January 22, 2015
Saudi Arabia may be taking a page out of President Ronald Reagan’s strategy book in using oil as part of a broader defense plan.
That’s why investors need to be mindful of geopolitics when it comes to predicting crude prices, said David Rosenberg, chief investment strategist at Gluskin Sheff & Associates Inc.
“Using oil as an economic weapon has to be assessed when forecasting what the bottom in the price is going to be,” he said in a January 22 report. “This is why it is so difficult to make a forecast for an essential commodity whose production is still largely dependent on a cartel.”
The Organization of Petroleum Exporting Countries, whose biggest producer is Saudi Arabia, in November decided against cutting oil output. The decision contributed to a 60 percent plunge in prices from a June high of $107 a barrel to about $45 this month.
The country is likely to maintain oil output after the death on Friday of King Abdullah, who had ruled the monarchy for about 20 years. His successor, King Salman bin Abdul-Aziz Al Saud, said he will continue the policies of his predecessors in a nationally televised speech.
Rosenberg said investors should consider the parallels between oil’s recent collapse and the price declines of the mid-1980s.
“The Americans and the Saudis conspired to use it as a strategy (among other initiatives) to bring down the Soviet Union,” he said. “This is certainly one reason espoused by political blogger Michael Reagan.”
Reagan, the late president’s adopted son, in a March blog posting described how his father’s administration used collapsing oil prices to pressure the Soviet Union, whose communist economy was heavily dependent on energy exports.
“Since selling oil was the source of the Kremlin’s wealth, my father got the Saudis to flood the market with cheap oil,” Reagan said. “Lower oil prices devalued the ruble, causing the USSR to go bankrupt, which led to perestroika and Mikhail Gorbachev and the collapse of the Soviet Empire.”
Today, Saudi Arabia faces a strategic threat from arch-rival Iran, which this week strengthened its military ties to Russia after getting the country’s help on building nuclear power plants. The U.S. has imposed economic sanctions on Iran in an effort to stall its uranium enrichment, especially since the radioactive material could be used in weapons of mass destruction.
“A week before the November 27 OPEC meeting, President Barrack Obama announced that he was bypassing Congress in his attempt to ink a deal with Iran and pledged to veto any further sanctions,” Rosenberg said. “Don’t think that this did not catch the eye of the Saudi policymaking club.”
He said Saudi Arabia may curb production only after squeezing the economies of Russia, Iran and Syria, which has been engaged in a civil war.
“The Saudis do remain the swing producer,” Rosenberg said, “and as we have seen at other fundamental bear market lows, they can end this thing with the snap of a finger as they did in 1986, 1991, 1999 and again in 2009.”
Bank of America Merrill Lynch said the collapse in oil prices, while beneficial to the U.S. economy, will negatively affect stocks whose earnings depend on energy demand and infrastructure spending.
“The benefit to the consumer from lower energy costs generally outweighs the headwinds of lower energy profits and investment,” according to BofA’s January 20 report. “But the impact for the S&P 500 EPS is quite the opposite: the direct hit from lower energy earnings and capital investment greatly outweighs the positive impact of increased consumption and lower energy input costs.”
The bank estimates the S&P 500 will end the year at 2,200, about 6 percent higher than its January 21 closing price.