Saudi Arabia is the swing producer of oil. 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 between Iran and the United States that took place at the time of the Obama administration was somewhat repressed during the Trump administration.
The consequence of this development could be greater rapprochement between the United States and Saudi Arabia. This may or may not be in Saudi Arabia’s energy interests. The Gulf country may have a limited interest in having another major oil producer active in global world trade. Iran would also have a stronger influence on the development of market prices for oil and natural gas. The relationship is complicated because Iran is also an OPEC member.
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 could be exacerbated by the fact that both countries are trying to restructure their national budgets, which is only possible to a limited extent for them due to volatile crude oil prices. Saudi Arabia, for example, may need a crude oil price of at least $80 per barrel to balance its own national budget. This could be feasible under current market conditions.
The rationale behind Saudi Arabia’s global energy policy could be 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 means that less oil is needed on the market, which means that the storage capacities of the oil-producing countries and the storage facilities in the major ports are no longer used up as quickly. A relative oversupply is created. Some oil and gas contracts are linked, so natural gas prices may also be affected to some extent. This is one scenario for market volatility and the reason why oil producers try to avoid it.
Regional energy policy might opened Pandora’s Box.
This means that Saudi Arabia is trying to perform a balancing act, as it needs to maintain its strategic edge in energy exports and as a key player in balancing global oil markets. Currently, it looks as if the global economy will not be able to pay crude oil prices above $80 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.
This also means that unless the Saudi domestic economy becomes more productive and Saudi Arabia continues to industrialize, the Saudi state’s sources of revenue will decline.
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].