Cutting Off Saudi Arabian Crude?

Donald Trump told the New York Times that he would consider cutting off United States oil imports from Saudi Arabia if the country refused to send ground troops to help fight against ISIS. Saudi Arabia is our second largest foreign supplier of crude oil, behind only Canada. I wonder what the economic implications of this decision would be – even further increased U.S. production, defaults in Saudi Arabia? When I saw this headline, my first reaction was to criticize Trump for his failure to respect or even recognize global cultures and nuances. But upon further investigation, Trump may not be suggesting anything that outrageous.

The United States have increased crude oil production in the last decade, almost doubling in 2015 what it put out in 2005. Trump calls this a “tremendous glut” on the market.

crude US

Melvin Backman, qz.com

With U.S. shale replacing so many foreign suppliers, the market share of crude oil is shifting dramatically. Things are made worse by the decision from OPEC countries and U.S. producers to essentially go their own way, producing rampantly without much regard for what’s actually happening in the market.

But more importantly, U.S. production increases have incredible influence over the economies and governing bodies of OPEC countries. According to Quartz, several OPEC countries can’t balance their budgets when oil is under $45 per barrel. Right now, the average price per barrel of crude oil is $39.91 according to the latest Brent benchmark. The International Energy Agency estimated that per barrel prices would climb back up to the $80 range by the end of the decade if U.S. shale production slowed. But if they do not decrease the volume they’re currently putting out, prices could stay below $50 for the rest of the decade.

So even if Trump is nominated and elected, his decision to cut off Saudi Arabia might not have the effect most would think – we would still have plenty of gas at the pump, and Canada would still be our number one foreign supplier. But that’s not the major concern. We should be more worried about what would happen in terms of OPEC economies if Saudi Arabia were cut off and U.S. production continued to grow exponentially. If we were to rely on Canada and other foreign suppliers, we could see more market stabilization and the possible increase of prices per barrel. But if we continue to attempt crude oil independence and produce independently of foreign supply or domestic demand, we could upset the global economy and possibly send 12 OPEC countries into (further) turmoil. Saudi Arabia said it would be willing to increase its borrowing to 50 percent of GDP in order to keep its market share in oil. The country sold $27 billion in bonds in August of 2015 to help fund their already impressive deficit. The IMF calculates that Saudi Arabia needs $106 per barrel average price in order to reach its deficit “break-even” point.

So how will the global economy react to this shift? What will happen if the United States continues to produce at this level? Will Saudi Arabia have any major effect on our foreign supply?

Sources:

Trump says he would halt oil imports from Saudi Arabia, but could the US survive without them?

In the oil price war, it’s hard to tell who’s losing—OPEC or US shale

Low oil prices could force the Saudis to borrow hundreds of billions of dollars to finance their deficit

10 thoughts on “Cutting Off Saudi Arabian Crude?

  1. There is an altruistic stance here that I had not previously considered. We so often hear the economic and geopolitical arguments for energy independence; at face value. they make a lot of sense. But it is a really important question: what would happen to the Middle East if America, and other nations, no longer needed to import oil? Would OPEC nations collapse and be denied growth for the next few decades? Would there be civil war and revolt against the present leadership? There are a number of angles to take here. The first, and either most or least logical, depending on your opinion, is that America would no longer have a vested militaristic interest in the Middle East. A second would be a complete and utter collapse of many OPEC nations’ economies. We have already seen what low oil prices have done to Venezuela, but the wealthier nations such as Saudi Arabia would be far from insulated in the case of American energy independence. The third, fourth, and fifth scenarios range from OPEC nations transitioning to new sources of income all the way to any other reality that only a fortune-teller could predict. Whatever the result is, it is clear that energy independence and innovations in fracking technology will continue to disrupt global geopolitics.

  2. I would argue that by cutting off the United States imports from Saudi Arabia and therefore losing our second biggest source of petroleum there could be large unforeseen consequences. As Kinsey mentioned this could led to market stabilization but at the price of a potential dramatic increase in the price of oil per barrel. However, what I don’t feel like was fully addressed is the effects that this could have on the U.S. economy. The stabilization of oil at a higher price could potentially raise prices for a number of firms that rely on the steady supply of oil, such as airlines and other transportation industries. This is even ignoring the price pressure that a number of Americans feel when oil prices have risen in the past.

    • Yes the U.S. economy would experience some fluctuations if this absurd policy measure was taken into consideration and implemented. However, we cannot predict what exactly will happen immediately afterward or within the next few years. In this scenario I would expect that, with most supply and demand problems, that an alternative solution would arise. While the Saudis are our 2nd biggest supplier currently this does not mean that they are our only option and I believe that many other nations would jump at the opportunity to take their place.

  3. From a totally different perspective, I want to discuss the economic impacts of the environmental destruction inherent in producing more domestic oil via tar sands – a route some consider to be a way forward for American energy independence while still staying on the fossil fuel track. Some publications have put return on investment for tar sand oil extraction at $50 – a hefty price, especially when considering the price of oil in today’s economy (Rosenbaum). How should we consider efficiency costs and environmental costs when making trade offs with the benefits gained from increased oil production via these tar sands? What, now, are the implications for this expansion given the Obama Administration’s staunch opposition to the Keystone XL Pipeline and four to eight more years of this same opposition should we find Clinton 2.0 in the WH? I don’t really know much on the economics involved here, but I was hoping someone else might be able to shed some light…

    Source: Walter Rosenbaum, Environmental Politics and Policy. 2013.

  4. Is petroleum a commodity? If so, then it is fungible: we import more from (say) Nigeria and Nigeria’s (former) customers import more from Saudi Arabia. At the end of the day there’s a bit of added cost in logistics, a bit of added cost due to mismatches between refineries that were designed to use Saudi crude but now must use Nigerian crude. So American consumers would pay more. But unless US actions affected global supply and demand, the Saudis will be able to sell just as much oil as before, at roughly the same price (again, logistics and mismatch could lower their “take” by a small amount).

    So Trump’s policy would be an empty gesture, though it would decrease whatever small amount of leverage we have in the Persian Gulf.

    A side note: if oil is a global market, then is energy independence valuable? Or would creating an isolated US market for both supply and demand actually detract from security by amplifying price swings [and paying a higher average price as well]? That is, I would argue that we would pay a lot extra for “national” independence, a form of insurance, but in fact such insurance would lead to greater volatility not greater stability.

    • I looked into the fungibility of oil a while back. Physically speaking, although light Arabian crude oil is fungible, many other crude oils are not. For example, tar sands oil is much heavier than others and requires special refineries. The article below talks about the fungibility of oil from the economic perspective. It argues that today’s crude oil market is actually the opposite of a competitive market due to international politics and oligopoly, so we have to be careful of the assumption that treats all crude oil products the same.
      https://www.ncafp.org/2016/wp-content/uploads/2013/01/Chanis-Crude-Oil-is-not-Fungible.pdf

      • Good. This is true for many commodities; the bottom line is the extent of substitutability. In petroleum long-term contracts, logistics considerations, refinery adaptations to specific crudes and national policy all fragment markets. But do prices correlate closely? And when there are big disruptions, do we find certain markets suddenly without gasoline/diesel? We have to be careful to distinguish technical issues from economic ones. (I need to look at this paper…)

  5. I think we have to realize Candidate Trump we are seeing right now would be very different from President Trump, because that is just how campaigning works. Like professor Smitka said in his comment above, since Saudi oil can be seen as interchangeable as oil produced in other countries, it really is not a real threat to Saudi Arabia unless every country stops buying oil from the country. It is true that US oil market would not be impacted by the cut, but neither would Saudi Arabia’s (since only about 5% of Saudi Arabia’s oil export goes to the US); hence, such act would be futile from a political perspective. Furthermore, note that the US is actually the second largest import origin of Saudi Arabia, so maybe Candidate Trump should consider the other side of the spectrum.

    • You make a good point about the difference between a candidate Trump and President Trump. Earlier in the semester, we discussed the hoteling principle as well as spatial competition. We can see how this applies to modern politics as in the primaries, candidates will space themselves as far left or right as they can in order to capture the base of their party. Then once they have received the nomination, they typically rush to the middle as fast as they can in order to capture the middle swing vote. While Trump has certainly made some interesting policy statements, it will be interesting to see if he actually sticks to them if he receives the nomination.

  6. I am not sure whether to believe Trump’s argument, if actually applied in reality, would have lighter or worse implications than we are expecting now. Kinsey makes a good point that in terms of quantity the U.S. doesn’t have as big of a concern as many might think, if to cut off Saudi imports, but like the blog mentions, it’s hard to predict what that will do to the global oil price. If U.S. were to cut off Saudi imports, that would almost undoubtedly increase gas prices and therefore likely rollback the shale boom that was somewhat killed by the low gas prices last year. If profitability rise, more producers are likely to enter the market. At the same time, Saudi has repeatedly said that it won’t cut back production…

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