The coming U.S.-Saudi fight over “energy independence”

By Eurasia Group analyst Greg Priddy

Are the United States and Saudi Arabia on the verge of serious tensions? They might be … if the Saudis continue to worry that U.S. energy policy could undermine their economy over the long-term.

Saudi officials are beginning to realize that the Obama administration is serious about gradual diversification away from U.S. dependence on oil and fossil fuels — a direct threat to Saudi Arabia’s “demand security.” That explains, at least in part, Saudi Oil Minister Ali al Naimi’s uncharacteristically hawkish comments on crude oil prices at the most recent OPEC meeting held late last month — comments that amounted to a warning shot directed at the U.S. ahead of President Obama’s visit. 

Despite serious recent Saudi efforts to diversify its economy away from dependence on crude oil exports, the certainty that large-scale use of hydrocarbon alternatives remains years away, and conservative budgeting that ensures the Saudis are hurt less than most energy exporters by lower prices, the Saudis fear that substantial U.S. investment in ideas like plug-in hybrids and electric vehicles could undermine demand growth in oil, which they had assumed would remain strong, at least in the developing world. The fear is that if they continue investing in oil production capacity, they could end up overshooting demand.

What tools do the Saudis have to show their displeasure? They could delay near-term increases in oil production that will complicate the U.S. path out of recession. The prospect of OPEC inaction in the face of rising prices will drive anxiety in Washington, where an aggressively expansionary monetary policy adopted to shock the economy back to life — including large purchases of treasury securities — already threatens to create strong inflationary pressures during the recovery. In the longer term, they could hold back on planned upstream investments — though this would not include the current round of expansions that will bring Saudi capacity to 12.5 million barrels per day (bpd) by the end of 2009.

Since the 1940s, the U.S. and Saudi governments have had a mutually beneficial commercial relationship based on crude oil, as well as a security relationship, grounded largely in mutual concerns first about the Soviet Union and later about revolutionary Iran. There have been plenty of tensions between the U.S. and Saudi governments over the years, particularly in the aftermath of 9/11, but these common interests have always helped resolve them. Now, the seriousness with which the Obama administration appears to be approaching the goal of reducing U.S. oil dependency and promoting an eventual transition toward electric vehicles is stoking fears among Saudi officials that there is at least a modest chance that their economy could eventually be fundamentally undermined.

The Saudis have made no moves to hold back on upstream oil projects already underway, and they’re likely to wait a couple of years before making big decisions on longer-term investment plans. The first big decision beyond the current projects will be on the 900,000 bpd expansion at Manifa, which is now slated to come onstream in 2013. The Saudis probably calculate that the Obama administration will soon face practical and political obstacles at home and will have to back down from some of its more ambitious goals.

But official caution also reflects a baseline assumption among management of Saudi Aramco (the Saudi state-owned oil company and the largest energy company in the world) that demand growth in China, India, and across the developing world will offset any gradual demand decline in the United States. The Obama administration’s recent decision to accelerate the timetable for the new CAFE standards will accelerate that decline, but the larger Saudi worry is probably that technology developments spurred by the shift in U.S. policy — like plug-in hybrids or even viable electric cars — will be adopted widely in the developing world and will more fundamentally undermine the long-term viability of an economy dependent on oil exports.