Geopolitical Update: America Adjacent

Key Points

1. Once again, oil is potentially at risk of being caught in a macro maelstrom. While OPEC has been quiet following the SVB collapse, we would expect the group led by Saudi Arabia to step in to cut production if oil appeared poised for a collapse in a sell-everything situation.

OPEC officials have indicated that it was a mistake not to intervene earlier during previous sell offs, such as 2015, as they found themselves in the difficult position of digging out from a very deep hole. Moreover, we think this latest market turmoil will only bolster OPEC’s faith that they made the right call in October as well as their concern about the inimical impact of aggressive rate hike action. Though the group seems to be in wait and see mode as they assess whether this is a clear cause for concern, the upcoming April 3 JMMC meeting does provide a venue for any potential production course correction.

The OPEC leadership has made it abundantly clear that they are not bound to the bi-annual meeting schedule and they can convert any JMMC meeting into a full ministerial session if it is deemed necessary. While Washington might again complain, we think the sovereign producers will seek to safeguard their balance sheets and the ambitious development plans aimed at generating millions of jobs for their citizens.

2. Meanwhile, Friday’s restoration of diplomatic ties between Tehran and Riyadh could potentially reduce the risk of attacks on Saudi’s critical infrastructure but also signifies China’s soft power ascent in the region.

Diplomatic relations between the two regional rivals were broken off in 2016 after angry demonstrators attacked the Saudi embassy in Tehran following the execution of Shiite cleric Nimr al-Nimr. The US exit from the JCPOA agreement and the decision to end exemptions for imports for Iranian oil led to a series of attacks on Saudi infrastructure by Iran and its proxy groups. The worst of which was the September 2019 cruise missile and drone strike on Saudi Aramco’s Abqaiq facility, which took off half of the country’s production. While the US killing of the IRGC Quds Force commander Qasem Soleimani seemingly put an end to the most spectacular Iranian infrastructure attacks, Yemen remained a launching pad for drone strikes on the neighboring states.

With the signing of Friday’s agreement, the risk of additional attacks emanating from Yemen potentially decreases, but more importantly so does the likelihood that Saudi Arabia is caught in the crossfire in the renewed shadow war between Israel and Iran.

We have heard concerns that Saudi Arabia could be the tip of the spear of an Iranian response to an Israeli military strike. Given Israel’s significant undisclosed nuclear arsenal, some security experts have suggested that Tehran might seek to retaliate against its Gulf adversaries instead and cause energy prices to spike.

Certainly, Friday’s deal does not diminish the risk that Iran’s nuclear advances will spark a crisis, as Israel’s leaders have made it clear that they will take active measures to deal with the proliferation threat. Hence, there is only so much pressure relief that can be provided by the Riyadh-Tehran rapprochement. Moreover, officials from the Kingdom have made it clear that they will seek a nuclear weapon if Iran does indeed develop one. Saudi leadership has announced they will develop their own nuclear program using domestic sources of uranium, indicating that they will not sign a 123 Agreement that would permit intrusive inspections.

3. The fact that China brokered the deal is one more indication of the “America adjacent” trend in the region.

With multiple US administrations attempting to pivot their focus away from the Middle East, China has been able to fill a vacuum and see its strategic stock climb. Beyond being the most important market for oil exports, China’s commercial and diplomatic ties have steadily strengthened. We have heard frustration with what is perceived as unending and ever-changing asks from the US on oil policy as well as the demand that the Kingdom fully aligns with Washington’s foreign policy agenda. At the same time, officials contend that they do not have a seat at the table for strategic discussions that directly impact their security situation, such as the JCPOA negotiations.

4. One clear appeal of partnering with China is the seeming lack of the type of conditionality that comes with a relationship with Washington.

Another irritant in the bilateral relationship is the fact that disputes between Washington and Riyadh that were previously discussed privately are now a much more public affair. White House officials and members of Congress now seem much more comfortable airing complaints with the media, such as in October following the OPEC production decision.

5. Nonetheless, Washington will remain an important partner due in no small part to the reliance of Saudi Arabia and other nations in the region on US military technology as well as the large number of their nationals that study in the United States.

In addition, we do not see any indications that Saudi Arabia is looking to abandon the dollar for oil transactions any time soon. And yet, it is clear that it is no longer an exclusive relationship with the US and that China is a friend that offers significant benefits.

Helima Croft authored “Geopolitical Update: America Adjacent,” published on March 14, 2023. For more information on this commentary or to access global commodities research, please contact your RBC representative.