September 21, 2023
IntelBrief: Saudi Energy Strategy Frustrates Washington
In early September, Saudi Arabia extended a 1 million barrel per day reduction in crude oil production, first implemented in July, until the end of 2023. The move reportedly surprised U.S. and allied officials, who are trying to tame high levels of consumer price inflation. Russia joined the Saudis by announcing an extension of its own production cut while reducing it from 500 thousand to 300 thousand barrels per day. The announcements caused world crude oil prices to rise to over $90 per barrel. Saudi energy officials argued that the extension was required to maintain balance in the oil market as Western economies slow and China’s economy remains weak. However, U.S. officials and global oil experts assessed that the extension will undersupply the oil market by approximately 3 million barrels per day –the biggest deficit in more than a decade according to experts. Many economists argue that this will cause world oil prices to continue to rise. The 2023 production cuts add to an October 2022 decision by Saudi Arabia, Russia, and other major oil exporters in OPEC+ to cut production by 2 million barrels per day. That move came three months after U.S. President Joe Biden visited Saudi Arabia to re-engage MBS after seeking to isolate him over his role in the 2018 killing of Saudi dissident journalist Jamal Khashoggi; his joint effort with the United Arab Emirates (UAE) to isolate Qatar in 2017; and the internationally-criticized Saudi-UAE military intervention in Yemen.
Saudi Arabia’s decision to extend its oil production cuts can be traced to anticipated shortfalls in the kingdom’s budget and drawdowns of its sovereign wealth reserves to fund its Vision 2030 economic diversification program. One MBS-led project in this program, the Neom megacity, is alone estimated to cost more than $500 billion. Saudi Arabia is also spending heavily to sponsor major sporting events, court superstar athletes, and outright buy high-profile leagues in professional sports like soccer and golf. Bloomberg Economics estimates that Saudi Arabia requires world crude oil prices to reach almost $100 a barrel to cover the costs of its capital investment projects and other financial needs. While the Saudi production cuts will reduce its oil revenue in the short-term, since the state will sell less oil than it could at full production, Saudi officials assess that elevated oil prices will more than compensate for any revenue forfeited once Saudi Arabia starts to put more oil on the market in early 2024, assuming it allows its voluntary production cuts to expire. Higher oil prices might also enable Saudi Arabia to obtain more favorable terms for a further selloff of equity in Saudi Aramco on global capital markets.
The Saudi effort to firm world oil prices comes despite new efforts by U.S. officials to collaborate with MBS, overriding the objections of some human rights advocates and the crown prince’s U.S. congressional critics. This year, U.S. officials have intensified negotiations with MBS to broker a normalization of relations between Saudi Arabia and Israel. The talks reportedly have advanced to address specific Saudi conditions, including security guarantees and U.S. technology support for the Saudi nuclear program, although U.S. officials say it could take up to a year to work out the fine points of the deal. Still, U.S.-Saudi engagement on Israeli normalization has eased MBS’ doubts about the U.S. commitment to help stabilize the Middle East – doubts that have prompted him and his main Gulf ally, United Arab Emirates (UAE) President Mohammad bin Zayed al-Nahyan (MBZ) to expand relations with both Russia and China. While any new U.S. security guarantees for Saudi Arabia may not approximate the Article 5 commitments of NATO members, which have pledged to militarily defend one another in the event of an attack, a U.S.-Saudi pact could be modeled after a comprehensive security partnership the United States signed September 13 with Bahrain, a close ally of Saudi Arabia. In addition, a 2023 U.S. military buildup in the Gulf has demonstrated to MBS and other Saudi and Gulf leaders that the United States is committed to deterring Iran from taking provocative actions in the Gulf. U.S. officials have also welcomed steps taken by Saudi Arabia to end the long-running conflict in Yemen, including through direct talks between Saudi negotiators and leaders of the Iran-backed Houthi movement.
U.S. leaders have expanded their working relationship with MBS even further to include cooperation on major regionwide economic initiatives. On the sidelines of the G-20 meetings in New Delhi earlier this month, President Biden, MBS, MBZ, Prime Minister Narendra Modi of India, and European leaders announced a new trade route – the India-Middle East-Europe Corridor (IMEC) – connecting India to the Middle East and Europe through railways and ports. The U.S.-led plan is comprised of two separate routes – an eastern corridor linking India to the Gulf states and a northern corridor connecting the Gulf states to Europe. MBS and MBZ’s participation in IMEC signals their willingness to deliver large financial contributions to the capital-intensive project, as well as renewed confidence in U.S. regional policy. Demonstrating a desire to balance their relations with both Washington and Beijing, Gulf officials stressed that they do not see IMEC as a direct challenge to China’s Belt and Road Initiative. Saudi participation in IMEC came just weeks after the kingdom and the UAE, as well as their regional rival, Iran, were invited to join the BRICS coalition, which China and Russia see as a counterweight to U.S. political and economic dominance in fora like the G7 and World Bank.
Despite this diplomatic progress between the United States and Saudi Arabia, the kingdom’s oil production cuts provides ammunition to MBS’ critics in Washington. Rising oil prices – which translate into higher gasoline prices for U.S. consumers – might become a political liability for President Biden’s re-election campaign. U.S. national gasoline prices are again approaching the sensitive threshold of $4 per gallon. Besides the domestic political impacts of rising gas prices, American critics of the Saudi crown prince cite the production cuts as evidence that the young Saudi leader is willing to harm U.S. interests by enabling the Kremlin to collect more revenues amid its war in Ukraine. Despite European Union and G-7 attempts to cap Russian oil prices, Russian Urals oil is trading above the EU’s price cap. In a statement that may have been intended to ensure the cuts do not set back the Israel normalization talks or other agenda items with MBS, White House officials said publicly that the oil cuts will neither complicate their efforts to curb inflation nor dramatically improve Russia’s faltering economy. Still, U.S. leaders may become more critical of MBS should U.S. gas prices increase further in the coming months.