How the Middle East Will Cope With the US Oil Boom

“If you thought the Middle East was a powder keg before, just wait till you see what could be on tap for 2013,” I wrote to you a year ago.

Today I want to give you an update on the whole story… As you can deduce if you’ve been reading my musings this past year, I don’t think we’re headed for $150 oil anytime soon.

But, as an investor it’s always important to keep an eye on these “fat tail” events. After all, that’s where the life-changing profits reside. So without further ado, let’s take a look at the scenario that could lead to $150 oil…

“It’s time to head down the wormhole” I told you last year. The story begins in Saudi Arabia.

Saudi, according to the U.S. Energy Information Administration (EIA), holds nearly “one-fifth of the world’s proven oil reserves” and currently sits at the head of the list for oil producing and exporting nations.

As it stands, Saudi is the “friendliest” and most stable of the oil producing nations in the Middle East. With that said, it’s safe to assume as Saudi goes, so follows the rest of the region.

Lately, Saudi’s position as top dog in oil production has come under some scrutiny. You’ve likely seen the reports from the International Energy Agency, Goldman Sachs and more, that predict the U.S. will out-produce Saudi Arabia (this could happen within the next year or two.)

Regardless of how quick that forecast pans out, the Saudis and OPEC are starting to feel the heat from increased U.S. production. After all, with more oil coming out of the ground here in the U.S. the demand for Saudi oil heads lower.

Indeed, from the peak in 2003, the U.S. now imports well below half of what it used to from the Saudis. (Note: that’s a lot of dollars NOT heading to the Middle East.)

This trend is immediately affecting Saudi and OPEC’s ability to manipulate prices, too. With less demand for their crude, it’s hard to jack prices artificially higher. This “added” premium, as you’ll see is vitally important to the Saudis.

Hold that thought.

In the meantime, Saudi Arabia has been smoking a lot more of its own dope. That is, with abundant and cheap oil over the past few decades, the country has increasingly been consuming its own oil production. Whether it be for power generation or vehicle use, the statistics are rather alarming.

Take a look at this chart, courtesy of the EIA:

Saudi Oil Consumption, 1980-2012

Saudi Arabia, with each passing day, uses more of its own oil. Residents crank their air conditioners on hot days, modern conveniences suck up more kilowatts and car use is spurring the demand for more gasoline. It’s all adding up in a big way.

The sharp up-tick in consumption in recent years is proof-positive that the people like this “cheap” oil.

Just how much oil is Saudi Arabia using? A write-up in The Atlantic puts it this way, “It’s astounding to consider that Saudi Arabia, for example, has an economy one-sixth the size of Germany and yet consumes as much oil.”

After all, that’s what the current Saudi subsidy does (it’s very similar to what happens in other emerging oil nations – and believe it or not, China – where most citizens don’t ever see a “real” price of oil.) Heck, if you and I were given subsidized gasoline imagine how much more we’d use!

But be warned, this cheap oil party in Saudi Arabia is going to come to an abrupt end.

The way I’ve said it in the past, it can only happen two ways:

  1. Give the oil to the people. In this scenario, the country uses so much oil that exports dry up (Citigroup suggests this could happen by 2032.) In short, this means the country no longer enjoys a constant flow of U.S. dollars – therefore the government struggles to stay solvent and pay for its welfare system.
  2. Sell the oil to the world. In this scenario, the country realizes it’s using too much oil, in country, and decides to take action. The obvious action would be a cut of the subsidy. At that point the price for energy, in country, could double or triple.

Either scenario leads to an unhappy population. Either the government has no money and can’t continue welfare programs, or it cuts its energy subsidies and prices skyrocket.

The Saudi government will soon be sinking in a sandpit of unhappy citizens. And when the government gets neck-deep, watch out.

Of note, this was a prediction I came up with last year – and this doomsday scenario has yet to play out. But rest assured that crazier things have happened! And with more U.S. oil production pressuring prices, we could get a glimpse of it soon.

Now, add restless natives to what we talked about above. Today, with more unconventional oil hitting the world market the Saudis are exporting less oil to the U.S., which is having a direct impact on Saudi’s ability squeeze a premium price from the market.

Without having that extra, say, $25 a barrel, the government is already struggling to keep pace. This gets back to something that Byron King calls “the breaking point.”

Oil Price Needed for Foreign Countries to Pay Their Bills

You see, if oil drops to $80 or less the Saudis have a hard time paying their ever-growing bills. Last year, Bloomberg put it this way: “Saudi King Abdullah promised to spend $130 billion on extra subsidies for housing and benefits as well as $500 billion for previously announced infrastructure projects.”

Rising budgets and shrinking revenue, as it tends to happen, won’t end well for this government.

And when things go awry (see: social unrest), and Saudi production is impacted, we’re talking about an epic impact on the oil market.

Not to mention if the whole region loses stability, all bets on oil prices are off. Short-term, we could see $150 easily – and higher prices aren’t out of the question. Compared to Arab Spring, this will feel more like Arab Armageddon.

Pretty ironic, huh? A fresh supply of U.S. oil puts pressure on prices and topples the Saudi government… leading to a short-term spike in global prices. Oh what a tangled web!

Keep your boots muddy,

Matt Insley
for The Daily Reckoning

P.S. The only silver lining to this Saudi story is that the U.S. finds itself in a much better position than it would have been, say, three years ago. Today oil is flowing through the pipelines in Texas and North Dakota at an ever-increasing pace. Heck, the black goo has even been filling up some of the pipeline systems and making its way onto barges, trucks and railways all around the country. This added oil, no matter the price, means more revenue for the right midstream players. These are the pipeline and processing plays that essentially collect “tolls” on this newfound bounty. And in yesterday’s issue of the Daily Resource Hunter, I gave readers a chance to access a list of some of the best names in the field. Not a Daily Resource Hunter reader? Sign up for FREE, right here, and never miss another great opportunity like this one.

Original article posted on Daily Resource Hunter