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Is OPEC Eating Its Own?

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Is OPEC Eating Its Own?

The Persian Gulf oil monarchies, led by Saudi Arabia, are resolute in sticking with their 13-month policy of flooding the global oil market in order to force out non-OPEC competition. This cunning plan hasn't gone according to script, however. US shale drillers have ridden new fracking technology to drastically lower operating expenses, and the Russians are old hands at the "enduring hardship in the face of external threats" game.

This means that the "junior partners" of OPEC are the ones most likely to collapse under the pressure. Dubbed by some analysts as "The Fragile Five," they are Algeria, Iraq, Libya, Nigeria and Venezuela. Much like the Gulf oil states, these nations have used the bounty from high oil prices to "buy off" their citizens to some extent or the other. Unlike the Arab oil monarchies, however, they do not have massive foreign currency reserves to help fund government programs in the current economic climate. This means that they have been forced into extreme cuts in social services that are fueling public unrest.

Venezuela

  • $40/bbl needed to balance 2016 budget
  • $60/bbl was assumed for 2015 budget
  • 95% of exports
  • 90% of government revenue
  • Stability: Widespread unrest, capital flight

The worst-off OPEC nation by far is Venezuela. Due to what some observers call world-class mismanagement of the economy by Hugo Chavez, Venezuela was teetering on the brink of default even when oil was selling for $100 per barrel. Oil exports account for 90% of government revenue, but up to 90% of that revenue is used to service debts (including $46 billion from China.)

A massive money printing campaign has led to a 99% devaluation in the Venezuelan bolivar since 2003. A scheme by the government involving four different exchange rates has failed to corral rampant inflation. The black market exchange rate is now 900 bolivar to the dollar.

A 70% fall in oil prices on top of these existing economic woes has meant that the government doesn't have enough hard money to import staples such as milk, eggs, and flour. This has led to violent protests that opposition parties rode to a majority in Congress. The current president stacked the Supreme Court with supporters shortly before the election, which means a Constitutional crisis is imminent. Most observers expect Venezuela to go into sovereign default by the end of the year.

Nigeria

  • $38/bbl needed to balance 2016 budget
  • $78/bbl was assumed in 2015 budget
  • 70% of exports
  • 75% of government revenue
  • Stability: Active Islamist rebellion

Nigeria is the largest economy in Africa, and also its largest oil producer. Despite this, frequent fuel shortages and power outages plague the country. The government sees expanding the nation's refining capacity and building up infrastructure to diversify from oil as the most pressing challenge. To this end, the government recently announced that it will ask the World Bank for a $2.5 billion loan, and the African Development Bank for $1 billion. Other planned borrowing will reportedly bring the total to $9 billion. This money is tagged to exploit mineral resources and provide the power needed by an expanding industrial base.

The hurdles facing Nigeria not only include social unrest over cuts to social programs, but also armed terrorist threats from two directions. Former militants in the oil-rich Niger Delta in the southern part of the country have been bombing oil pipelines in protest over cuts in social programs and "hush money" paid to former rebel commanders, who were granted amnesty in 2009.

In the north, the notorious Islamic jihadist group Boko Haram has terrorized and murdered Nigerians on a large scale. Their goal is to overthrow the government and revive the Sokoto Caliphate, which ruled northern Nigeria from 1809 until it was defeated by the British in 1903. The group forbids anything they deem "Western," including elections, education, and Western style dress.

Algeria

  • $37/bbl needed to balance 2016 budget
  • $60/bbl was assumed in 2015 budget
  • 70% of exports
  • 75% of government revenue
  • Stability: Unrest, fractured government, subdued Islamist terror activity

Another nation looking to diversify its economy is Africa's second-largest oil producer, Algeria. Like many other small OPEC members, Algiers is looking to China for infrastructure loans, including for a $5 billion seaport that a Chinese company will manage. It is possibly in the best condition of any in the "Fragile Five" when it comes to foreign reserves, but is working to reduce spending. The 2016 budget calls for a 9% decrease in government spending, which will include reducing subsidies for gasoline, water, and electricity. It's also taking the unpopular move of raising taxes. The VAT on certain goods will more than double to 17% from 7%.

The Algerian government painted itself into a corner during the Arab Spring uprisings of 2011, by greatly increasing subsidies and handouts to defuse anti-government protests. While the measures prevented a rebellion similar to those in Egypt, the underlying cause of corruption was left untreated. Public discontent with the government is rising with the abrupt cancellation of many infrastructure projects causing sudden spikes of joblessness in many communities. Differences over the budget and which projects to cancel has devolved into physical altercations, with the government fragmenting into rival factions. Toss in the fact that the country is in the process of writing a new constitution, and capital flight from all the uncertainty is understandable.

Most Algerians remember the horrific civil war in the 1990s between the government and Islamist militant groups. This makes them unwilling to cross the line when protesting that the new constitution solidifies authoritarian control of the government.

Iraq

  • $45/bbl needed to balance 2016 budget
  • $72/bbl was assumed for 2015 budget
  • 99% of exports
  • 90% of government revenue
  • Stability: Active Islamist rebellion

Iraq and Libya are in the worst shape of any nation in OPEC, torn apart by Islamic extremist revolts. Iraq was the second-largest oil producer in OPEC (and 7th-largest in the world,) but the capture of western oilfields by Daesh has reduced output. Nearly all of the country's 2016 budget is devoted to operations, fighting Islamists, and loan repayments to the IMF. Nothing is left over for investment in repairing war-torn infrastructure. Attempts to diversify the economy in such conditions is basically futile. By accepting loans from the IMF, Baghdad has opened itself up to having austerity measures forced upon it.

Due to seizure of a large portion of the Sunni north of the nation bythe Wahabbist terror group Daesh (ISIS,) the Shiite-dominated Iraqi government in the south has come to increasingly rely on Iran for military support. This further alienates the Kurds and Sunnis in the north, and may eventually lead to the break up of Iraq. Needless to say, attracting foreign investment in such an environment is a non-starter.

Libya

  • $??/bbl needed to balance 2016 budget
  • $??/bbl was assumed for 2015 budget
  • 95% of exports
  • 90% of government revenue
  • Stability: Active Islamist rebellion

Libya has the largest oil reserves in Africa, and some of the largest in the world. This bounty is mostly going untapped after the fall of the Gaddafi government. Libya is basically a failed state at this point, with two rival governments and rebels claiming swaths of territory. No budget data is available to compare to other oil exporters.

Can They Last Long Enough?

The one thing all these nations have in common with each other and the rest of the oil exporting nations, is that the 70% drop in the price of oil has taken away the ability to paper over differences and placate the masses. The question for the "Fragile Five" is whether the pressure the Saudis are feeling from their own population will be enough for OPEC to cut production, before things get much, much worse for the "little guys."

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product

About the Author

Everett Millman

Steven Cochran

Precious Metals Market Analyst
BS University of South Florida (2002)

A published writer, Steven's coverage of precious metals goes beyond the daily news to explain how ancillary factors affect the market.

Steven specializes in market analysis with an emphasis on stocks, corporate bonds, and government debt. He writes a monthly review of the precious metals markets for SurvivalBlog.com.

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