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Saudi oil policy shaped by defence dependence on USA

Oil markets
By Paul Hodges on 15-Oct-2014

Saud, FDRThe world now faces a supply glut in almost every source of energy, including oil, gas and coal.  It is also seeing major increases in output of key products including gasoline, diesel and petrochemicals.  Yet as the International Energy Agency has warned, “the recent slowdown in demand growth is nothing short of remarkable.”

The blog is therefore launching today a 3-part series that looks in more detail at how this New Normal world will develop.  It starts today with supply, and will look at demand tomorrow, before discussing price implications on Friday.

The above picture is key to likely developments.  It marks the start of the critical partnership between the US and Saudi that has been central to global oil policy since 1945.  It shows US President FD Roosevelt (right) and Saudi Arabia’s King Ibn Saud (centre) on the deck of the USS Quincy on Valentine’s Day, 1945.

Over the next 5 hours, their meeting changed the course of history.  The reason was that in 1938, oil had been discovered in Saudi Arabia by geologists working for Standard Oil of New York.  In turn, this company became Aramco, and today Saudi Aramco.  And Saudi Arabia became the world’s largest oil producer, with the largest oil reserves.

America needed the oil to support its post-War development.  And Saudi Arabia needed America’s protection in case it was attacked.  A small nation with enormous wealth is an obvious target for invasion.  This became the basis for the “oil for defence” policy which has guided US-Saudi relations for the past 70 years.

But now, of course, America may no longer need Saudi oil. The focus on fracking and increased gas supplies has obscured the more important development, that the US is about to replace Saudi as the world’s largest oil producer.

The pace of change has been unprecedented.  It was only last year that the International Energy Agency forecast that this could happen in 2015.  Today, it is already happening:

  • So suddenly the Saudis face a critical question – does the US still need the 1.3 million barrels/day they supplied in 2013?
  • And if not, will the US still be prepared to defend Saudi from attack, as it did during the first Gulf War in 1990-1991?
  • This is the question that keep senior Saudi officials and Ministers awake at nights in Riyadh

And it is no idle threat, with the Caliphate terrorising everyone to the north, and the potential for problems in a wide range of neighbouring states such as Iraq, Syria, Yemen and Iran.

Nigeria has already lost its entire export position to the US, yet until recently it was a Top 5 supplier of 1.3mbd.  The rest of Africa, including Libya, Angola and Algeria, will soon be in the same position on current trends.

Tomorrow, the blog will focus on the other side of this question, namely what has been happening to demand.