Mohammed bin Salman was under pressure to make radical changes or face Saudi extinction
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The dramatic events of the past two days in Saudi Arabia imply a whole new era in geopolitics. The problem is trying to figure out what that new era will look like.
From the moment oil prices began falling in July of 2014, I knew something like this was possible.
Currency, Currency, Currency
The Saudi Riyal is pegged to the U.S. dollar. This forms the backbone of the petrodollarsystem that has been the foundation for U.S. dollar diplomacy and dominance over the past forty-five years. With rapidly falling oil prices thanks to record pumping levels by the Saudis, they and the U.S. attempted to break Russia by destroying the ruble and their state budget.
They ran this same playbook in the 1980’s which took oil prices down below $10 per barrel. The Saudis sold oil down near the cost of production and put the Soviets under water, crippling the economy.
But, this time Russia survived because Putin did the unthinkable. He took the ruble off of its soft-peg to the dollar. Russia liked to defend the Ruble/Dollar exchange rate in a narrow band, similar to China and the Yuan. They allowed it to move with the market, but slowly so as to not cause undo domestic problem.
No one in the Washington or Riyadh though Putin would do this. He did and he saved Russia by doing so.
But, the Saudis were intent on breaking Russia and were willing to spend hundreds of billions to achieve their goals.
And Putin called their bluff. They kept on pressuring oil down to $28 per barrel in January of 2016. By free-floating the ruble Russia was able to survive the drop in oil prices because its oil companies pay their bills in rubles, not in dollars.
It was the state treasury that was in trouble. So, Russia cut spending, per its auto-budgeting rules, shored up domestic firms over-exposed to the dollar and rode out the new reality of a weaker ruble.
The Saudi Conundrum
Fast forward to today and it’s the Saudis that are in trouble and Russia is on the cusp of a generational bull market. The Saudis are the ones who cannot pay their bills, must sell off its major assets (Aramco) and rebuild its economy and political system from scratch.
Eventually the extreme pressure of the Saudi financial situation produced the predictable event, regime change. This is what I knew would happen. When? No clue. But, eventually something had to give.
The old way of doing things had to go. This is why King Abdullah’s last major act as King was to visit, not his U.S. masters, but his Russian one, last month.
It was there that he bent the knee, kissed the ring and sued for peace. His new Crown Prince, Mohammed bin Salman was no longer going to antagonize Russia directly. And they would coordinate oil prices from here forward.
But, make no mistake, the Russians now produce the marginal barrel of oil in the world. Not Saudi Arabia, not U.S. wild-catters in the Permian Basin.
Why? Because the Russians are very profitable selling oil at $40 per barrel. They’ve budgeted around that number through 2020. Again, that pesky floating ruble. They can go as low as $20. It wouldn’t be comfortable but it’s possible. Saudi Arabia can’t.
The Saudis ran a 14.8% budget deficit in 2015. 212th in the world. This year the numbers are improving, why? A rising oil price. They still stink. And they are the main reason why the Aramco IPO hasn’t happened yet.
Politically and economically, both Saudi Arabia and the U.S. need oil prices in the $60’s. The Saudis for budgetary reasons the U.S. for profitability of the oil majors who are still saddled with so much over-valued property bought during the boom.
And that is only fueling the incipient Russian boom. Once the Bank of Russia gets out of the economy’s way it will be stunning. And itself will be the nail in the ridiculous narratives spun by U.S. and Saudi media.
For now, the situation is clear, $60-70 oil is the near future.
But, Saudi Arabia isn’t out of the woods yet. In fact, it’s trials are just beginning. And the consolidation of power by Mohammed bin Salman is only the first step. So, what can we look forward to?
Desperation or Salvation?
Nothing has changed economically for the Saudis. Bin Salman’s moves this weekend are in line with Donald Trump’s mandate to clean up the corruption of U.S. media and political institutions. The people who were purged, especially Prince Alwaleed bin Talal, who was the main vector of such corruption.
He and Trump were public enemies, sparring on Twitter. His reach within the U.S. was long. This purge, in my mind, was done in part as payment for Trump’s backing bin Salman’s regime. At the same time Putin wants assurances that the Saudis will keep their adventurism to a minimum.
We’ll see if bin Salman is smart enough to see that just having Trump at his back is not enough to ensure his Kingdom’s survival. The oil war truce is just the starting point. Now he has to completely dismantle the regime change apparatus the Saudis had abroad if he wants to keep Putin appeased.
And it started with Lebanese Prime Minister Saad Hariri and the next step was calling for the arrest of two former Syrian separatist leaders Ahmed al-Jarba and Riad Hijab. Now the Palestinian leader Abbas has been called to Riyadh to speak with King Abdallah and bin Salman.
It looks to me, despite the incessant sabre-rattling at Iran that the Saudis have been neutered by both Trump and Putin. Putin started the process by winning first the price war in oil and then the ground war in Syria.
Iraq has rebuffed their entreaties and continues to edge closer to the Russia/China/Iran axis. Turkey as well. Syria is firmly a Russian ally. Russia reassured Iran with a $30 billion deal with Rosneft which also brings Azerbaijan into the fold.
Putin has organized a major summit in Sochi on the 18th to begin the post-civil war political process for Syria. Simply everyone will be there, except the usual suspects. The writing for this was on the wall when the first peace conference was organized in Astana two years ago. It marked the end of the Saudi/U.S. control of the diplomatic game in Geneva and the beginning of Russia’s.
If you begin to look at the game board the battle lines are clearly marked. It’s the Saudis, U.S. and Israel versus pretty much everyone else. And with a board that lopsided, it’s time for a grand peace bargain to emerge.
The desperation of Saudi Arabia, under financial existential threat for nearly three years, has driven us towards a new reality in the Middle East. Putin played a perfect game of attrition, using Syria as the battlefield. One where the interests of the Saudis, the Israeli and the Americans have a lot less importance than they did previously.
For the Saudis, it was either this or extinction. It may be too early to say this, but it looks like Mohammed bin Salman chose life. We’ll know if I’m right in a few weeks after Astana.