What The U.S. Position On Saudi Arabia Means For Oil Prices

| About: The United (USO)

Summary

Lower oil prices better for Saudi’s security.

Higher oil prices better for U.S. oil security.

Saudis planning to monetize oil reserves.

Prefers diversified investment portfolio.

Long-term plan to bolt the desert kingdom?

Donald Trump is right about something:"If we weren't protecting them (the Saudis), they wouldn't be there for a week."

Doha was no fluke. Saudi Arabia wants to keep oil prices low for now. It's not about market share, as initially claimed by Saudi oil minister Al-Naimi. Saudi Arabia needs to remain of strategic importance to the United States -- for its own protection and survival.

Low oil prices have caused them huge budget deficits. It's draining tens of billions from their foreign reserves every few months.

But KSA may have more recently come to the realization that if American shale oil production gains remained on track, U.S. dependence on foreign oil would drop to zero by 2020. (Note: The graph below shows a continuation of the net oil import trend as of the OPEC Thanksgiving meeting in November 2014.)

If that were to happen, Saudi Arabia's strategic value to the U.S. would drop significantly--not to zero. But it would be far less valuable than it is to an America addicted to imported oil.

The U.S. has done what was needed over the decades to keep KSA militarily defended for oil security. But the U.S. political winds have been shifting since the Presidents Bush, 41 and 43, have been in office.

Obama Visit

The U.S. and Saudi Arabia are divided by numerous issues, including the approach to the wars in Syria and Yemen, the Iranian nuclear deal and the influence Tehran wields in Iraq.

When President Obama told The Atlantic Magazine this year that he was aggravated by "free riders" -- "people who push us to act but then showing an unwillingness to put any skin in the game" -- he received a rare public rebuke from the Saudis.

Though he hadn't named any country, former Saudi Intelligence Chief Prince Turki asked him in an open letter whether it was "because you have pivoted to Iran so much" and said that he had forgotten "the Kingdom's 80 years of constant friendship." This was hardly true (see 1973 Oil Embargo addendum below).

President Obama met with Saudi King Salman this past week in Riyadh. Turki said that there is going to have to be "a recalibration of our relationship with America…How far we can go with our dependence on America? How much can we rely on steadfastness from American leadership? What is it that makes for our joint benefits to come together?"

Obama once (2002) described the Saudis as our "so-called allies" and has complained their policies fuel anti-U.S. terror and regional chaos. Turki told CNN that the changes underway will last long after Obama leaves office.

The U.S. Congress is considering a bipartisan bill to let families victimized by the 9/11 terrorist attacks sue Saudi Arabia. Secretary Clinton and Senator Sanders both voiced their support of the bill. Senator Cruz is a co-sponsor.

Osama bin Laden's family has close ties with the Saudi royal family. Fifteen of the nineteen hijackers on 9/11 were Saudis.

There were no Iraqi hijackers. Bush found no weapons of mass destruction in Iraq. The unintended consequence of removing the dictator from Iraq is ISIS. Senator Sanders has said that the vote to invade Iraq is the biggest foreign policy blunder in recent times, and Secretary Clinton has admitted that her vote was a mistake.

Saudi Foreign Minister Adel al-Jubeir warned lawmakers last month in Washington that the kingdom would sell $750 billion in U.S. assets, including treasury securities, if the measure became law. Donald Trump responded,"Let 'em sell 'em. No big deal."

MbS

When the idea of a freeze was first floated in February, it appeared that the Saudis were on board. Oil prices had fallen much further than they had anticipated.

Although Saudi Deputy Crown Prince Mohammed bin Salman (MbS) said, "I don't believe that the decline in oil prices poses a threat to us," the Saudi budget deficit and drawdown of reserves painted a different picture. He then shot down any potential freeze unless Iran fully participated, when he knew they would not.

Saudi minister al-Naimi attended the conference in Doha, but Venezuelan Oil Minister Eulogio Del Pino told reporters he was under the impression the Saudi delegation, including minister Ali al-Naimi, "had no authority to decide on anything," as they were under strict instructions from Riyadh.

MbS has taken control over Saudi Arabia's economy and has announced a "transformation" plan to sell shares of Aramco to monetize its oil reserves. But the investment income would not appear to support the Saudi economy, and the plan to sell shares on Saudi Arabia bourse would far exceed existing limits of foreign ownership.

You Can't Take It With You

Saudi Arabia is keeping oil prices low for its security interests. Low prices have caused U.S. production to drop and has begun to tighten the supply-demand balance in the U.S. by stimulating petroleum product demand. By keeping America dependent on foreign oil, Saudi Arabia guarantees its protection.

The plan to diversify is to monetize its oil reserves. Much of the wealth of the Saudi royal family is in the ground and may prove to be too difficult to protect longer-term. It may not be able to count on U.S. protection long-term.

Perhaps it prefers the investment portfolio MbS talked about in his interview. And perhaps the portfolio would not support the country long-term. The royals could relocate once the oil reserves have been monetized down the road. Why do they have to support the population long-term?

Conclusions

Ironically, low prices are in Saudis' security interest, and higher prices are in America's oil security interest. One would naturally assume that the Saudis would prefer higher oil prices, and the U.S. prefers lower oil prices. Higher prices means more income to Saudi Arabia. Lower prices means less cost to an oil importer such as the United States.

But with lower oil prices, the Saudis get protection of their wealth, due to the continued dependence of the U.S. on imported oil. With higher oil prices, U.S. shale output would rise again, and the U.S. could meet all of its oil needs from domestic production of oil, sooner rather than later.

So, Saudi Arabia will not try to do anything to push oil prices higher, for now. MbS appears to be in total control now.

The Saudi royal family may be formulating a different exit strategy than anyone might have predicted. Their pivots suggest something new is afloat.

Why wouldn't the young and future generations move to London or Paris with a couple of trillion dollars in their portfolio and let the new owners work the oilfields and let the country take care of itself?

Addendum

History of the Beginning of Co-Dependency

The U.S.-Saudi relationship is based upon co-dependency: KSA needing military protection and the U.S. needing foreign oil. This all started during World War ll. Ironically, the initial threat wasn't the Nazis, it was the British.

Bilateral relations between the Kingdom of Saudi Arabia and the United States had begun in 1933. In May of that year, the California Arabian Standard Oil Company (CASCO), later called the Arab American Company (ARAMCO), started the exploration for oil in the country. They found some.

During World War ll, Italy, an Axis power, bombed a CASCO oil installation in Dhahran, crippling Saudi Arabia's oil production. And in 1940, there was a complete stoppage of the pilgrimage to Mecca. Oil and the pilgrimage were the two major sources of income for the kingdom.

Ibn Saud needed money. He turned to CASCO for advances. After the company was unwilling to do more, the company asked the U.S. and British governments to help out. FDR asked his Administrator for the Federal Loan Agency, "Would you tell the British I hope that they can take care of the King of Saudi Arabia? This is a little far afield for us!"

President Franklin Delano Roosevelt (FDR).

Thereafter, it became increasingly clear to the U.S. government that the British were trying to take over CASCO's oil concession in Saudi Arabia. So FDR took the unusual step of declaring in February 1943 "to arrange for lend-lease aid to the government of Saudi Arabia, I hereby find that the defense of Saudi Arabia is vital to the defense of the United States."

Later that year, the president approved the creation of the state-owned Petroleum Reserves Corporation, with the intent that it purchase all the stock of CASCO and thus gain control of Saudi oil reserves under a veil of secrecy. Once the matter became public, the White House backed off when Congress shot it down. What if Congress had seen the wisdom of owning half of Saudi's oil reserves?

German Field Marshal Rommel.

Concerns over an imminent oil shortage to prosecute the war were relieved, and German Field Marshal Rommel (the Desert Fox) was forced to retreat in Africa. He was unable to advance in the direction of the Arabian peninsula.

1973 Arab Oil Embargo

On October 20, 1973, King Faisal had decided to join in an oil embargo against the United States and Europe in favor of the Arab position in the Yom Kippur War. In an interview with international media, King Faisal said, "America's complete Isreali support against the Arabs makes it extremely difficult for us to continue to supply the United States with oil, or even remain friends with the United States."

The price of oil quadrupled, resulting in a recession, underscoring America's dependence on foreign oil. The U.S. began building the Strategic Petroleum Reserve (NYSE:SPR) to provide a cushion in the event of another supply disruption. Ironically, Arab Light was the first crude purchased. I know because I was consulting to the SPR Office, saw the first bids, and designed an evaluation process.

America's oil import dependency peaked in September 2006 at 10.7 million barrels per day (mmbd). U.S. crude production had peaked in November 1970 at 10 (mmbd), and by September 2008, output had fallen to 3.8 mmbd.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.