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SAUDI ARABIA READY TO BOOST CRUDE OIL OUTPUT

Kingdom holds last OPEC spare capacity as crude price nears $50 

CURRENT DEVELOPMENTS

Saudi Arabia, the world's largest oil producer, announced August 11 that it was ready to increase the Kingdom's crude oil production to help reduce and stabilize high oil prices. The Kingdom estimated that it could increase production by 1.3 million barrels of oil per day (BPD) if necessary.

"The Kingdom of Saudi Arabia, in collaboration with the other OPEC member countries, endeavors to ensure the stability of the international oil market and prevent oil prices from escalating in a way that may negatively affect the world economy or oil demand," said Ali Al-Naimi, Saudi Minister of Petroleum and Mineral Resources, in a statement released to the Saudi Press Agency.  

Naimi noted Saudi Arabia already increased oil production during the past three months to meet the growing demand.  The increases amounted to over one million barrels per day, bringing to over 9.3 million barrels per day.

The oil market initially responded positively to the Saudi announcement with prices closing last August 11 at $44.80 per barrel. However, this was only down slightly from the record price hit of $44.84 on August 9. Prices opened the week of August 16 in excess of $45.00 per barrel and have pushed to new levels through the week, touching $47.81 on August 19.  Although oil prices continue to remain high, USA Today reports that current oil prices, adjusted for inflation, are below levels seen in the mid-1970s and early 1980s.

Other factors affecting the market served as the reason for only a marginal drop in market prices after the Saudi announcement.  Adel Al-Jubier, foreign affairs advisor to Crown Prince Abdullah, told Fox News on August 11, "When we indicated today that we are ready to increase production by an additional 1.3 million barrels, we really haven't seen an increase in demand by our clients. We believe the reason we have had prices -- high prices now is because of factors having nothing do with supply-demand. [See "Factors.." below]  People are concerned about the situation in Iraq and concerned about the situation with Yukos [oil company] in Russia, concerned about possible instability in Venezuela, and as a consequence, you have massive speculation by hedge funds, which are driving prices high."

Rising oil prices are not only making headlines in the news but also have become a campaign issue in the race for the presidency. Controversy erupted last April with the suggestion that Saudi Arabia could influence the outcome of the election by lowering oil prices to influence the vote.  In reaction to critics of Saudi motives Ambassador to the US Prince Bandar bin Sultan writing in an Op-ed on August 15 said, "Let me be unequivocal in stating that Saudi Arabia has always stood by America and the world when our intervention was required to stabilize oil prices."

BACKGROUND

Saudi Arabia and World Energy Stability

In June 2004, the Energy Information Administration asserted, "With one-fourth of the world's proven oil reserves and some of the lowest production costs, Saudi Arabia is likely to remain the world's largest net oil exporter for the foreseeable future."

Saudi Arabia is a vital player in stabilizing the world oil market. The Kingdom's vast oil reserves allow for the capacity of swing production. Swing production means that the Kingdom may increase its production if the demand is present in the market. This in turn helps to stabilize crude oil prices. The August 11 announcement that Saudi Arabia could, if necessary, increase current production levels by 1.3 million BPD is an example of the Kingdom's surge capacity.

In contrast, the other members of OPEC are currently reported to be producing at their production capacities with Saudi Arabia positioned as the only OPEC 10 source that has spare capacity available. 

Sadad Al-Husseini, former executive vice-president of Saudi Aramco, predicted last May that ".. the Kingdom can certainly increase its production to 15 million barrels per day based on its existing reserves base."

Ali Al-Naimi, Saudi Minister of Petroleum and Mineral Resources, reinforced the commitment of the Kingdom in insuring world oil prices last April at a conference hosted by the Center for Strategic and International Studies and the U.S.-Saudi Arabian Business Council.

Al-Naimi said, "The reliability of supplies from Saudi Arabia is not just the product of good fortune, rather it's a direct result of Saudi Arabia's commitment to ensuring oil market stability. We work at it day in and day out, investing huge sums in the latest technologies, searching the world for the best talent, and then continuously training our workforce to meet the challenges of the new millennium.

"It comes from our commitment to maintain spare production capacity at a significant cost to ourselves, to provide an insurance policy for world oil markets. And it comes from our commitment to maintain relationships in all major markets, even when it is contrary to our short-term economic interest to do so. We do all this so that we can maintain the reliability upon which the world has come to depend."

Most of the Kingdom's proven oil reserves are located in the Eastern Province, including the largest onshore field in Ghawar and the largest offshore field, Safaniya, in the Arabian Gulf. Currently, Saudi Arabia's reserves, as stated by Saudi Aramco, have been established at 260 billion barrels. In 2003, Saudi Arabia supplied the United States with 1.7 million BPD of crude oil, or 18%, of U.S. crude oil imports for the year.

Factors Driving Crude Prices

The ability of Saudi Arabia to quickly add crude oil to the world market is only one factor in the price calculation.  The current market forces include a number of supply/demand factors as well as speculation and fear about instability and terrorism.   

A key factor in the current escalation of crude prices is world demand:

• China's refineries have processed 17.2 percent more crude so far this year than in 2003. Crude imports have soared nearly 40 percent from last year.
• India expects the nation's crude oil imports to rise by 11 percent between 2004 and 2005 with demand rising by nearly 4 percent.
• Demand in the U.S., has jumped 3.4 percent this year. Inventory building slowed as rising consumption absorbed extra imports.

Shocks to the pricing system are also felt by the availability of crude inventories:

• U.S. stockpiles of crude oil fell by 1.3 million barrels last week..  sending prices to another record high. Crude inventories, excluding the Strategic Petroleum Preserve, fell by 0.4 percent to 293 million barrels..

A more perplexing element in the pricing calculation is speculation about potential disruptions in supply posed by civil and political instability, and fears of terrorism.

• Russian oil giant Yukos continues to teeter on the brink of bankruptcy as the government tries to collect $3.4 billion in back taxes -- a move that threatens to cut off Yukos' daily crude supply of 1.7 million barrels.
• In Venezuela, the world's fifth-largest exporter, opposition leaders refused to participate in an audit of last Sunday's referendum to oust President Hugo Chavez -- which officials say he won convincingly.
• Export of crude from Iraq's southern oil terminals has been cut by half for a week because of threats to infrastructure from Shiite Muslim militia.
• Oil traders report that fears of terrorist attacks that might disrupt Middle-Eastern oil exports may account for as much as $8 of the current per-barrel price.

These factors are complicated by the lack of spare capacity in world oil producing states.  Among OPEC suppliers only Saudi Arabia is ready to increase production according to EIA data.  "OPEC produces almost at capacity while you have very strong demand - that's pressuring the market," said Muhammad-Ali Zainy, an energy analyst at the Center for Global Energy Studies, based in London. "If there are supply disruptions you'll see a spike in prices because we have little or no cushions left.."

Analysts said the uncertainty could see prices continue to rise -- "$50 isn't so unreasonable anymore," said Victor Shum, oil analyst at Texas-based energy consultants Pervin & Gertz in Singapore.

"Whatever spare production capacity the market thought was out there has been wiped out by what's happening in Iraq," said Lawrence J. Goldstein, president of the Petroleum Industry Research Foundation in New York. "The market is very fragile." [NYTimes]

Despite the drop in crude and gasoline inventories, the amount of oil coming into the U.S. averaged 10.4 million barrels per day, up 883,000 from the previous week. The EIA said the increase was likely from increased shipments from Saudi Arabia and the beginning of shipments from Libya. [CNN]

The resolve of Saudi Arabia to use its excess production capacity to stabilize world energy markets has been called into question by partisans in the U.S. presidential election season. This suggestion was taken by the media from Washington Post reporter Bob Woodward's bestselling book Plan of Attack, which outlines the Bush Administration's lead-up to the war in Iraq.

Woodward reports in his book, " 'I'm worried about the adequacy of the oil market,' the president [President George W. Bush] stated, expressing concern for the world oil market's ability to absorb temporary shortfalls during a war in the Middle East. The ripple effect in the U.S. economy could be gigantic, and he asked about the excess production capacity of the U.A.E. and Saudi Arabia. Saudi oil policy could be the saving grace. According to Prince Bandar [Saudi Arabia's ambassador to the United States], the Saudis hoped to fine-tune oil prices over 10 months to prime the economy for 2004. What was key, Bandar knew, were the economic conditions before a presidential election, not at the moment of the election" [page 324].

Both Woodward and Prince Bandar responded to the media's allegations of the Kingdom's oil policy influencing the coming presidential election.

Woodward said on CNN's Larry King Live on April 19, "What I say in the book is, according to Bandar, the Saudis hoped to control oil prices in the 10 months running up to the election because if they skyrocketed, it would hurt the American economy."

According to CNN, Prince Bandar responded last April to the media's allegations by saying, "When it comes to oil prices .. the Saudis always, as far as the media is concerned, damned if I do, damned if I don't. If the price is high, we are blamed for it."

Democratic presidential candidate Senator John Kerry (D-MA) has taken issue with alleged Bush-Saudi ties and America's energy policy. In July, he made clear his position for a future America independent of Middle Eastern oil. Kerry said last month at the Democratic National Convention in Boston, "I want an America that relies on its own ingenuity and innovation, not the Saudi royal family."

Despite Senator Kerry's and others' criticisms, Saudi Arabia serves as the world's largest oil producer with approximately 25% of the world's proven oil reserves and the only OPEC country able to pump more crude into the current volatile market. 

Conclusions

The American economy may have been stalled by higher crude oil prices in recent months, but consumers seem not to be alarmed by the skyrocketing world crude prices. Oil analyst Trudy Lundberg was quoted in various media on August 16 as saying that gas pump prices in the U.S. have dropped 20 cents per gallon since May, but the trend is likely over given the high crude price surge. Potential voter reactions to higher retail gasoline prices may reignite the Saudi oil issue among election partisans.

Notwithstanding the Saudi announcement on August 11 of increased production, oil prices continue to remain high. The markets will continue to respond to current conditions, such as production at near capacity, surging demands in the United States and China, as well as speculation about: terrorism, fighting in Iraq and the shutdown of its oil exports, uncertainty in the Russian oil industry, political instability in oil exporters like Venezuela and Nigeria are factors beyond supply-demand calculations that may reduce the impact of Saudi Arabia's increased production effort to lower prices.

The prospect of energy cost ripples throughout world economics, especially among American motorists, will bring the U.S.-Saudi relationship vis-à-vis oil supplies to the forefront of election year politics in the near-term despite Riyadh's aggressive steps to stem rising prices.