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Oil price spike on Saudi upheaval will be short-lived

  • The 32-year old crown prince of Saudi Arabia, Mohammed Bin Salman, consolidated his power over the weekend arresting political rivals on corruption charges.
  • The move was all part of the Saudi's efforts to get oil prices higher.
  • Here's why the price spike will be short-lived.
Saudi Arabian Prince Mohammad bin Salman.
Dursun Aydemir | Andalou Agency | Getty Images
Saudi Arabian Prince Mohammad bin Salman.

In a move worthy of Michael Corleone of The Godfather movie fame, the 32-year old crown prince of Saudi Arabia, Mohammed Bin Salman, consolidated his power, over the weekend, by trotting a tried-and-true method of vanquishing political rivals in a monarchy: charge them with corruption.

This move changes the set up in the kingdom. Power used to be shared among the several descendant children and families of the former King Abdullah. Now, power is wholly within the grasp of the Bin Salman branch.

It was shocking to see the familiar face of billionaire investor Prince Alaweed Bin Talal get caught up in the purge, but you had to know something was amiss for him when he failed to attend any of the "Davos in the Desert" festivities last week.

The conference, Future Investment Initiative 2017, was a who's who of international finance, and it was the articulation of the crown prince's vision for the future of the kingdom. The presentation was replete with high stylized presentations and the announcement of a futuristic $500 billion business city called Neom.

In order to achieve these lofty goals, the crown prince is going to need a lot of investment capital, and low oil prices, below $50, are not part of the planning.

The Saudis led the charge to get OPEC members and Russia to limit production to alleviate the global supply glut, and even reduced their own output more than required. Initially, while production volumes were reduced, exports continued apace, but the Saudis awoke to that issue. They have steadily decreased export volumes this year, especially to the U.S.

"Unfortunately for the crown prince, the rising prices will only invite more U.S. production, along with less compliance from other OPEC members and increased pressure from Russia to end the pact."

This cutback in exports to the U.S. is one factor in the fall of overall U.S. crude oil inventories, and the rising prices.

The moves show just how high the crown prince sees the stakes. After all, by engaging in these reductions, the kingdom is ceding market share to the likes of Iran, Iraq, and U.S. shale producers, who have recently ramped up exports to record levels of over 2 million barrels per day.

By consolidating power, the crown prince has put the burden of his grand plans all on himself. To be sure, he has made a lot of enemies, within the royal family and among the religious elements, with his liberalization measures, such as allowing women to drive, finally.

With all these various interests now arrayed against the crown prince, his plan for the future needs to have some early success in the present. His free hand may come at a price among Saudi Arabia's allies, but his early embrace of President Trump keeps the kingdom's key ally in his corner.

For success to be achieved, expect Saudi Arabia to work even harder to limit production and get other countries to do so. The crown prince desperately needs the revenue and the highest possible valuation for the piece of Saudi Aramco that is set be sold to the public.

There is already a consensus among Russia and other producers to extend the production accord through the entirety of 2018.

In the bond market, traders say "don't fight the Fed." In the oil market, it's "don't fight Saudi Arabia."

In this case, the Saudi leadership is highly incentivized to get oil prices higher, making it a tough fight for the bears in the market, for now. WTI oil prices are knocking on the door of $60 and Brent crude oil could approach $70.

Unfortunately for the crown prince, the rising prices will only invite more U.S. production, along with less compliance from other OPEC members and increased pressure from Russia to end the pact. That and the realization the governance situation within the kingdom is settled, for now, will combine to make this a short-lived price spike. Prices will head back down, likely in time for the upcoming OPEC meeting at the end of the month.

Commentary by John Kilduff, a partner at Again Capital, an investment-management firm that specializes in commodities. Follow him on Twitter @KilduffReport.

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