Updated: Apr 5
OPEC+ decided to surprise markets and cut oil production over 1 million barrels a day on April 2nd. These cuts were led by Saudi Arabia announcing their plan to cut production by 500,000 barrels a day starting in May. The cut, occurring only a few weeks after China brokered a normalization agreement between Saudi Arabia and Iran, shows a diverging of US and Saudi policy. We are likely seeing the greatest change in US-Saudi relations since the 1970’s.
The divergence of US-Saudi relations should not come as a surprise. Over the past decade the United States has gone from being one of the largest importers of oil from Saudi Arabia to being a net oil exporter. Remember, the relationship with Saudi Arabia dates back to the cold war when the US not only bought large amounts of oil from Saudi Arabia, but also helped build up the Saudi military to suppress any internal instability and serve as a bulwark against the spread of communism in the Middle East. The US also provided Saudi Arabia with protection from external risks such as Iraq and Iran. With communism no longer a threat, Iraq no longer being a risk with the fall of Saddam, and with China brokering a normalization of relations with Iran, the US-Saudi relationship has become less important. The recent events with Iran have also coincided with US oil producers no longer being the swing producer for oil markets.
A major strength of OPEC since its inception in the 1960’s was that OPEC was responsible for being the swing producer able to bring production up during times of rapid growth or rapidly cut production during economic downturns. The swing producer position gave OPEC incredible power, especially in the 1970’s and early 2000’s during periods of tight oil markets. During those periods, Saudi Arabi was able to rapidly increase the price of oil since non-OPEC producers were unable to bring new barrels of oil onto the market at a rapid enough pace. The US fracking boom of the past decade diminished Saudi power. Since 2012, the US has rapidly increased oil production from 5.5 million barrels a day to a peak of 13 million barrels a day in early 2020 making the US the swing producer of oil for the last decade. Now, it appears that the newly created power of the US being the swing producer could be running out of runway. Over the past year, despite high oil prices, the US has been unable to increase production more than 500,000 barrels a day. These gains have also slowed rapidly over the last few months with signs of US oil fields peaking. We have seen a substantial slowdown in production growth out of the Permian basin (Texas) which is by far the largest US oil field by production. Also, other fields such as the Bakken and Eagle Ford have also grown slower than analysts had estimated last year. This slowdown in oil production growth has now given the power of being the swing producer back to OPEC+.
The relationship between the US and Saudi Arabia has also been diminished by the diverging energy needs of the US and Saudi Arabia. From the 1960’s to only a few years ago, the US was a major purchaser of Saudi oil. The rise of US fracking ended that relationship. Now China and other Asian buyers are the biggest purchaser of Saudi oil. This has caused Saudi Arabia to strengthen its relationship with China at the expense of the United States. The drop in US oil imports from Saudi Arabia has allowed it to strengthen relations with countries such as Russia, since the US has less influence on Saudi Arabia’s economy with the US limited imports of Saudi oil. These facts are important to the most recent production cuts of OPEC+. With less need for the military support the US offers and with a shrinking economic relationship between the US and Saudi Arabia, Saudi Arabia will likely continue to make decisions that negatively impact US-Saudi relations.
A few final thoughts. We will likely continue to see a Saudi Arabia led OPEC+ make production decisions that irk US policymakers going forward. We will also likely see the increasing influence of China and other Asian buyers in the Middle East as they become larger consumers of Middle East production. The Petrodollar will likely continue to be the main currency of payment since it is liquid and easily convertible, unlike an alternative such as the Petroyuan (China). Many hurdles remain for a currency to replace the US dollar as the currency used in most oil trades. Finally, we will likely continue to see a tight energy market supporting a faster pace of the energy transition.