Oil and Saudi ArabiaÆs balancing act

The Land of the Two Holy Mosques treads carefully in order to find an oil price equilibrium that suits its best interests.
The US energy department estimates that 13 members of the Organisation of the Petroleum Exporting Countries (Opec) could earn a record $1 trillion this year in net oil revenues, a leap of 48.4% from last yearÆs $674 billion. Saudi Arabia, owner of a fifth of all known reserves and supplier of an eighth of the worldÆs oil, will account for more than a third of that amount.

In inflation-adjusted terms, the price of crude has surpassed its previous peak in April 1980 at the start of the Iraq-Iran war. Hence, the Arab-dominated Opec-cartel, responsible for two-thirds of world exports, is enjoying huge windfalls. Yet a decade ago, total Opec revenues had collapsed to $110 billion with oil selling at $10 a barrel.

But although Saudi Arabia stands to benefit to the tune of up to $400 billion, double what it earned from selling oil last year, it appears that some of the leaders of the kingdom are anxious about a repeat of the consequences of the 1970Æs oil shock. The Arab boycott, called in 1973 to protest against Western support for Israel, tripled oil prices, but also led to a boom in oil exploration throughout the world, a long-term slump in crude prices, and a fall in the SaudiÆs market share.

A search by the West for alternative energy might result in the same thing happening again. Also, high oil prices could slow the global economy, triggering a sharp drop in demand for Saudi oil, and additionally, a decline in the value of the kingdomÆs hundreds of billions of dollars in overseas holdings. Finally, high oil prices strengthen Shia-controlled Iran, who is Sunni-led Saudi ArabiaÆs chief local rival for regional influence.

These factors might help explain why King Abdullah appeared to succumb û somewhat û to pressure from Western governments to raise crude production. Though the amount the kingdom is increasing barely keeps up with demand, which is on the up-tick thanks to IndiaÆs and ChinaÆs growth. And many fear the proposed output increase will be insufficient to cap oilÆs inexorable price rise.

In June, Saudi Arabia announced that it would pump more crude oil, after its price surged to almost $140 a barrel. The decision was widely perceived as an admission by the Saudis that they have been partly responsible for record high prices due to their recent supply cuts, despite their insistence that market speculation and a lack of refining capacity was to blame.

The SaudisÆ status as a swing producer û they hold almost all spare Opec capacity û means they are a considerable force, but the predicted rise of about 200,000 barrels a day (to 9.7 million b/d û the highest level in 30 years) might have little effect if the increase is made up of low quality crude which cannot be refined due to a shortage of capacity. Besides, that increase amounts to just 0.2% of the worldÆs current consumption of 87 million b/d, and China, India and other emerging economies are certain to have even greater future demand, even if the pace of growth has been slowing recently. The Saudis also said they plan to raise crude production capacity to 12.5 million b/d by 2012, although some commentators are sceptical, either because of delays and costs, or due to the Saudis' desire to maintain reserves for future generations.

Saudi Arabia is forced to tread a delicate path, which means it is wary about raising production to a level which might drive crude prices down. Possibly King Abdullah is worried about a repeat of the unrest experienced in the kingdom in the late 1990s when oil prices fell, government revenues collapsed, the economy stagnated and unemployment rose. On the other hand, some analysts speculate there are constraints to raising production due to falling yields from its Ghawar oil field, the worldÆs biggest.

And, of course, Saudi Arabia is far from being the only producer with clout. Shortly after the agreement, the oil price rose above $140 a barrel when Libya announced that it might cut production in reaction to a bill presented before the US Congress which would empower the US to sue Opec for cutting supplies. Back in April, Opec president Chakib Khelil warned that oil prices could reach as high as $200 a barrel this year. And markets have plenty to worry about. Political tensions over Iran, anarchy in Iraq, attacks on pipelines in Nigeria and the hurricane season in the Gulf of Mexico all threaten to hurt production, at a time when demand is out-stripping supply and there is scarce spare capacity.

This story first appeared in a Middle East Report that was published together with the July issue of FinanceAsia magazine.
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