from Energy Realpolitik

Déjà vu, Saudi Style

U.S. President Donald Trump delivers remarks as he welcomes Saudi Arabia's Crown Prince Mohammed bin Salman in the Oval Office at the White House in Washington, U.S. March 20, 2018. REUTERS/Jonathan Ernst

October 15, 2018

U.S. President Donald Trump delivers remarks as he welcomes Saudi Arabia's Crown Prince Mohammed bin Salman in the Oval Office at the White House in Washington, U.S. March 20, 2018. REUTERS/Jonathan Ernst
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The longer I write about oil, the more I have become convinced that names and faces can change but the basic storylines repeat themselves. For students of history, it might be tempting to say that this is because each generation of new blood comes without the experiences of the past. But perhaps it is just the nature of oil. The inexorable boom and bust pattern of the oil market follows a geopolitical cycle that has proven next to impossible to break. Geopolitical events of the past few weeks look poised to show both the U.S. president and Middle Eastern leaders how difficult it is, even with so many structural changes in energy markets, to avoid debacles of the past.

Famous TV anchor and Saudi media figure Turki Aldarkhil wrote on government-owned news service AlArabiya, “If U.S. sanctions are imposed on Saudi Arabia, we will be facing an economic disaster that would rock the entire world.” The commentary continued, “Riyadh is the capital of its oil, and touching this would affect oil production before any other vital commodity. It would lead to Saudi Arabia’s failure to commit to producing 7.5 million barrels. If the price of oil reaching $80 angered President Trump, no one should rule out the price jumping to $100, or $200, or even double that figure.” He continued, “An oil barrel may be priced in a different currency, Chinese yuan, perhaps, instead of the dollar. And oil is the most important commodity traded by the dollar today.”

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In larger print, a summary statement warned, “There are simple procedures, that are part of over 30 others, that Riyadh will implement directly, without flinching an eye if sanctions are imposed.”

No doubt, rising tensions between the United States and Saudi Arabia surrounding the circumstances of missing journalist Jamal Khashoggi has become an oil matter of rising importance. The escalating incident has laid raw an uncomfortable fact: serving as the central bank of oil requires a steady hand.

Global oil markets were already tense upon speculation that the kingdom’s spare capacity, the amount of extra oil production that can be brought online quickly within 30 days and maintained for 90 days, was lower than previously thought. For years, Saudi Arabia has maintained it has the ability to raise production to 12 million barrels a day (b/d) and stay at that level. But analysts have recently said the kingdom may be currently producing almost at its maximum, and would need to make investments to be able to raise production further. Energy Intelligence Group reported earlier this month that “producing beyond 11 million b/d will take significant drilling and require more rigs.” The oil newsletter also reports that the kingdom will be able to add more oil to markets once the repaired Manifa field can come back on line in January 2019. Its expansion at the Khurais field is due to add 300,000 b/d by mid-2019. The Saudi oil minister has stated production is currently at 10.7 million b/d and sources report the kingdom has also sold oil from storage in September and October.

Prior to the new U.S.-Saudi tensions, U.S. President Donald Trump had repeatedly expressed frustration over Twitter regarding Saudi Arabia’s wavering hand on global oil markets. Twice in recent months, the kingdom’s statements of intended closer oil collaboration with Russia to support oil prices have been met with marked public displeasure from the White House, prompting the Saudi oil minister to reverse course at recent gatherings of oil producers in a sign that Riyadh viewed its long standing relationship with the United States more critical than its newer ties to Moscow.

But in an example of how difficult oil diplomacy can be, oil prices continued to rise on fears that any new supply disruptions could not be physically met by either increases in supply from Saudi Arabia (based on capacity constraints) or from the United States whose production increases are temporarily stalled by pipeline bottlenecks.

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With oil as the backdrop to new additional strains in the U.S.-Saudi relationship over other matters, President Trump told supporters in a highly personal reference at a rally last week, “King, we’re protecting you. You might not be there for two weeks without us. You have to pay for your military.”

The escalating rhetoric between Saudi Arabia and the United States is bound to harken back to memories of past colossal oil debacles of 1973 or 1979, for those old enough to recall those turbulent times. My book with Rice University econometrician Mahmoud El-Gamal has a chart on page 35 in chapter 2 that might give solace to U.S. policy makers. It shows how U.S. real per capita gross domestic product recovered quickly in the 1980s while that of Saudi Arabia collapsed and did not start recovering until the mid-2000s.

But there is another lesson in my book as well. National oil companies (NOCs) that face a geopolitical collapse take years, if not decades, to recover, if they recover at all. Today, there are many NOCs at risk simultaneously, whether from war, international sanctions, financially destabilizing policies of populist leaders, or via anti-corruption campaigns that have left some important NOCs rudderless. That situation has lowered the resilience of oil markets, even with the positive role of U.S. oil and gas exports and emerging oil-saving digital technologies. The reverberations would be large if an erratic U.S.-Saudi relationship or any internal Saudi domestic political or economic issues were to damage the future operational efficiency of state oil firm Saudi Aramco.

That said, the United States has shown on many occasions that it has many other values that supersede oil, including international norms of behavior, free democratic elections, and freedom of speech.

U.S. sanctions against Russian metals firm Rusal and its officers will be one such case. Those sanctions were imposed by the Trump administration despite a large impact on global aluminum markets and Russia’s important role in oil markets. In a prior Republican administration, justice for the families of victims of Pan Am flight 103 took priority over oil holdings in Libya.

Generally speaking, history has judged taking a stance on democratic principles in precedence over oil positively, even when outcomes are less than positive in the immediate aftermath. Virtually no American historian looks back on 1973 and suggests the United States should have backed down on its foreign policy to avoid an oil embargo. More disagreement exists on whether U.S. support for the Shah of Iran’s top down modernization program, implemented via massive repression across Iranian society, was smart or misguided. Active U.S. support for the Shah’s nuclear power aspirations and its Bushehr nuclear plant still haunts U.S. national interests four decades later.

Much is at stake in the current escalating diplomatic crisis between Saudi Arabia and its long-time ally and backer, the United States. So far, oil traders appear to be assuming cooler heads will prevail. History would suggest that this sentiment might be mistaken. Middle East conflicts, once begun, tend to spiral towards disaster, regardless of the hard work of well-meaning diplomacy. Let’s hope this one proves to be the exception. 

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