Saudi Arabia is the swing producer of oil, and oil production is crucial for the international monetary system.
Saudi Arabia’s energy policy differs fundamentally from that of other countries because Saudi Arabia is the country with the most oil reserves in the oil production business. It is not only the fact that Saudi Arabia has such huge quantities of oil, but also how it influences the energy policies of other countries through its energy reserves, especially the United States of America.
Where once the British ruled over the energy of the world, the desert wind is now blowing in favour of the Americans. For more than 70 years, the two countries have been working closely together in various areas of energy policy and military affairs. Now, 70 years ago, the United States supported the still young monarchy in the Gulf and forged a pact. The British were forced out of the Middle East, eventually they left Iran.
The United States protected Saudi Arabia militarily, and in return Saudi oil reserves were traded in US dollars on the world market. This special relationship still shapes the behaviour of both countries vis-à-vis Iran today.
Just like Saudi Arabia, Iran is one of the most important oil-producing countries, but Iran also has enormous natural gas reserves. The political rapprochement that took place at the time of the Obama administration was now repressed during the Trump administration. The United States has left the laboriously worked out pact for the desescalation of political conflicts and the dissolution of Iran’s sanctions.
The consequences of this development will be a greater rapprochement between the United States and Saudi Arabia. It is to be assumed that this is also in Saudi Arabia’s energy policy interest. The country in the Gulf has a limited interest to have another important oil producer active in the global world trade. Iran would also have a stronger influence on the development of the market prices for oil and natural gas.
We must bear in mind that the medium- and long-term gas contracts are linked back to the oil contracts. This gives Iran a greater influence in the global energy trade than one would first suspect.
The geopolitical tensions between Iran and Saudi Arabia will be exacerbated by the fact that both countries are trying to restructure their national budgets, which they are only able to do to a limited extent due to the current low prices for crude oil. Saudi Arabia, for example, needs a price for crude oil of at least 80 US dollars per barrel in order to restructure its own national budget, which is hardly feasible with the current market prices.
The basic principle of Saudi Arabia’s global energy policy is is as follows:
If the oil price is over 80 US dollars per barrel of oil, the oil-producing countries and big oil companies benefit. More capital is invested in shale oil and shale gas production, as well as in Canadian tar sand and offshore platforms. Due to the high cost of capital, these investments only pay off if the oil price remains at over 80 US dollars per barrel of oil in the medium to long term. Ideally, however, due to the high cost of capital for the production of crude oil and natural gas, it should be more than 100 US dollars per barrel of oil. This is utopian at the moment.
If the oil price is below 80 US dollars per barrel of oil, however, the buyer countries, whose consumers, the global trade with goods that require a high capital input, and the global economy in general benefit because the main share of consumption constitutes the main share of the global economy. Contrary to popular belief, the production of shale oil and shale gas, as well as Canadian tar sand, only leads in the short term to lower energy costs for consumers and consumption in the United States.
The reason for this is that the risk of a permanent drop in prices with simultaneously rising capital costs has not yet been priced into the lending of banks and investment companies. Due to the low interest rate policy of banks and investment companies, investors and investment companies have been looking for investment opportunities with a good return. It was assumed that shale oil and shale gas is a product with consistent, or at least rising, market prices, while at the same time the global economy was expected to record rising energy consumption.
But the assumption is in some ways a false reflection of reality, because although some in the energy industry do not want to admit it, it is far from certain whether the price of crude oil will rise again. As described in the last paragraph, a rising price of crude oil results in stagnating global economic growth. This naturally also reduces the production of goods, in particular goods that contain oil, such as chemical products and products that require a great deal of oil, for example in agricultural production. Rising prices also mean less consumption.
This vicious circle leads to less oil being needed on the market, and as a consequence the storage capacities of the oil-producing countries and warehouses in the major ports are no longer used up so quickly. There is a relative oversupply, and the price of oil and, in part, natural gas falls.
Why the Saudi energy policy has opened Pandora’s Box, and why Saudi Arabia has a hard time assessing the consequences of its own trade.
That means Saudi Arabia is trying to get a balancing act done, precisely because Saudi Arabia has to maintain its strategic edge in energy geopolitics. At the moment it seems that the world economy is not able to pay prices for crude oil of more than 80 US dollars per barrel.
At the same time Saudi Arabia of course wants to have low market prices for crude oil over a longer period of time, because this destroys the long or short term business model of the shale oil and shale gas producers in the United States which could possibly become a competitor of Saudi Arabia. Low market prices for crude oil clean up the market for crude oil from Saudi Arabia’s point of view and give Saudi Arabia a monopoly position in global energy trading.
However, it must also be considered here that Saudi Arabia did not expect the fall in the price of crude oil to last so long and eat up its own financial reserves.
A wind of change blows through the desert
Furthermore there are big problems within OPEC, because some states of OPEC which are decisive for the market cannot endure such low market prices for crude oil in the long run, such as Venezuela which has its own political problems at the moment.
The question of how Saudi Arabia reacts to international price fluctuations also depends on the net consumption of its own country. Saudi Arabia’s energy consumption is growing rapidly, partly because of its growing population. This means that Saudi Arabia has less and less leeway to control global energy trade because less and less oil is exported.
Of course, this also means that the sources of income of the Saudi state will decrease, unless Saudi Arabia’s domestic economy becomes more productive and Saudi Arabia industrializes.
I mentioned Qatar’s energy policy and geopolitical strategy in a previous article. Now it turns out that Qatar wants to leave OPEC. Now you have to know that Qatar is one of the largest natural gas suppliers in the world. So Saudi Arabia loses further influence over the global energy trade due to diplomatic tensions over Qatar.
Probably Saudi Arabia will continue to hold on to its military ally, the United States, and therefore it is more likely that energy policy decisions from outside will affect Saudi Arabia, and the country will have to change again as the wind blows through the desert.
Simeon Kerr and Anjli Raval, Financial Times, Qatar’s exit from Opec deepens rift with Saudi Arabia, December 2018 [available at: https://www.ft.com/content/a4b4e90c-f7a1-11e8-8b7c-6fa24bd5409c].
Many thanks for the shared interest in the energy world!