The Fuse

Saudi Arabia Oil Supply: Disruption Scenarios and Potential Economic Impacts

May 03, 2017

Guest Post by Thomas Buonomo | @thomasbuonomo

Thomas Buonomo is a geopolitical risk analyst with Stratas Advisors.

As events in Syria and the wider Middle East continue to evolve, the possibility of a major oil supply disruption, and the associated impacts to the global economy, remains a serious risk. Territorial gains against the Islamic State in Iraq and Syria could be reversed or eclipsed by any number of disasters-waiting-to-happen throughout the region, including: An escalation between Iran-aligned and Israeli forces or perhaps even American and Russian forces in Syria; revolutions sweeping the Iraqi or Jordanian governments from power; and/or escalation of the Saudi-Iran proxy conflict in into Saudi territory. Even those conflict scenarios that would not immediately affect Gulf oil supplies could expand into the Gulf considering the integral role that Iran and Saudi Arabia in particular play throughout the region.

As history has repeatedly demonstrated, the potential for conflicts to end in disaster for their participants has not stopped political leaders from either initiating or otherwise becoming embroiled in them, in some instances out of perceived necessity.

As the authors of Crude Strategy: Rethinking the U.S. Military Commitment to Defend Persian Gulf Oil write, “The American military presence in the Middle East and the U.S. maritime commitment to protecting the free flow of oil are driven, at least in part, by the assumption that oil supply security is critical to U.S. prosperity. The empirical record appears to support this assumption: Oil price shocks have preceded ten out of eleven post-World War II recessions in the United States.”

Moreover, “All of the world’s current spare oil production capacity is located in the Persian Gulf region. Spare capacity is defined as “production that can be brought on within 30 days and sustained for at least 90 days.”

The authors continue, “Empirical studies confirm that both oil demand and supply are relatively unresponsive to price changes in the short term; consequently, shortages can cause severe price escalations. A recent study [indicates that] for every million barrels of oil taken off the market, the world oil price will rise by about $5 per barrel, given a baseline oil price of around $60 per barrel. This suggests…a large-scale disruption in Saudi Arabia could cause an upswing of 50 percent or more, and that a catastrophic regional disruption could result in the doubling of oil prices.” A 100 percent increase in oil prices could reduce U.S. GDP by around 5 percent.

estimates

Source: Crude Strategy: Rethinking the U.S. Military Commitment to Defend Persian Gulf Oil

The authors clarify, “Part of [the] uncertainty derives from the potential policy responses that governments could undertake to address a supply shock. The main instrument that the United States has to address oil supply outages is the Strategic Petroleum Reserve, which consists of 696 million barrels of crude oil that can be released at a rate of 4.4 million barrels per day…Combined IEA stocks stood at more than 4 billion barrels in 2013.”

They also caution, “These calculations do not capture the duration of a disruption. The methodology used in vector autoregression start with an oil price shock at a single juncture (e.g., one quarter), then measures the observed GDP responses over varying periods. In most cases, this approach implicitly assumes that a shock lasts for one month or one quarter….”

The price of gasoline would increase to $6.50/gallon and the disruption would result in a loss of more than 1.5 million jobs in the U.S. in the first year alone.

In a study published in April 2012 in the wake of the mostly ill-fated “Arab Spring” uprisings (Tunisia being the nascent exception), the Heritage Foundation concluded that a Saudi oil supply disruption of three years in duration would exhaust the strategic petroleum reserves of oil-consuming countries in 12 months, leading to an increase in global oil prices of more than 120% in the first quarter, sustained at 45 percent above the baseline level at the end of the second year. The price of gasoline would increase to $6.50/gallon and the disruption would result in a loss of more than 1.5 million jobs in the U.S. in the first year alone.

The study models an initial net loss of 5.4 mbd in the global petroleum market and “assumes that Saudi production would recover “to an average of 2.8 mbd in the second year and 5.6 mbd in the third year,” recovering fully in the fourth year. The study does not delve into the U.S. military and technical response that might be needed in order to achieve such a recovery.

table 2

Source: Heritage Foundation

It remains to be seen whether Deputy Crown Prince Mohammad bin Salman will seriously attempt to challenge this inertia under the auspices of Vision 2030 and the National Transformation Plan.     

For those interested in greater detail on Saudi oil infrastructure security scenarios, retired CIA officer Robert Baer’s 2003 book Sleeping With the Devil is more colorful and illuminating. Baer concludes that if the Saudi monarchy were toppled, it would be replaced by a radical Islamist government that would require a massive U.S. military and technical intervention in order to secure the country’s oil infrastructure. Unfortunately, the monarchy’s efforts to attenuate the influence of its radical Islamist elements over the last decade and a half have been more of an exercise in international public relations than substance. It remains to be seen whether Deputy Crown Prince Mohammad bin Salman will seriously attempt to challenge this inertia under the auspices of Vision 2030 and the National Transformation Plan.

Although U.S. shale oil would partially mitigate the global economic consequences of a major Saudi oil supply disruption, it is not a solution to the structural problem of an overconcentration of oil supply capacity in the region.

Saudi Oil Supply Disruption Scenarios

A number of scenarios leading to a Saudi oil supply disruption are foreseeable. In order of near-term likelihood, they include:

  • An Iran-Israel conflict on the Golan Heights, potentially leading to Israeli and U.S. military strikes on Iran’s nuclear infrastructure, a U.S.-Iran military confrontation in the Strait of Hormuz, and an exchange of Iranian ballistic missile and Saudi airstrikes targeting each other’s oil infrastructure.
  • An escalation of the Saudi-Iran proxy conflict in Yemen, leading to ballistic missile attacks on Saudi oil infrastructure, whether via the Houthis or perhaps even Iran directly.
  • internal instability in Saudi Arabia caused by low oil price-imposed fiscal austerity contrasted with corruption and ostentatiousness within the royal family. The introduction of Western cultural influences into Saudi society via the National Transformation Plan will be especially threatening to the kingdom’s radical Islamists, who will undoubtedly challenge the legitimacy of the monarchy in response.  If the monarchy does not address such issues carefully, its powerful clerics could agitate for its overthrow, similar to what occurred in Iran, culminating in the 1979 revolution.

Notably, the analyst who wrote the section on Iran’s threat to Saudi Arabia in Crude Strategy did not consider Iran’s ballistic missile threat significant but cited a paper on the subject that was published in 2010. The accuracy of Iran’s ballistic missiles has undoubtedly improved since then, along with its naval capabilities. Iran has also since deployed Russia’s S-300 surface-to-air missile system, which would make it more challenging and potentially costly to degrade its military capabilities in the event of a conflict in the Strait of Hormuz or with Saudi Arabia directly.

ADD A COMMENT