Will Trump Trigger a New Oil Price War Between OPEC and The West?

One thing will have become extremely clear to Saudi Arabia’s Crown Prince Mohammed bin Salman in the lead-up to Donald Trump beginning his second stint as U.S. President.

This is because he wants oil prices lower. He aims to achieve this by dramatically increasing oil exploration and production at home and by pressuring OPEC and its effective leader Saudi Arabia to lower their oil prices too, however they can. Surrounding this are various carrots and sticks that are part of the usual rough and tumble of dealmaking as Trump likes to practice it.

These include demands for even more investment from Saudi Arabia into the U.S. than the US$600 billion it has already pledged and Riyadh signing a relationship normalisation deal with Israel. In return, the underlying promise from the U.S. is that it will guarantee the security of Saudi Arabia in the Middle East and beyond and, by extension, the continued reign of the House of Saud across the Kingdom. In sum, it is a full re-assertion of the 2017 Trump variation of the ‘Quincy Pact’ reached on 14 February 1945 between U.S. President Franklin D. Roosevelt and Saudi Arabia’s King Abdulaziz bin Abdul Rahman Al Saud, as fully analysed in my latest book on the new global oil market order.

The original version agreed by the two leaders at that time on board the U.S.S. Quincy in the Great Bitter Lake sector of the Suez Canal was essentially that the U.S. would receive all the oil supplies it needed for as long as Saudi Arabia had oil in place. At that point, the U.S.’s domestic production of oil and gas was insufficient to drive the high level of economic growth it wanted. In return for this, the U.S. would guarantee the security of Saudi Arabia and the ruling House of Saud. This deal held well enough until the 1973/74 Oil Crisis when OPEC members plus Egypt, Syria and Tunisia, began an embargo on oil exports to the U.S., Great Britain, Japan, Canada and the Netherlands. This was in response to the U.S.’s supplying of arms to Israel in the Yom Kippur War that it was fighting against a coalition of Arab states led by Egypt and Syria. As global supplies of oil fell, the price of oil increased dramatically, exacerbated by incremental cuts to oil production by OPEC members over the period. By the end of the embargo in March 1974, the oil price had risen from around US$3 per barrel (pb) to nearly US$11 pb before settling down for a while, but then it trended higher again. This, in turn, stoked the fire of a global economic slowdown, especially felt in the West. Some branded the embargo a failure, as it did not result in Israel giving back all the territory that it had gained in the Yom Kippur War. However, in a broader sense, a wider war had been won by Saudi, OPEC and other Arab states in shifting the balance of power in the global oil market from the big consumers of oil (mainly in the West at that time) to the big producers of oil (mainly in the Middle East at that point).

This delicately rebalanced relationship between the U.S. and Saudi Arabia (and OPEC) also continued to function well enough for another forty years or so, until the U.S. began to significantly develop its own shale oil (and gas) resources. From a modest start, U.S. shale oil production increased from an average of slightly less than 0.2 million bpd in 2011 to just over 8.7 million bpd in 2014, according to Energy Information Administration (EIA) figures. Not only did these numbers represent the largest such volume increase since record-keeping began in 1900 but also by 2013 it meant that the U.S. had overtaken Saudi Arabia and Russia as the world’s largest producer of crude oil. Worse still for Saudi Arabia was that both the U.S. and Russia were producing far more gas as well than was the Kingdom. The only encouraging factor for the Saudis at that point in this dramatic expansion of oil production in the U.S. was that, according to virtually all industry estimates, the cost at which each barrel of U.S. shale could be produced (the ‘lifting cost’, in industry parlance) was around US$70 pb of West Texas Intermediate (WTI) crude oil, the U.S. benchmark oil grade. By stark – and positive for the Saudis – contrast, the average lifting cost for Saudi oil (and Iranian and Iraqi oil) was US$1-2 pb only. This apparently high lifting cost and the relatively nascent point of development of the U.S. shale oil sector – plus Saudi Arabia’s success in the 1973 Oil Crisis (which can be regarded as the First Oil Price War) — meant that the Kingdom was extremely confident of another success when it launched the Second Oil Price War in the middle of 2014.

This proved to be a terrible miscalculation, as also analysed in my latest book. Suffice it to say here, the U.S. shale oil sector was brilliantly able to reorganise into a leaner, meaner production machine capable of lifting barrels in the low-US$30 pb cost region, and consequently much better able to withstand the lower prices cause by OPEC production cuts than were OPEC countries and Saudi Arabia itself. Consequently, having seen their finances wrecked by this Second Oil Price War, OPEC and Saudi Arabia gave up the fight, reversing the long-running overproduction of oil to attempt to bring prices to levels that would begin to enable them to rebuild their budgets. Crucially though, 2016 also saw a hugely significant change in the ‘Quincy Pact’ as the prime driver of the U.S.-Saudi Arabia relationship. The agreement then effectively changed to one in which the U.S. would receive all the oil supplies it needed for as long as Saudi Arabia has oil in place and in return would guarantee the security of Saudi Arabia and the ruling House of Saud, but it included the proviso that Saudi Arabia does not jeopardise the economic well-being of the U.S. Or to put it more simply as one senior White House official commented off-the-record to OilPrice.com at the end of 2016: “We’re not going to put up with any more crap from the Saudis.”

For key economic and political reasons examined in my latest book on the new global oil market order, Trump has never wanted to see oil above the US$75-80 pb of Brent level. With his plans to dramatically increase U.S. production and to encourage more output from elsewhere, it is clear he wants the oil price even lower than this in his second term as president. Meanwhile, Saudi Arabia’s 2025 budget breakeven oil price is $98 pb of Brent, according to the IMF. So, there is a problem, and the problem looks remarkably like that which caused Saudi Arabia to launch the 2020 Third Oil Price War. This was also done to safeguard its oil market share so that it could ultimately steer oil prices above its budget breakeven level and secure its finances. And it was also executed with the same strategy as the 2014-2016 Second Oil Price War, which was to overproduce oil to crash prices to put as many non-OPEC producers out of business as possible. U.S. Secretary of State Marco Rubio last week talked with Saudi Arabia’s Crown Prince Mohammed bin Salman about “the strength of the U.S.-Saudi partnership in this time of momentous change”. However, if that change becomes momentous enough that oil prices fall too far below the Kingdom’s budget breakeven level and stay there, the Saudis may feel they have no choice but to embark on another oil price war in the not-too-distant future.