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Fears are spreading that Saudi Arabia, in retaliation against the growing global outcry caused by the disappearance of Saudi journalist Jamal Khashoggi, may hit back at potential economic sanctions by weaponizing its oil dominance.
Saudi Arabia's not-so-veiled threat issued in a government statement Sunday emphasized its "vital role in the global economy" and that any action taken upon it will be met with "greater action". But as oil ticks upward, a look at history and geopolitics suggests that while a Saudi-driven oil price spike would bring pain for much of the world, it would ultimately backfire on itself.
"If this is something the Saudis were allowed to do, they'd be really shooting themselves in the foot," Warren Patterson, commodities analyst at ING, told CNBC's Squawk Box Europe on Tuesday. "In the short to medium term we'll definitely see an incremental amount of demand destruction, but the bigger issue is in the longer term."
Any action in withholding oil from the market, he said, "would only quicken the pace of energy transition."
The crisis began after Turkish officials alleged that Khashoggi, a U.S. resident and Washington Post contributor, was murdered on orders of the Saudi government after he was last seen entering the Saudi consulate in Istanbul on October 2. The Saudis have fiercely denied this claim, but have so far provided no evidence to the contrary, sparking furor in Congress, where momentum is building to impose sanctions on weapons imports to the kingdom. Media companies and corporate executives are pulling out of Saudi Arabia's annual investment conference, scheduled for late October, in droves.
And Saudi markets are already feeling the impact — its benchmark Tadawul index tumbled 7 percent on Sunday, and fell 4 percent on opening trades Tuesday.
An incendiary op-ed published in Saudi news outlet Al Arabiya on Sunday threatened "economic disaster" if countries came down on Saudi Arabia over the Khashoggi case. "If the price of oil reaching $80 angered President Trump, no one should rule out the price jumping to $100, or $200, or even double that figure," the outlet's general manager Turki Aldakhil wrote.
Trump has already chastised the Saudis on Twitter for high oil prices, demanding they up production to bring prices down ahead of the November midterm elections.
As OPEC's largest producer and the force behind more than 10 percent of the world's crude demand, a Saudi move to withhold production would rock markets and send prices far above their current four-year highs. Brent crude recently broke $86 a barrel and prices initially rose Monday after the Saudi statement, though they backed down on news that U.S. Secretary of State Mike Pompeo was being dispatched to Riyadh for talks.
But the extraordinary move to place a stranglehold on oil markets — one not taken since the Arab oil embargo of 1973 — would ultimately backfire on Saudi Arabia, leading many analysts to believe it's not a likely course of action.
"Riyadh would be hesitant to go down this route. While there would probably be a significant near-term boost to the Kingdom's oil income, pushing oil prices higher would only serve to rile President Trump," London-based research consultancy Capital Economics wrote in a client note Monday. "The Saudis are determined to remain close with Washington to preserve its 'anti-Iran' axis."
What's more, if history is any guide, oil embargoes are self-defeating. The 1973 oil embargo, imposed by Arab OPEC members on countries supporting Israel during that year's Yom Kippur war between Israel and several Arab states, quadrupled oil prices and led to shortages across the U.S. But it failed to diminish support for Israel and only spurred the development of alternative energy research and increased exploration in other markets.
"In addition," Capital Economics wrote, "higher oil prices would simply encourage other producers to raise output and grab market share from Saudi Arabia."
With the already massive outages in the oil market resulting from Venezuela's collapsing economy and impending U.S. sanctions on Iranian exports, any Saudi move to curtail supplies would jolt prices upward.
This would also trigger demand destruction, particularly in large emerging market importers like India and East Asia, said Helima Croft, head of global commodity strategy at RBC Capital Markets.
But the real cost, Croft emphasized, would be the U.S.-Saudi relationship. "This would raise the very real prospect of a host of U.S. sanctions and you would likely hear members of Congress questioning why we are spending so much money of providing a security guarantee for the country."
Still, the threat follows a series of aggressive foreign policy moves from Riyadh and the country's young and assertive crown prince,
In June of 2017, bin Salman led a region-wide blockade of Qatar, and last fall rounded up scores of Saudi royals and businessmen for detention in what he called a "corruption crackdown" but what critics allege may have involved torture. The Saudi government was later accused of kidnapping and detaining Lebanese Prime Minister Saad Hariri, and more recently set off a diplomatic spat with Canada over a tweet about human rights. So at this point, a combative backlash is not off the table.
"If the Saudis were to withhold supply from the market, the price oil could easily hit $200 (per barrel)," warned John Kilduff, founding partner at commodities investment firm Again Capital. "How high prices go would depend on the amount withheld. The Saudis have avoided using oil as a weapon, but, depending on how cornered Mohammed Bin Salman feels, anything is possible."
"I sense that this episode will be his Waterloo, which will only add to the rising security premium in oil prices."
As the market tightens with the loss of other major exporters, the stakes are only moving higher, he added. "A material loss of supply from Saudi Arabia could not be replaced."