May 13, 2016
Interviewed by: David Snow
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Why Shorter Oil Price Cycles are Here to Stay

Gal Luft of the Global Forum on Energy Security discusses Saudi Arabia’s motivations for keeping oil prices low, and why oil prices will go into a new state of perpetual volatility.

Gal Luft of the Global Forum on Energy Security discusses Saudi Arabia’s motivations for keeping oil prices low, and why oil prices will go into a new state of perpetual volatility.

Saudi Arabia and the Future of Global Energy

With Gal Luft the Global Forum on Energy Security

Matt Malone, Privcap:

Hi, I’m Matt Malone from Privcap. I’m here today with Gal Luft, the co-chairman of the Global Forum on Energy Security. Welcome to Privcap.

Gal Luft, Global Forum on Energy Security:

Good to be here.

Malone:           So much of the global economy and global energy markets hinge on Saudi Arabia. What do investors need to know about what’s going on in Saudi Arabia right now to make informed decisions about the direction of energy policy in the U.S., but also just global energy crisis?

Luft: Saudi Arabia is fighting multiple wars at the moment. It’s an embattled state in the sense that they’re fighting a proxy war against Iran in two locations: one in Yemen and the other in Syria. They are extremely concerned about the Iranian nuclear project and it’s in the context of rivalry between Sunnis and Shiites in the Muslim world, but also rivalry about who is going to be the hegemon in the Persian Gulf.

At the same time, they’re also fighting an economic war. Who is the enemy? The enemy is Texas. The enemy is Pennsylvania. The enemy is North Dakota. Why? Because in Saudi Arabia, people don’t pay taxes, so all the money to keep the country intact has to come from oil. And they need over $90 a barrel to break even. They’re not getting it, as the same situation in the rest of the OPEC countries.

The Saudis made a strategic decision to keep the prices of oil low enough for a long enough time in order to disseminate, to decimate the competitors, to destroy as many American oil companies. Most of them need break-even prices of $50 or $60 a barrel and, if they eliminate enough of the competition, while hurting the Iranians, they’re getting two benefits. And I think they’re willing to pay the price. The other thing I would urge investors to know that the figure that controls Saudi Arabia today is not the legendary minister of oil, Ali bin Ibrahim Al-Naimi and it’s not the king, even. It’s a 30-year-old prince going by the name of MBS—Mohammad bin Salman.

This young man is calling the shots. So, the whole kingdom that is so essential to the future of our energy and global economy is controlled by this very ambitious prince. And what he does, where he goes, will tell us where the future of oil is going to be.

Malone: In terms of this notion of keeping prices low to shake out the global oil industry, it’s obviously a complicated and potentially perilous endeavor because, of course, no one knows exactly when a competitor is going to fall, then what the exact breaking point is, correct? So, what are the risks for Saudi Arabia? How long do they need to keep this up? What’s the current thinking on that and what’s the downside of this policy?

Luft: Obviously, the downside is that it’s costing them money. Every day that the price is low, below what they need, is a net loss for them. But they take the long-term approach here and they have deep pockets. Unlike most of the other OPEC countries, like Venezuela, Nigeria or Angola, who have no money, Saudis have cash reserves. They still have hundreds of billions of dollars in cash reserves, so they have deep pockets. That can go on for a few more years.

I think their strategy is beginning to work because we already see an increasing number of American companies moving towards bankruptcies. It’s very hard for them to recycle their debts. But you’re right. We don’t know how long exactly it will take. They still have time and I think they still can do it for another year or two, easily. After that, it’s going to be quite complicated because that will mean they will not have enough money to keep their population happy. At that time, they’re taking the risk of a disgruntled population [that] may storm the palace and they may end up like Mubarak or Gaddafi. They don’t want to get there. So, it’s a fascinating game of chicken. Who’s going to blink first?

Malone: You talked a bit about Iran. How much does the Iranian situation and what Iran is looking to expand its economy factor into all of this? How much maneuvering and how much political capital do they have to influence this situation?

Luft: The Iranians have huge potential, but they don’t have money. In order for them to materialize their potential, they need investment and their investment is not there, not that I see it. It’s one thing to materialize your pre-existing capacity. It’s another thing to increase production capacity, which will take many, many billions of dollars to do.

The Saudis don’t want to see this happening. They don’t want Iran to resume its legendary role as a leader in oil and gas production. And they prefer to keep the price low, for now, in order to stall investments and to make the investor community less excited about long-term, very expensive products and so forth.

Then, there is another wildcard here. What’s going to happen in Libya? Remember, Libya is another producer that has stalled because of civil war. But, if we see a movement towards a peace agreement, which I think we’ll see in the next several months, we could see potentially another one million barrels of oil coming into the market. So, that’s also a wildcard: what’s going to happen in Libya?

Malone: On news recently about Saudi Aramco, the plan to take that public, what do you make of that move generally? What do you see as the global implications of having the world’s largest publicly traded company in Saudi Aramco?

Luft: What that idea came out of is Prince Mohammad bin Salman, who I mentioned before, who has a lot of ideas out of the box. He’s talking a lot about moving beyond oil and finding a way to lessen the dependency of the Saudi economy on petrodollars. However, when it comes to privatizing a company like Aramco, certain things need to happen that are very, very difficult to do, the most important of which is to provide transparency.

Nobody is going to register a company like Saudi Aramco without having the entire portfolio of data so investors could make sound decisions. That will take a huge change in the thinking of the Saudis. And I’m not convinced that they are ready to make this change and submit all of this information that they have kept secret—their reserve data, all of their financial data.

Barring that, they will not be able to execute this plan. So, I am sitting on the fence on this. I think, in principle, it may be a good idea for them to do it, but I’m not sure that they’re up to the actual execution of a plan like this.

Malone: You’ve got the possibility of the Saudis putting together a large—in the trillions of dollars—sovereign wealth fund to diversify its investments. How likely is that or what’s the progress on that? What do you think that means for the private equity funds that… are always looking to raise capital from sovereign wealth funds? Certainly, with a pot that big, it’s going to be very attractive to private equity fund managers.

Luft: The Saudis, in the grand vision of reducing their dependency on petrodollars—it all comes back to two different initiatives. One is the privatization of parts of Saudi Aramco and that has to do with a lot of things they will have to embark on the terms of providing access to data, which is something that is very difficult to know if they will be able to execute.

The other one is the creation of this fund, but the numbers that they are talking about don’t sound realistic to me. In my estimation, the Saudi cash reserves are something in the order of $500 to $600 billion right now. If low oil prices continue, that money will be eliminated gradually and I don’t know where they can bring up such an amount of money.

So, while it may be a good idea for them to create a fund and to begin to invest in things that make sense that provide revenue for the long term, what they want to do is to make sure that they have other sources of revenue. They’re not only dependent on the price of oil and the volatility that comes with it, but they have steady sources of revenue.

The question is do they have the money to do it? I don’t see that they have the money to do it. I mean, $3 trillion is about the amount of cash reserves that the whole government of China has. So, we’re talking about a very large sum of money. I don’t think the Saudis can really get any close to this number.

Malone: Let’s take the perspective of a U.S. energy producer, assuming that the Saudis are successful and the shakeout happens, as they hope. What then does the longer-term picture look like? Obviously, the U.S.’s ability and production of energy is not going to go away. So, what would then be the new normal, once this current volatility subsides?

Luft: I think that, as long as we live, we will see volatility in the oil market. We are looking at what I call “perpetual W.” For many years to come, oil prices will go high, will go low and will fluctuate perpetually.

Malone: Just so I understand: obviously, the energy markets have always been cyclical, but you’re saying this is of a different type—do you think it’s going to be shorter cycles, given the various levers that could be pulled and the increasing number of players who can pull them?

Luft: We’ve seen cycles of about 20 years. That was the going average: 20-year cycles. Now, we’re probably going to see five-year cycles and that’s the difference. It would be much more frequent and it means that, for the life of a company, it requires adaptation to the whole new normal.

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