Saudi Arabia Changes Kings, But Not its Oil Policy

by | published January 28th, 2015

Last Friday, I appeared on CNBC’s “Closing Bell” to discuss the new Saudi King Salman and his impact on oil prices.

The interview was set up on a flight back to Pittsburgh, and took place via satellite feed almost as soon as I landed.

Now, these hastily put together appearances can be somewhat trying if the anchors are not up to speed on the material.

But I’ve done spots with Bill Griffeth for years and Kelly Evans and I have had good sessions since she came on board. So it went very smoothly.

The interview primarily centered on what the Saudi change at the top would do to oil prices. But the broader implications of the change in leadership are where the significance actually lies.

As you might expect, there’s more to this story than meets the eye…

A Tougher Time for U.S. Policy Makers

First, initial concerns over political instability upon the death of 90-year-old King Abdullah were overblown from the outset.

The new king, Salman, had been Crown Prince since 2012 and Defense Minister since 2011. In truth, he has been calling the shots for over a year due to Abdullah’s declining health.

Salman’s first moves – appointing his half-brother and former head of intelligence Muqrin as heir and Prince Mohammed bin Nayef (the Interior Minister) as the new Crown Prince – will secure an orderly transition.

That’s the good news.

At 79, Salman is rumored to have health problems that may include Parkinson’s and dementia, although both have been denied. He’s had a stroke and is partially paralyzed in his left arm. Muqrin is younger at 69. They are the last two sons of the country’s founder, Ibn Saud.

At 55, Nayef represents the transition to the next generation of house leadership, where there are a number of other challengers. That’s the juncture at which some political infighting may occur.

Second, and more of a problem for Washington, is Salman’s views on a range of issues.

He’s more traditional than Abdullah and has voiced misgivings over social and political reforms, including the status of women and the extension of democracy. The new king regards democracy as a destabilizing element.

He once said that providing greater political accountability would only allow the tribal heads to increase their power at the expense of the central government, and foment unrest.

Salman is also a concerted opponent of Shiite Iran, and will take a harder line in the region against what he considers a direct threat to Saudi security. That may ultimately prove to be a big problem for American overtures to Tehran.

In fact, security is a strong theme that permeates the careers of all the figures in the new line of succession. Muqrin is the former director of Al Mukhabarat Al A’amah,Saudi Arabia’s central intelligence agency, while Nayef, as Interior Minister, has been leading the fight against Al-Qaeda.

While there is no sign of a rift forming between primary Saudi and American interests in the region, U.S. policy makers will have a tougher time with the leadership in Riyadh than it has had in some time. Salman will emphasize the Saudi requirements in any ongoing relationship.

That certainly includes oil.

Oil Prices: Despite the Change, the War Rolls On

Oil Minister al-Naimi has been retained. Owing to Abdullah’s declining health and his position as heir/Crown Prince, Salman has been the effective decision maker for the past year. These two are the architects of the current policy not to cut production and drive global oil prices down.

Unlike other price declines over the past generation, Saudi Arabia will not permit OPEC to cut supply in any attempt to raise the oil market. This time, the price war is all about maintaining market share. This time around, the Saudis are working to create supply declines in non-OPEC countries: Russia first and then the U.S.

In this case, the drop in oil prices is a classic case of supply and demand. Demand for crude oil is inching up globally, but the availability of supply is increasing much more quickly. So this is a situation where a supply glut is sending prices lower, not a decline in demand.

Now it’s true, the decline in oil prices does further some major American foreign policy objectives, including additional pressure on Iran to move away from nuclear development, and hitting Moscow where it hurts most in order to force a change in Russian policy toward Ukraine.

The problem, however, emerges closer to home.

Unconventional (shale and tight) oil production has suddenly provided a huge economic benefit inside the U.S., generating significant employment advantages and new revenues. This presents the best of both worlds: lower oil and oil product prices that boost economic development, and a robust domestic oil industry that can inject capital into the system.

The newfound U.S. production is one of three main Saudi targets in the decision to hold the line on OPEC production. The other two goals involve an attempt to undermine Russian competition in the exploding Asian energy market, and a broader move to offset calls for much higher prices by OPEC members whose budgets are dependent upon triple-digit oil. Iran, Venezuela, and Nigeria head the list here.

The effect on Russia has been swift. Lower oil prices have sent Moscow into an immediate and deepening economic recession, has prompted a collapse in the ruble, and has significantly weakened its policy options in Ukraine.

Meanwhile, on the OPEC internal front, Saudi Arabia still has strong support to maintain current production levels from Kuwait and the United Arab Emirates, at least for now.

However, the move against U.S. production is the ultimate objective.

Here’s why.

American oil production has reached levels unseen in over 40 years. At over 9 million barrels a day, it is within a million barrels of current Saudi production. This is where the battle lines have formed.

U.S. oil production has become the largest threat to the Saudi and OPEC positions in the sector. Yet what is necessary here, the exact triggering moves that will cut American production, is still unknown.

In other words, how low will prices have to go before U.S. producers begin to delay projects and significantly reduce the volume? That remains to be seen.

There is also the potential, from the Saudi perspective, that the remedy could make the situation worse.

As I’ve previously noted, most crude oil exports are still prohibited by American law. Given the new importance of the oil industry to economic expansion, the newly elected Congress may now decide to take the fight globally by loosening export restrictions.

That’s exactly what the Saudis don’t want. After all, 86% of the recoverable shale and tight oil is located someplace in the world other than North America, so the Saudis will be facing this test elsewhere. For the Saudis, the price war with U.S. producers is as much to establish a future global strategy as it is to punish Americans.

Either way, the Saudis are playing a losing game.

OPEC is under threat from newfound oil reserves emerging almost everywhere on earth. The cartel’s ascendant position is now completely eroding.

And as I noted on CNBC last Friday, controlling 40% of the world’s oil supply just doesn’t buy what it used to.

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  1. Emil Marzullo
    January 28th, 2015 at 17:03 | #1

    seems as though the Us and its allies are complacent publicly on this issue. Could it be that we not only support the Saudi policy but are behind it in order to inflict punishment on Russia?

  2. DockyWocky
    January 28th, 2015 at 17:04 | #2

    Saudi Arabia won’t change it’s oil policy, OR it’s policy of supporting islamic terror around the world. Hypocrisy is the name of the game over there in the Sandbox – after all, what else does a king have to do after bowing and scraping to the Moon god from dawn to dusk?

  3. UBetcha
    January 28th, 2015 at 20:39 | #3

    I think Saudi has 2 main goals: drive out US oil competition in the short term and de-stabilize regional geo-political rival Iran. Russia probably wasn’t one of the primary targets, but Saudi is happy to cause them problems. Venezuela, Nigeria and their ilk are roadkill in their calculation.

    Putin is a wild card, there’s no telling what he might do if Russia is under stress for too long. I have no idea what Iran might do, but since Obama has eased restrictions they’re under less pressure in the near term. In the longer view, very low oil prices will cause even more global geo-political unrest.

  4. January 28th, 2015 at 21:48 | #4

    Thank you Kent for the good article explaining the different political strategies and views of OPEC .
    It seems the Saudies are losing control of the oil markets and the are not capitalizing on their own
    Oil productions. Here the only winner is the United States. Oil investors need to observe carefully American oil companies as they expand and diversify.

  5. brian redmond
    January 29th, 2015 at 18:54 | #5

    Wouldn’t Iran want to develop its nuclear power industry even faster so it can export oil to build its foreign exchange and use nuclear power at home to conserve oil? The U.S. could help Iran develop a peaceful nuclear power industry by providing technology and engineers. Our people
    could keep an eye on any treaty violations because they would be inside the facilities to ensure compliance. We could use the Aramco model from Saudi Arabia.

  6. Peter Sperandio
    February 10th, 2015 at 17:17 | #6

    I think the Fed’s loose money policies have driven yield seekers into the corporate bond bubble that’s made the shale oil boom possible.

    Once this bubble pops, I think the lower EROEI and the short life of the shale wells, will see the price of oil rise again.

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