Why Are Oil Prices Dropping?

By Habib Al Mulla *
With the price of oil down 28 percent in recent months, financial analysts and political pundits are all asking the same questions: What are the reasons behind this drop and why isn’t OPEC taking steps to stop the bleeding?

It’s Economics 101. When the price falls, you cut supply. OPEC nations are amongst the world’s top oil exporters. It’s certainly within their capability. If there was even a hint they would slow production, prices would certainly jump from current lows of about $82 a barrel.

According to recent estimates, Saudi Arabia needs the price at $99.20 to break even. Even at that point, many OPEC nations would still be in the red. So why is OPEC sitting on its hands?

Theories why oil prices are so low

A number of theories have emerged. OPEC itself posits that the declines are due largely to speculation in the market and that demand isn’t as low as many may think. Others contend that increased competition—in the form of increased U.S. shale oil production—provides incentives for OPEC to keep prices down. However, some studies suggest that oil prices have to fall to $60 or even lower to halt shale production growth.

Both would explain the recent move by U.S. driller Continental Resources Inc. to monetize its hedges in the oil market. Not only does it show great confidence that demand will recover; it also provides Continental with added liquidity ahead of a potential price war with OPEC.

Some argue that Saudi Arabia, the world’s largest producer, is defending its market share by cutting prices rather than production. Others would go so far as to say that Saudi Arabia is pushing prices down to hit its regional rival, Iran, where it hurts most; the economy. Some estimate that Iran needs oil at $136 a barrel to finance its growing spending plans.

The problem with all of these theories is that they do not provide an explanation for the relatively short period in which prices have fallen, particularly if one accounts for continued economic growth in the U.S. and the UK.

A way to combat the Islamic State?

Perhaps that is why yet another theory is making the rounds—and it may be the most interesting of all; not because of its validity, but because of the important geopolitical questions it raises. Could OPEC be keeping prices down to combat the Islamic State? There is no question that the best funded terrorist organization ever relies heavily on seized energy assets to support a burgeoning population and intensifying war effort. Why wouldn’t the OPEC nations at IS’s doorstep do everything in their power to slow its flow of revenue and stop its murderous rampage?

Because, when it comes to oil prices, IS profits either way.

Consider that the OPEC nations in the Middle East and North Africa are universally confronting massive budget cuts due to shortfalls in oil profits. Now, consider the programs those cuts will most acutely impact: Welfare programs. Even rich Gulf Oil exporters face inevitable cuts. Look at the recent statement issued by the Kuwaiti Finance Minister. Kuwait has already revealed plans to slash costly subsidies on diesel, kerosene, and jet fuel. Electricity and water subsidies may also come under scrutiny.

Budget cuts and the risk of losing popular support

Whenever welfare programs are cut, oil producing nations run the risk of eroding the popular support their governments enjoy. In other words, falling oil prices are a boon for IS recruiting and networking. With little aid from their governments, how many more marginalized and disaffected Sunnis will pour into IS-controlled territory, become militarized, and join the fight for the Caliphate? With fewer resources to prevent domestic strife in OPEC nations, how many radical groups throughout the region will be emboldened to work with IS, or alongside it?

Worst of all: When prices do rise again—perhaps because of the very disorder and turmoil created while prices were low—IS will be better positioned to fund its growing territory and influence. It’s a win-win for IS and a loss-loss for the world, no matter how you slice it.

If oil price manipulation is indeed an element of regional strategy to combat IS, then OPEC nations on the front lines need to rethink their approach. While we all share the burden of lost revenue, IS alone reaps a significant benefit. Increased radicalization and destabilization are precisely what IS wants. When the impacts of falling oil prices hit home, we’ll be handing them over on a silver platter.

* founder and executive chairman of the UAE law firm Habib Al Mulla.

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