With its OPEC cuts, Saudi Arabia won the battle but will lose the war

Heading into an intense midterm election year, with soaring oil prices resulting from the Ukraine war, U.S. President Joe Biden felt no choice in July but to fly to Saudi Arabia, tail between his legs, and beg the country he’d called a “pariah” to open the oil taps.

A lot of good it did him. In return for the fist bump seen (and scorned) around the world, Saudi Arabia, in a move co-ordinated with Russia, spearheaded an OPEC+ output cut to raise prices.

From both an economic and ideological standpoint, it’s easy to see Saudi Arabia’s position – it is an oil-heavy economy that, regardless of its official position, seems to be siding against the West in the Ukraine war. Last week, Saudi Arabia reportedly expressed interest in joining the BRICS economic alliance dominated by Russia and China.

Nevertheless, history shows that oil shocks always backfire on OPEC, and regional geopolitical developments are reducing how much the United States needs Saudi Arabia as an ally. Saudi Arabia’s de facto ruler Crown Prince Mohammed Bin Salman may have just overplayed his hand.

There is a lot on MBS’s side, to be sure. In the new year, China’s economy is expected to emerge from its lockdown funk, tipping the market further in favour of suppliers.

Besides, industry dynamics favour a persistence of high prices. Ignoring pressures from the White House to expand production, the big oil companies are paying fat dividends rather than boost investment. That hesitancy to boost supply will keep it sluggish for the foreseeable future.

But so far, prices have barely budged. Releases from the U.S. Strategic Petroleum Reserve and concerns among traders about a slowing global economy have kept the balance between demand and supply fairly steady for now.

And whatever one’s thoughts about the reluctance to boost production from big oil companies – greedy investors who prefer short-term returns to long-term investments – there’s a logic to that hesitancy.

Namely, that the long-term demand picture may not justify heavy investment in an industry with long project timelines. The world increasingly sees its dilemma. It can continue to exploit the cheap energy of carbon fuels, or it can ensure a future in which humans occupy a livable planet.

Even if the global community is still moving slowly on climate change, it is waking up to the reality that unless we’re banking on Elon Musk saving us a spot on one of his rocket ships to another planet, we’ll have to change our ways. Already, investors in carbon fuels may thus be sitting on over a trillion dollars of what will eventually become stranded assets. There’s little incentive to widen that exposure.

The stakes are therefore high for the Saudis.

First off, one clear rule of history is that the solution to high oil prices is high oil prices. Oil shocks reduce carbon intensity. When prices jump, both producers and consumers cut their consumption. That’s already happening today, where even in the famously car-loving United States people are reducing their driving to save on gas bills.

Second, whereas previously the main way to reduce carbon intensity was by improving efficiency – driving smaller cars or improving home insulation – today you can do it at source by switching to new forms of energy. The cost of producing renewables has dropped precipitously. With investment in green energy already ramping up, an oil shock will only put wind in the sails of the energy transition. Painful in the short term, oil price increases may thus rebound to the long-term advantage of consuming countries, as they switch to cheaper, cleaner green technologies.

Over time, therefore, Saudi Arabia’s leverage over the U.S. looks set to diminish. And there may even be an immediate risk for Riyadh.

A big part of its stranglehold on Washington’s affections stems from the fact that Saudi Arabia is an indispensable ally in its conflict with the Iranian regime, the two united by their mutual loathing of Tehran. But given the upsurge of protest in the Islamic Republic, which is motivated in no small part by the country’s dire economy, Iran’s securocrats might just spy an opportunity to tamp down discontent with an economic opening to the U.S.

Phil Gurski, a former CSIS analyst who covered the Middle East region, notes “the Saudis are playing all the wrong cards,” and that an opportunistic Iranian regime might spy a window in Saudi-U.S. tensions, offering some form of détente in return for an easing of sanctions.

That would break with past patterns. But then so much of politics in the Middle East just now is doing so, raising the possibility of further big changes in the region’s geopolitics. So while MBS won this battle with Mr. Biden, time may well prove it a Pyrrhic victory.

Places like Alberta, which can ride this oil boom, should thus use it as an opportunity to transition to new industries. Because in the long run, the biggest winner of all this may be Elon Musk, who’ll get to build even more rockets with the money he makes selling cars.

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