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What went wrong with the US Saudi relationship?

This is not how friends treat friends

Back in 1945, when two mighty gentlemen, with their own competitive advantages, joined hands for mutual good, what emerged was a 75 year long and alive alliance that weathered uncountable ravages of time just to evolve taller and stronger. The then US President, Franklin D. Roosevelt, and Saudi King, Abdul Aziz Ibn Saud, laid the foundations of a generation of friendship with a deal of U.S. military protection in exchange for access to Saudi oil reserves. A glimpse of their ‘standing by you’ relationship was re-echoed to the world as near as last October 2019, when immediately post an Iran suspected 18 drones attack on Saudi Aramco oil facilities, the US sent about 3,000 additional troops to Saudi Arabia, including fighter squadrons, an air expeditionary wing, and air defense personnel.

However, the amicable relationships saw a turn of events last month, when the once supportive Republicans (who always acted as a shield for Saudi against US Congress’ attempts of punishment over its ruinous war in Yemen or brutality towards dissenters) spoke up and said, “This is not how friends treat friends!”

In this piece, we look into the turn of events in this friendship story, the threat that led to a historic OPEC+ agreement, and the impact of the same in times to come.

The relationship goes south

Early March 2020, two of the mightiest oil suppliers, Saudi Arabia and Russia, entered in a bitter fight when Saudi failed to persuade Russia on the need for a deep supply cut to deal with the loss of demand from coronavirus. The OPEC+ alliance fell apart. A reckless solution to the spat, as visualized by the Saudi Prince, was defending its share in a shrinking market as against acting rationally to come to a joint conclusion with Russia. Accordingly, he ordered propelling oil output to previously unseen levels (reaching 12 million barrels a day in early April) and also granted unprecedented discounts to oil refiners (without considering that such moves would impact Saudi growth as well when low prices would hamper revenues of its companies – in fact, recently Saudi Aramco cut its capex by ~30% under the heat of low revenues).

You must be wondering where the US comes into the story.

Well, the US is among the top 3 oil producers of the world along with a friend, Saudi, and foe, Russia. An oversupplied market with certainly foreseeable diminishing demand is not good for the top line of companies selling oil, especially when they are producing shale oil which is pumped through an expensive process called fracking, funded majorly through debts.

As oil prices tumbled (US oil futures fell to negative territory - meaning sellers paid buyers to avoid taking delivery of oil they had no place to store), hard manual labor, truck drivers, and engineers promptly witnessed job losses. Whiting Petroleum Corp., once North Dakota’s largest producer, filed for bankruptcy on April 1. Texas and other oil-rich states were under clouds on unemployment by the commencement of April, 2020. The US was on the brink of losing its Energy Industry and that too at a time of pandemic crisis and President Trump’s re-election campaign.

Hence, a tinge of sourness marred the US-Saudi ties.

The US “Threatening” Response

Considering Saudi’s actions “inexcusable”, senators introduced a legislation to remove all U.S. troops, Patriot missiles, and anti-missile defense systems from the kingdom unless Saudi Arabia cuts oil output, shaking for the very first time the foundations of the 75-year-old US-Saudi alliance. Acting progressively, as often seen, President Trump dialed in to the Saudi Prince and gave a cold threatening of withdrawing the military support (extremely crucial for Saudi).

What followed then was a U-turn from the Prince, few video conferences and a historic agreement amongst the world's biggest oil-producing nations outside the US, “brokered” by President Trump, to cut production by a quantum never agreed before. OPEC, Russia and other allied producers slashed production by ~10 million barrels per day (bpd), or about 10% of global output.

The agreement above all re-emphasized the supremacy of US power. “Broker” to the deal, Trump, who refused to deliberately cut American oil production, but was still able to close the deal, emerged as the clear gainer. In fact, an afraid Saudi Prince, post the threat, moderated his stance against Iran and agreed to have a ceasefire in Yemen, in fear of a possible loss of US military support.

However, keeping geo-politics away and looking back at the objective of the ‘threat’ and the ‘agreement’, the key question still remains unanswered. Will it solve the global oil price crisis problem?

Though a truce was reached by mid-April, the Saudis continued to keep production high for much of the month leaving OPEC nations with a huge glut to deal with, with the price war adding almost 100 million barrels of additional supply into an already oversupplied market and production from the OPEC soaring by 1.73 million barrels a day in April, the biggest monthly increase since September 1990, according to Bloomberg calculations.

Meanwhile, the market is likely to remain saturated for months to come by the catastrophic collapse in demand caused by the lockdowns (demand being down by about twice the cut from the agreement).

The agreement shall show the impact on volumes later this month, but oil price stability is surely several months away. It shall not prevent sharp inventory builds in the coming months, and hence near-term oil prices in the physical market will likely remain under pressure.

Post the ‘threat’ driven Trump deal, Daniel Yergin, the renowned oil historian said, “Of all the deals he’s done in his life, this has to be the biggest!” Going forward, this friendship tale of US-Saudi shall see smears of fear and thrust with the sole foundations of the relationship being used as a ‘stick’. Nonetheless, for us, it would be interesting to see how the oil price movements keep a grip on both bearish and bullish investors for the coming months!

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About the author: The post is written by our EZPP partner Aayush Jhawar with relevant edits and changes by our editorial team. Aayush has graduated from SPJIMR and currently works with the Boston Consulting Group.

Disclaimer: All views expressed in the post are personal, and not related to any organization to which the writer belongs.


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