, the U.S. Treasury Department's Under Secretary for Terrorism and Financial Intelligence, David Cohen, has stated that the "Treasury is committed to ensuring that [ISIS] is unable to access the international financial system."  The value that ISIS derives from its oil trade has been estimated to be as much as $3 million per day. It's not hard to figure out why the U.S. would like Saudi Arabia's help in fighting ISIS. Could the Saudis' decision to lobby OPEC to hold production in the face of collapsing oil prices really be a stratagem to starve a dangerous rival of necessary funding? While the idea has a certain appealing logic, this tactic might prove to be akin to trying to kill a mosquito with a tank.

That's because the Saudis recently released their 2015 budget which assumes an average price of oil at $60 per barrel and results in a $38.6 billion deficit, which represents a staggering 17% of its 2015 total spending plan. What if oil prices were to remain at $50 per barrel? Well, then the situation looks even worse. Granted, Saudi Arabia has used the recent boom years of high oil prices to amass a $750 billion foreign currency reserve, but even that will only last so long if oil remains this cheap for an extended period. 

Source: Oilprice.com.

However, as the above table illustrates, Saudi Arabia's ability to weather the current low oil pricing environment is much better than many other OPEC nations, especially Venezuela, and Iran. Which brings me to the second part of the great Saudi oil conspiracy -- the idea that the Saudis are not only trying to hurt rivals such as U.S. shale producers and ISIS, but also key geopolitical rivals.

Why Saudi Arabia's pricing war may be targeting Russia, Iran, and Syria
Venezuela's president Nicolas Maduro recently told a group of Venezuelan businessmen that he believes the U.S. and Saudi Arabia have conspired to lower oil prices to attack Russia and Venezuela. 

"Did you know there's an oil war? And the war has an objective: to destroy Russia...It's a strategically planned war ... also aimed at Venezuela, to try and destroy our revolution and cause an economic collapse."

This is a sentiment that's been echoed by none other than Russian president Vladimir Putin:

We all see the lowering of oil prices. There's lots of talk about what's causing it. Could it be an agreement between the U.S. and Saudi Arabia to punish Iran and affect the economies of Russia and Venezuela? It could.

Such claims have been vociferously denied by the Saudi government with Ali al-Naimi, the Saudi Oil Minister, stating: "We do not seek to politicize oil... For us it's a question of supply and demand, it's purely business." 

While it's plausible the U.S. may wish oil prices to decline so as to starve Russia's budget, which is 50% dependent on revenues from oil and natural gas exports, Saudi Arabia, which gets 80% of its budget revenues from oil sales, would be harmed even more by such a strategy. So why would the U.S. and Saudi Arabia consider such a self-damaging tactic of pushing oil prices down? The answer potentially lies not purely in economics, but also in long-standing military, religious, and geopolitical calculations. 

The friend of my enemy is my enemy
The U.S. and Saudi Arabia both share a common interest in ousting Syrian President Bashar al-Assad. Specifically, Saudi Arabia dislikes that its largest regional rival, Syria, is allowing Iran to smuggle weapons and cash to Hezbollah in Lebanon.

Meanwhile, Russia, a strong ally of Iran's nuclear program, -- Russian companies have signed contracts to build as many as eight nuclear reactors for Iran, as well as supply them with enriched uranium -- is Assad's largest supplier of weapons. In fact, Russia has an estimated $4 billion of defense contracts with the Assad regime. 

Thus, the Saudis may view long-term low oil prices as a way of combating their geopolitical rivals and hinder Tehran in its efforts to develop its nuclear program and perhaps build nuclear weapons. After all, thanks to international sanctions, Iran requires the highest oil price to balance its budget of any oil-producing nation. 

Source: Reuters.

If oil prices decrease far enough and remain low long enough, not only might Saudi Arabia steal market share from U.S. shale producers and thus gain far more long-term revenue, but it might also economically and militarily weaken its major rivals in the Middle East and expand its sphere of influence. From a long-term perspective such a strategy might be seen by Saudi Arabia as both highly lucrative and strategically smart, from a diplomatic, military, and geopolitical perspective. 

How this impacts you and your investments
So what do these potential Saudi geo-political-petro economical machinations have to do with you and your portfolio? The answer lies in the fact that Saudi Arabia has pretty much all of the world's spare oil production capacity of 2 million barrel per day. 

This makes them the 800-pound gorilla in the world oil markets with the ability to crash the price of oil even further should it decide to throw the taps wide open. While that scenario may not be diplomatically feasible, Saudi Arabia is still in the driver's seat when it comes to affecting the price of oil.

In other words, Saudi Arabia is the key market maker, while many of the oil companies we invest in are market takers. Thus, investing in the oil sector for the long term means accepting the risk of periodic volatility like we're seeing today. The key to earning great returns over time is to remain levelheaded when everyone else is freaking out. Short-term volatility can present opportunities for those willing and able to look past current shortcomings -- even if we are reminded of the short term risks everyday.