By Paul Cochrane for Petroleum Review
With a quarter of the world's reserves Saudi Arabia is the most influential member of the Organization of Petroleum Exporting Countries (OPEC) and able to put an extra two million barrels of oil on the international markets within days. But the kingdom is notoriously opaque about its oil policy and reserves, with decisions made at the highest level by the ruling House of Saud. It is an elite that even the White House appears to have minimal influence over, and one that is keen to ensure its own survival in the face of growing domestic concerns and a changing geopolitical environment.
Since oil company Saudi Aramco was fully nationalized in 1980, the kingdom's oil policy has been relatively clear and consistent. Based on a low price band (between $18-$25 a barrel), Saudi aimed to maintain price stability through excess spare capacity, thereby avoiding price spikes, and ensuring the long-term profitability of its large reserves. But from 1999, the Kingdom's oil policy started to change course as internal problems started to mount: rising unemployment, a population that has grown 300 percent in 30 years, and an oil dependent economy seriously in need of diversification.
To boost revenues, Riyadh in conjunction with OPEC reigned in production to lower oil inventories. In a period of surging global demand driven by the emerging Asian economies, oil prices steadily rose, pushed further by speculation. As a result of this boon, the kingdom's accumulated some $500 billion in foreign reserves and was able to dismiss the Bush administration's calls for heightened oil production. But the global financial crisis in late 2008 caused oil prices and demand to drop. Pressure was again put on Riyadh, this time to keep prices low to stimulate economic recovery.
“Why did the Saudis let the price of oil go up and up, when they of all people would realize there would be a correction?” said Simon Henderson, director of the Gulf and Energy Policy Program at the Washington Institute for Near East Policy. “As the swing producer it would be left to Saudi leadership to get OPEC into line afterwards which, frankly, they have managed to do to everyone's surprise.”
In June, Saudi Aramco increased output to 12 million barrels per day (bpd) after three new projects came online, at the Nuayyim, Khurais and Shaybah fields. With an estimated 4.5 million bpd in spare capacity, Saudi Arabia's OPEC output is 8 million bpd.
The financial crisis has presented Saudi Arabia with major challenges. High oil prices are needed to fund economic diversification and infrastructure projects, while at the same time the country has a vested interest in the recovery of the global financial system. Equally, Saudi Arabia is aware of the growing importance put on alternative energies, which could in the long run lessen the West's dependence on the Kingdom, changing a relationship that since 1945 has been based on security in exchange for oil. Furthermore, given that the Saudis effectively subsidize oil sales to the US through discounted transportation costs, the Asian markets – especially India and China – are becoming increasingly attractive given their geographically proximity and willingness to pay international market prices.
Cementing the foundations of a long lasting relationship: King Saud with President Roosevelt in 1945
“Surging demand from Asia will almost certainly divert supplies east and unless Saudi supply keeps growing, it could mean a big reduction to the USA, unless we start paying a security premium, which I suspect China would top,” said Matthew Simmons, Chairman of energy consultancy Simmons & Company in the US, and author of “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy.”
Saudi Arabia has worked particularly hard to foster warm relations with China, investing in refineries and the Chinese economy. “China is a secure market for Saudi Arabia, and will be in the future, so it is very clear it's not just exporting crude, but upstream and downstream activities are also being explored,” said Othman Cole, research associate at Cambridge University's Centre for Energy Studies in Britain.
This shift eastwards has been observed by OPEC. “The last full revision of the OPEC Masterplan in 2003-2004, estimated that by 2050 they didn't expect any Gulf OPEC member to be selling oil to the US. The entire Gulf market has been moving east for sometime,” said Kent Moors, an energy policy expert at Duquesne University in the US.
The current, and indeed long term, significance of the Asian markets was made crystal clear by King Abdullah's first overseas visit since ascending the throne in 2005. It was to Beijing, notably not to Washington. Next on the monarch's itinerary was New Delhi.
Saudi Arabia has been increasingly looking to the Eastern markets: King Abdullah with Indian Prime Minister Manmohan Singh in New Delhi, 2005
“Asia is a growing market for Saudi, and how that re-balance will effect the US influence and relationship is still unclear,” said Cole.
Any change in bilateral relations has not yet been reflected in current US foreign policy towards Riyadh, demonstrated during President Barrack Obama's visit in June.
“Relations are good between King Abdullah and Obama, that was the surprising thing, for Obama to have bonded with an Arab potentate with global views very different from European and US perspectives,” said Henderson. “Logically, Obama should have said, for God's sake, keep oil prices down, but gave them a pass, which I thought was a mistake.”
What is not clear is if the US and Saudi Arabia might actually be seeing eye-to-eye on the current OPEC price band of $75-$80 per barrel. Simmons thinks the West is tacitly supportive of higher oil prices. “Our government leaders now seem to understand that higher prices open all sorts of doors, such as creating alternate energy sources and helping create economic prosperity in the Middle East,” he said.
Such a policy would be to kingdom's advantage. “I suspect Saudi would love to see prices exceed $200 a barrel to pay for the seven new industrial cities and other critical expenses to modernize a kingdom soon to be 40 million people,” Simmons added.
Oil policy is decided by what Daryl Champion, author of “The Paradoxical Kingdom: Saudi Arabia and the Momentum of Reform”, said was an “an inner circle of elite decision-makers centered around the king and key princes.”
Within this elite, Simmons said two camps are emerging in regard to oil reserves and what that could mean for oil prices.
“One, as best expressed by many Aramco and Petroleum Ministry officials, is that none of the great fields have many problems and will last for many more decades. The other end of spectrum worry that these same fields are at risk of being overproduced and favour a new era of field-by-field production flow transparency. If they embraced transparency, I suspect the results would send oil prices far higher, benefiting the Kingdom,” said Simmons.
While Petroleum Minister Ali Al Naimi represent the oil technocrats, he also addresses the interests of the king and the estimated 7,000-25,000 members of the House of Saud. How a change in leadership will impact on policy when King Abdullah, aged 84, passes away is not evident. With Crown Prince Sultan in declining health, interior minister Prince Naif, 74, is considered next in line for the throne after being recently appointed second deputy prime minister.
Currently, Riyadh appears to be hedging against changes in the energy market, with Al Naimi acknowledging at a summit in Houston in February the need for nuclear power and renewable energy, adding that in the future Saudi Arabia would export the same British Thermal Unit (BTU) equivalent in electricity from solar power as present crude oil levels. The kingdom is also actively moving beyond the production process. “Saudi Arabia and Kuwait have put aside between $12 billion and $15 billion for controlling future energy from the Caspian region,” said Moors, “moving from the traditional approach of controlling the process, facilities and refineries, to being gate keepers to access and future projects. There has also been an increase of Saudi money to control tanker production facilities.”
But while Saudi Arabia is secretive about its oil policy and reserves, the kingdom does not necessarily have a firm grasp over where the oil markets are going.
“Many people assume senior Saudi officials have some magic crystal ball on oil, but they are just as puzzled as the folks at the International Energy Agency or [the US'] Energy Information Administration and most of everyone’s data comes from 'guesstimates'. The blind are really leading the blind,” said Simmons.