U.S. oil strategy complicated by geopolitical fallout from Khashoggi affair

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The death of Saudi dissident journalist Jamal Khashoggi is adding another toxic element to the geopolitical risks that result from the world’s reliance on Middle East oil exports.

Saudi Arabia’s King Salman is working to contain the fallout, and U.S. President Donald Trump appears eager to de-escalate the situation, despite threatening “very severe” consequences if the Saudi government is found to be responsible for Mr. Khashoggi’s death. For the Trump administration, however, Saudi Arabia is too important an ally in its escalating battle with Iran to jeopardize the relationship over such a case, analysts said on Friday.

Late on Friday, Saudi Arabia said Mr. Khashoggi died in a fist fight at the Saudi consulate in Istanbul on Oct. 2 and that 18 Saudis have been arrested in the case.

The Saudis and Washington are “looking for an exit strategy to keep everyone calm,” Ayham Kamel, Middle East analyst for New York-based Eurasia Group, a political risk consultancy.

Oil traders this week largely shrugged off the heated rhetoric, despite Saudi Arabia’s implied threats to use oil as a weapon. The price fell for the international benchmark, North Sea Brent crude. Brent settled at US$80.13 a barrel, well down from the US$86 peak hit earlier this month, when traders were more focused on looming U.S. sanctions on Iranian crude exports.

Mr. Trump appeared this week to accept the Saudi government’s denial of involvement in what happened to Mr. Khashoggi; the President even suggested on Twitter that “rogue killers” might have been responsible. However, other Western governments, including Canada, are demanding a credible investigation. Some members of the U.S. Congress – already targeting the Organization of the Petroleum Exporting Countries (OPEC) – are threatening to impose sanctions on its leading member if reports that Mr. Khashoggi was tortured and murdered by Saudi agents are confirmed.

Riyadh warned this week that it would retaliate if it was targeted, noting that the world relies heavily on its crude exports.

At a conference in India this week, Oil Minister Khalid al-Falih described the kingdom as the “central bank of the oil market.” He said that, given the disruptions that have already taken place, the price of oil would be easily in the triple-digit range without Saudi Arabia’s effort to boost production.

In the long-term, the Saudis have as much to lose from an oil crisis as their customers. In the short-term, higher crude prices would hit consuming countries hard, particularly as developing economies are already showing strains from the $10 a barrel increase this fall to US$80.

“Our reading is that [the Saudis] were trying to remind everyone of the high stakes involved, to stop any international effort to consider punitive action before it gets off the ground,” said Torbjorn Soltvedt, principal analyst for the Middle East and North Africa with Verisk Maplecroft, a London-based political-risk firm. “And so far, that seems to have worked.”

The Trump administration is unlikely to let the concerns about Mr. Khashoggi undermine its partnership with the Saudi royal family in maintaining stability in the kingdom and countering Iran’s power in the region, Mr. Kamel said.

“This is about the U.S.-Saudi strategic relationship,” he said.

The Americans – along with Britain and Canada – are supplying weapons and military equipment the Saudis are using in the war in Yemen, where the United Nations says up to 13 million people are at risk of dying from hunger. That conflict is seen as a proxy war against Tehran, which backs the Houthi insurgency.

The Saudis also support Mr. Trump’s decision to tear up an agreement to contain Iran’s nuclear weapons ambitions, and re-impose sanctions on Iranian oil exports.

There is always a chance that the oil-rich kingdom will retaliate in the short term to Western criticism by holding back on exports as Iran faces a tightened squeeze from U.S. sanctions, which formally begin on Nov. 4.

However, that would likely be a last resort. The OPEC leader has always been mindful of the need to support long-term demand for its crude, and roiling markets with a politically inspired price spike would undermine that policy, Mr. Soltvedt said.

As prices rose early this month, Mr. Trump took to Twitter to condemn OPEC – and by extension the Saudis – for not producing more crude to keep a lid on them. With control of Congress at stake in November’s mid-term elections, the President is eager to keep the world’s top crude exporter on his side.