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Tim Daiss

Tim Daiss

I'm an oil markets analyst, journalist and author that has been working out of the Asia-Pacific region for 12 years. I’ve covered oil, energy markets…

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The Implications Of A Fractured U.S., Saudi Alliance

After the resurgence of the U.S. oil industry in recent years due to hydraulic fracking and the shale oil revolution, most thought the days of Middle Eastern oil producers, Saudi Arabia in particular, being able to threaten use of the so-called oil weapon as geopolitical leverage or even coercion were over. But that couldn’t be further from the truth.

Even though the U.S. is pumping oil at record levels, hitting 11 million barrels of oil per day, a rate that should have negated such a threat from ever resurfacing, it seems that Washington has also arguably shot global oil markets in the foot by re-imposing economic sanctions against Iran, with more sanctions slated to hit the Islamic Republic’s energy sector in just a matter of weeks.

The loss of Iranian barrels from global oil markets has already pushed prices well past $80 per barrel recently, and prices could break into the $90 plus range after November. Added to the fray are long term production problems in major OPEC producers Venezuela, Nigeria and Libya - in effect offsetting the ramp-up in U.S. production and the ability for shale producers to play the coveted role of oil markets swing producer. Now Saudi Arabia has taken at least marginal control of oil markets back again - not a comforting prospect for many. Related: Goldman Sachs: This Is The Next Big Risk For Oil

Saudi Arabia said on Sunday it would retaliate against any punitive measures from the U.S. linked to the disappearance of Washington Post columnist Jamal Khashoggi with even “stronger ones.”  In what Bloomberg News called an implicit reference to the kingdom’s petroleum wealth, the Saudi statement noted the Saudi economy “has an influential and vital role in the global economy.”

1973 oil embargo remembered

While many analysts doubt that Saudi Arabia would use oil as a geopolitical retaliatory weapon if forced into a corner, history dictates otherwise. A flashback to 1973 and long lines stretching as far as the eye could see at petrol stations not only in the U.S. but across much of Europe should be a reminder of Saudi resolve.

However, the Saudis for their part, should also consider how the U.S. and its allies responded to that infamous embargo. Demand destruction set in amid then-historic oil prices, the Paris-based International Energy Agency (IEA) was formed to help monitor oil markets for its member states, the U.S. and others established strategic petroleum reserves, and governments passed fuel efficiency standards that eroded oil demand to the point that it eventually hurt participating oil producers as much or even more than the intended victims.

Some naysayers also claim that too much has changed in the past 45 years for that to happen again, but that is also likely shortsighted. For one, oil remains the top source of revenue for Saudi government coffers, despite the kingdom’s ongoing attempts to diversify its economy - something that will take considerable time, foreign investment and global political goodwill - something the Saudis, if implicated in wrongdoing over the Khashoggi incident, will find themselves short of.

Second, Saudi Arabia was for all practical purposes embarrassed by its ill-fated attempt to regain control of an oil market in serious supply overhang in late 2014 when it decided to forgo decades of oil market wisdom and pump at all costs, first to maintain oil market share and also, though still vehemently denied by Riyadh, to drive prices down and force U.S. shale oil producers - whose oil production break even points were exceedingly high - out of business. Related: This Giant Gas Field Is Rising From The Dead

However, it didn’t work as planned and forced the Saudi economy into a tailspin with threats of economic collapse. Though they may deny it, regained control of global oil markets, even the well-being of the global economy, would bring respect back to the country’s storied but now slightly tarnished oil production legacy.

Geopolitical and diplomatic dysfunction

Of course, the fallout from any kind of punitive actions against Riyadh from Washington would be cataclysmic for stability in the already turbulent middle east. It would effectively see Washington not only have sanctions in place against Saudi regional arch rival Iran but also against longtime ally Saudi Arabia itself - perhaps an unprecedented situation in terms of geopolitical and diplomatic dysfunction.

It would also strain U.S.-Saudi ties, complicate matters in Syria and Yemen and in joint efforts to reign in Iran’s nuclear development plans, ballistic missile program and regional hegemony ambitions. In short, what an infuriated U.S. Congress should take into account before it forces President Trump’s hand over any punitive actions against Riyadh is the end game. How could this play out over the next few years in both oil markets, global economic growth and even American national security? Without a strong U.S.-Saudi alliance, a power vacuum will open up in the Middle East that a host of players, mostly with nefarious ambitious, will seek to fill.

By Tim Daiss for Oilprice.com

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