Thirty Years of U.S. Arms Sales to Middle East Endogenous to Unstable Oil Prices, Research Shows

As the White House hosts Saudi Crown Prince Mohammed bin Salman today, policy makers need to be reminded that any new arms sales across the Middle East could become part of a repeating pernicious cycle that could lay the seeds to the next big oil crisis. That’s an important conclusion of my new economics and policy paper published today with co-author Rice economics professor Mahmoud El-Gamal in the academic journal Economics of Energy and Environmental Policy (EEEP).

Bin Salman kicked off the preliminary public relations for his current trip with an important and serious interview aired on the American TV news magazine 60 Minutes, in which he noted “Saudi Arabia doesn’t want to own a nuclear bomb. But without a doubt, if Iran develops a nuclear bomb, we will follow suit as soon as possible.” While Saudi Arabia and the United States share a common view that Iran is a destabilizing force the region, the United States has been resistant to Saudi lobbying that standards for a U.S.-Saudi nuclear deal should not ban enrichment of uranium. Westinghouse and a consortium of U.S. companies are discussing a bid for the multi-billion tender to build civilian nuclear reactors in the kingdom in competition with China. Coincidentally, the U.S. Department of Energy (DOE) tweeted today that the United States needs to “modernize our nuclear weapons arsenal, continue to address the environmental legacy that the Cold War programs, further advance domestic energy production, better protect our energy infrastructure, and accelerate our exascale computing capacity,” noting that nuclear deterrence is a core part of the DOE mission.”

In our EEEP article, we argue that geopolitical events that are often considered exogenous to the debt-driven financial boom and bust global economic cycle are part of an endogenous and self-perpetuating meta-cycle, linked by high petrodollar recycling during periods of high oil prices that typically accompany high economic growth periods, like the one seen in the early 2010s. Petrodollar recycling takes many forms, including rising military spending and buildups. El-Gamal offers a theoretical model that explains why an oil exporting country could be “incentivized” to time its military activism during periods of oil price slumps, with the coincident effect of boosting national revenues, thus converting military capital into civilian capital. A significant part of Arab countries’ military equipment (and Russia’s) used in recent conflicts was accumulated during oil boom years following the Iraqi invasion (2003-2007) and during the Arab Spring uprising (2011-2013). Last year escalations in conflict across the Middle East from Yemen to Northern Iraq helped raise the price of oil on the heels of the major down cycle of 2014-2015. The paper using discrete wavelet analysis of oil production at the country level to demonstrate that military conflicts that destroy production installations or disrupt oil transportation networks are the “most significant antecedents of sustained long term disruptions in oil supply.”

The paper recommends that “rather than increase arms sales as rentier states seek to externalize their problems, major economies such as the United States, China, Japan and Europe multilaterally and through international agencies should encourage the acceleration of economic reforms such as those proposed by the Saudi Crown Prince. Forty years of military buildups have failed to bring peace and economic prosperity to the Middle East. While it is unlikely that the Middle East oil exporters will intentionally escalate regional proxy wars in a manner that leads to the destruction of oil facilities, the nature of war can be irrational and unpredictable, hence explaining the return of the geopolitical risk premium to the price of oil. The hedge fund community, which trades in oil, has so far appeared relatively unconvinced by announcement of economic reforms in Saudi Arabia. It has also been skeptical of the success of the Iranian nuclear deal. Meanwhile, the oil industries of Syria and Yemen have been decimated by recent geopolitical conflicts. A similar fate befell Iraq and Iran during their eight-year war, our research shows.

In light of this self-perpetuating cycle, industrialized governments would benefit from revisiting coordination mechanisms for use of strategic stocks, including discussions with Saudi officials currently visiting for how the United States could respond (in conjunction with Saudi Arabia?) to further deterioration of Venezuela’s oil industry. The United States imported just over 500,000 barrels per day (b/d) of Saudi crude oil last fall, the lowest level since May 1987 and down from 1.5 million b/d a decade ago. The kingdom is now the fourth supplier after Canada, Mexico and Iraq. The drop reflects more than rising U.S. production since Saudi Arabia and Venezuela supply a heavier grade of crude oil used by coker units that economically upgrade poorer quality crudes into light products like naphtha and gasoil. Rising tight oil production is a lighter grade of crude oil less desirable for coker units of the U.S. gulf coast. In years past, the U.S.-Saudi security partnership has included coordination of responses to sudden changes in global oil supply, including strategies that involved targeting Russia when lower oil prices were needed to send a firm message of geopolitical deterrence. The question is with the current Saudi-Russian oil bromance and the United States itself now an oil exporter, is this critical element to the U.S.-Saudi relationship still viable?