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On Monday, a Saudi general and two border guards died in a shootout along the Iraqi–Saudi Arabian border with fighters thought to be members of the Islamic State of Iraq and al-Sham (ISIS). The attack—the first against Saudi Arabia since it joined the U.S.-led coalition against ISIS—came amid uncertainty both at home and abroad, over questions surrounding the health of 90-year old King Abdullah, who is in the hospital battling pneumonia, and over the global price of oil.
Oil prices recently dipped below $50 per barrel for the first time since May 2009. Observers have attributed the drop to both an increase in supply, resulting from the shale revolution in the United States, and a decrease in demand, owing to sluggish global growth. All eyes have been on the Kingdom, a leading producer in OPEC, which accounts for roughly 73 percent of the world’s proven oil reserves, to cut back its production and help stabilize prices. But Riyadh has refused to play ball, breaking from its traditional preference for high prices, in order to keep pumping.
Although some analysts are puzzled by the Saudi strategy shift, pure economic logic may well be driving Saudi behavior: As its competitors struggle to keep production going, Riyadh is likely looking to increase its global market share—trying to avoid the mistakes made during previous wild oil price swings. Keeping prices in the $50–60 range for a year or two would have major repercussions. Investment in the U.S. oil and gas sector declined by 37 percent last year and it could fall further there, as well as elsewhere. More cheap gas could also increase consumption and make energy-efficient vehicles, as well as wind, solar, and nuclear power, less cost-competitive. Reducing global competition now, then, might pave the way for steep price increases in the future.
Still, it’s hard to believe that the Saudis did not consider the geopolitical repercussions of their bold gambit. Lower oil prices will mean lower revenues for competing petro-states, two of which—Iran and Russia—are longtime rivals. If a drop in prices politically destabilizes governments in Tehran and Moscow, Riyadh certainly wouldn’t lose any sleep. What’s more, cheaper oil could put more pressure on Iran to reach a nuclear deal and Russia to roll back its operations in Ukraine.
Yet in the end, the motivations behind the Kingdom’s new oil strategy matter less than its likely outcomes, some of which could be quite negative.
Despite Saudi Arabia’s considerable pricing power, U.S. oil and gas production will probably slow for a time but eventually bounce back. The effects will vary from one location to another; only some U.S. shale fields can still make a profit when oil is in the $50–60 range. U.S. shale oil will still benefit from the advantage of being “sweet” crude, meaning that it is easier to refine and store than Saudi Arabia’s “sour” crude. And with the Saudi commitment to balancing prices in question, shale producers could come to replace the Saudis as the world’s “swing producers,” capable of redressing mismatches in supply and demand.
Causing pain in Tehran and Moscow won’t necessarily result in concessions or cooperative behavior. It may even have the opposite effect. Iran could double down on its support for Syrian President Bashar al-Assad and its efforts to expand Shia influence to the Mediterranean and the Arabian Peninsula. And Russian President Vladimir Putin could stir up national support by blaming Russia’s imploding economy on a U.S.–Saudi conspiracy to overthrow his regime. Even now, despite a precipitous fall in the value of the Russian ruble, there are few signs that Putin is ready to withdraw his forces and equipment from eastern Ukraine.
The biggest risk associated with Riyadh’s oil strategy is domestic. An $89 billion revenue loss in 2015, assuming the price of oil hovers at $55 a barrel, will not lead to a social revolution. But sharp cuts in welfare spending and salaries for government workers, which account for 50 percent of budget spending, could have unpredictable consequences. Indeed, an increase in unemployment could undermine the Kingdom’s stability much sooner than its leaders expect. Throw in incitement by a vengeful Iran in Saudi Arabia’s Shiite-majority and oil-rich Eastern Province, and Saudi worries multiply. That said, Saudi officials have privately told diplomats and industry analysts they have enough foreign currency reserves, some $750 billion, to weather any short-term financial storm and prevent big budget cuts.
Governments typically make big bets either when they are overly confident or increasingly worried. Saudi Arabia’s oil strategy doesn’t reflect confidence. With the frail health of King Abdullah, possible succession rivalries, domestic pressures for change, conflict in neighboring Yemen, and the many challenges posed by ISIS, Riyadh may be in for more than it bargained for. It has chosen an odd time—one of tension, chaos, and uncertainty—to launch its boldest initiative in the geopolitics of oil since its oil-for-security bargain with U.S. President Franklin Roosevelt in 1945.