Two historic things happened this month. First, Chinese Premier Xi Jinping visited Moscow, in an obvious show of support for Russia in the Ukraine conflict. Second, and arguably of even greater historical importance, Saudi King Salman bin Abdulaziz invited Iranian President Ebrahim Raisi for a state visit.

That’s right: the Saudis have invited their arch-enemy to visit and, presumably, to talk through their differences. Moreover, this is occurring right on the heels of Xi’s trip to Moscow. Iran is a close ally of Russia.

Does this imply that the Saudis are slipping out of their long US orbit?

Legendary stateman and former US Secretary of State Henry Kissinger thinks so. As the Washington Post reported last week:

The Saudis, who have been among Washington’s closest allies in the Middle East for decades, “are now balancing their security by playing off the US against China,” he explained.

According to Kissinger, Riyadh’s actions are comparable to what he himself accomplished in the early 1970s when, as secretary of state in the Nixon administration, he helped achieve rapprochement with Beijing amid its tensions with Moscow.

A historical rapprochement between the Kingdom and Iran would potentially change the global energy landscape. Indeed, one could argue that the formation of a Saudi-Iran-Russia “oil axis” would be the single most important development for the global oil markets since the formation of OPEC in the 1960s.

And so some history is in order.

Persian oil: Britain’s strategic national asset

Although Persia was never formally part of the British Empire, nevertheless Britain held substantial influence over the region in the early 20th century. In a policy that was linked to that of transitioning the Royal Navy from primarily coal- to oil-powered ships, the British government was directly involved in the expansion and modernisation of the Anglo-Persian Oil Company from 1913.

In exchange for a large injection of capital, Britain effectively acquired a controlling stake in the company. No longer would Great Britain be entirely dependent on independent firms such as Royal Dutch Shell or Standard Oil for its oil imports.

British Petroleum, as the Anglo-Persian Oil Company would eventually be re-named, became a strategic national asset.

On multiple occasions in the 20th century, that asset came under threat of partial or even full nationalisation by Iran’s leaders. In 1952, well into what had become the Cold War between Soviet Russia and the West, Mohammad Mossadegh was elected prime minister. A staunch Iranian nationalist and suspected communist, this alarmed both the British and Americans.

Mossadegh insisted on re-negotiating the ownership structure of the Anglo-Persian Oil Company. Before long, he was toppled in a CIA-led coup and placed under house arrest. The threat of nationalisation had been scotched, at least for a while. But Iranian public opinion turned decisively anti-British and anti-American.

In 1979, there was another coup. But this time, it was the Western-supported Shah who was deposed by an Islamic revolutionary government led by Ayatollah Khomeini.

All Iranian oil assets were immediately nationalised. Iran created a state oil company to operate the fields and export oil into the global market. Iran also became an enemy of the Americans, the British and, as a Shiite regime, of the Sunni Kingdom of Saudi Arabia across the Gulf.

Overnight, Iran became a global pariah. The US and numerous other countries imposed economic sanctions, which in many cases remain in place today. But with the economic rise of China and India, both thirsty customers of Iranian oil exports, the global situation began to change.

Throughout, Iran has remained an ally of Russia. The two share a common inland sea, the Caspian, and both border NATO member Turkey. Now that the old NATO-Russian rivalry has heated up into kinetic war in Ukraine, Iran and Russia have a particularly good reason to close ranks as never before.

When placed in the above context, the Saudi offer of an olive branch to Iran is of historical, geopolitical importance. It marks a major move on what former US National Security Advisor Zbigniew Brzezinski called the “Grand Chessboard” of international relations.

Towards a new OPEC?

Of particular interest here is the potential oil export power of a combined Saudi-Iran-Russia “oil axis”.

OPEC, mentioned above, was blamed by some for the rolling oil crises of the 1970s. First in 1973-4, then again in 1979-81, global oil prices rose sharply as OPEC began to coordinate production and price targets. The result was a painful combination of inflation and relative economic stagnation, today known as “stagflation”.

However, from the 1980s onward, OPEC has had relatively less influence, in part as oil has been discovered around much of the world. Supply is thus more widely distributed.

Another reason is that in Russia, a non-OPEC member, production has grown by such a huge amount. For years now, Russia and Saudi Arabia have held the two top spots for oil exports. Iran is also well up on that list.

But what if today, due to a possible rapprochement between the Saudis and Iranians, and blessed by the Russians, these three top producers seek to exert some unified influence on the global oil market? Might they have the power to do something akin to what OPEC did in the 1970s?

Keep in mind the timing of the first big OPEC oil price shock in 1973. This corresponded to the Yom Kippur War between Israel and her Arab neighbours. Some accused Arab-dominated OPEC of revenge for their defeat in the form of sharply higher oil prices.

Might something similar happen again, if the Saudi-Iran-Russia axis is displeased with US or NATO-members’ foreign policies? About escalating US and NATO involvement in Ukraine specifically? Or about something else entirely?

The risk seems obvious.

Oil, money and power

Another, related risk is that, among other major oil producers, Saudi Arabia reinvests a substantial amount of its oil revenues in US assets, including Treasury securities. This constant source of demand helps to keep US interest rates low.

It also helps to support the US dollar’s position as the dominant global reserve currency. The “petrodollar”, as it is sometimes known, is currency-backed, if indirectly, by oil production.

It just so happens that the Russian rouble is also indirectly oil-backed, specifically by Russian oil production.

So what would happen if, for example, the Saudi-Iran-Russia axis chose to cooperate in international financial and monetary matters? What if they began to cross-invest in one-another’s assets?

What if they did a deal with China to sell oil in renminbi and to accumulate some Chinese assets? What if they did the same with India?

Any or all of the above could result in less overall global demand for US assets. That could place relative upward pressure on US interest rates, and those of her close allies. It could also weaken the US dollar.

If combined with higher global oil prices generally, that would contribute to stagflationary economic conditions perhaps even worse than at present. Perhaps worse than the 1970s.

(For those readers who recall the impact that sharply higher oil prices had in the 1970s, I’d be curious to hear your stories. For my part, I remember queueing for petrol and special sessions in school learning ways in which to save energy.)

A historical, multidimensional transformation

Regardless of whether a Saudi-Iran-Russia axis actually forms, or if so, how it chooses to exercise power and influence over oil and possibly over international money and capital flows, the fact is, the global energy markets are on the cusp of a historical, multidimensional transformation:

  • Renewable energy technologies have overpromised and underdelivered and remain heavily dependent on taxpayer subsidies. That’s unsustainable.
  • Investment in fossil-based energy has declined for years as the ESG craze has gathered in intensity. That is now changing.
  • Nuclear generation power share in much of Europe and North America has declined. That is now set to reverse.
  • Energy security has been called into question by the war in Ukraine and other potential global conflicts.

Due to the above, in all aspects – affordability, security and sustainability – the global energy market is in crisis.

But as we know, where there is crisis, lies opportunity.

Until next time,

John Butler
Investment Director, Fortune & Freedom