With Extra Oil, Trump Already Has His Big Saudi Win

President Trump’s two-day visit to Saudi Arabia is expected to focus on bilateral deals, including a Saudi pledge to invest $600 billion in the United States. Cooperation on arms deals and a civil nuclear program for Riyadh are said to be on the agenda. Trump and his host, Crown Prince Mohammed bin Salman, will surely also discuss regional hot spots, including Gaza, Yemen, and Iran.

But even before leaving Washington, Trump had already secured an important win from Riyadh in the form of extra crude oil that has contributed to a drop in oil prices.

The oil market was surprised in early April when a subset of eight members of the OPEC+ (Organization of the Petroleum Exporting Countries) producer group announced it would be increasing supply at triple the previously expected rate. That’s because the Saudi-led coalition had worked assiduously for more than a year to keep supply tight—twice postponing a program to very gradually add barrels until the market was strong enough to support the move.

Suddenly, in early April (just as financial markets were reeling from the trade war), the producer group announced it would be hiking May output by 411,000 barrels per day—three times the volume it had previously publicized. And just last week, it doubled down, maintaining the faster supply rate for June.

What explains the about-face from the Saudi-led group that has helped sink oil prices?

Pundits have offered uncompelling justifications, such as punishing Kazakhstan and Iraq for “cheating” on their production quotas. But the more likely explanation is the simplest—to curry favor with Trump at relatively low cost.

Trump returned to office determined to bring oil prices below $60 per barrel and has sought supply increases from both Saudi Arabia and the domestic U.S. oil and gas industry. One is well-positioned to deliver; the other can’t, even if it wanted to.

For U.S. drillers, Trump has sought to “unleash” more supply with aggressive deregulation and fast-track project permitting. But U.S. drillers, already supplying (record-high) volumes greater than 13 million barrels per day, can’t do more without disappointing their shareholders. That’s because the average breakeven price for new U.S. onshore oil wells is $65 per barrel, well above Trump’s preferred range in the $50s.

Investors don’t care about “energy dominance”; they demand energy dividends. That’s why much of the discussion in the recent round of corporate earnings calls focused on whether operators would maintain their dividend payments and stock buyback programs amid the new lower price environment.

Because of the strict requirement for attractive shareholder returns, U.S. drillers are already slowing down in response to the oil price downturn: Companies are employing fewer drilling rigs and fracking crews as managements turn more conservative on spending.

Saudi Arabia, on the other hand, has both the capability and motivation to ramp up supply at this juncture. It’s sitting on close to 3 million barrels per day of spare capacity, kept offline in recent years to bolster prices. And Riyadh recognizes that U.S. shale oil will need to pare back activity amid the price downturn. Delivering more barrels offers a double win—scoring points with Trump and recapturing some market share lost to U.S. exporters in recent years.

To secure the lower-price victory, however, Trump will also need a geopolitical achievement—preventing a military conflagration in the Arabian Gulf.

It’s no secret that Trump is open to reaching a deal with Tehran that would defuse tensions with Washington; this is the motivation for several rounds of diplomatic negotiations held in recent weeks.

Israel, however, may have other plans.

Determined to end Iran’s support for proxy forces waging war against it, Israel knows just how vulnerable the Islamic Republic is to a disruption of its own oil exports and domestic fuel supplies.

While most attention is focused on Iran’s nuclear facilities, it’s the nation’s oil assets that represent an existential vulnerability for the regime. Without crude exports and domestically refined gasoline, the country would shut down.

And the most important handful of facilities, including the Kharg Island export terminal and Iran’s largest refineries, are within range of Israel’s strike capabilities, as demonstrated by its long-range attacks against Iranian targets last October.

Senator Lindsey Graham (R-SC) alluded to this vulnerability just last week, advising Israel via social media, “It is long past time to consider hitting Iran hard. It would not take much to put Iran out of the oil business.”

The potential for oil market whiplash—from recent downturn to potential spike—comes not from an Israeli attack on Iranian oil, but from Iran’s potential response. OPEC can easily cover an outage of Iran’s daily exports of 1.5 million barrels, but there is no offset to a potential Iranian closure of the Strait of Hormuz, through which 20 million barrels of oil transit each day. Oil facilities in Saudi Arabia and neighboring Gulf states could also come under Iranian fire. This threat may have motivated the recent visit to Tehran by former Saudi Minister of Defense Prince Khalid bin Sultan, likely telling Supreme Leader Ali Khamenei face to face that the kingdom will play no part in any aggression against Iran.

Trump has already scored an easy win with more oil from Saudi Arabia, which in turn will benefit from Trump’s favor and more effective competition against U.S. drillers. To safeguard the oil price reduction, Trump will also need Israel to hold fire on Iran’s vulnerable oil assets.

Clayton Seigle is Senior Fellow and James R. Schlesinger Chair in Energy and Geopolitics at the Center for Strategic and International Studies in Washington, D.C.