Saudi Fears of High Oil Prices Fade With Demand

5/5/2008 1:46:00 PM

ENERGY MATTERS: Saudi Fears Of High Oil Prices Fade With Demand



HOUSTON (Dow Jones)--For all the benefits of soaring oil prices, Saudi Arabia has historically viewed them with a measure of trepidation.



Besides the worry that high energy prices could hinder economic growth and eat into demand, Saudi officials have traditionally argued that sky-high crude prices would hasten the development of renewable energy that would displace petroleum.



But as oil prices have crept up in recent years, from the $20 a barrel range early in the decade to Monday's record above $120 a barrel, the kingdom has repeatedly used its clout within the Organization of Petroleum Exporting Countries to sanction an ever-higher price deck. At the same time, while Saudi Arabia's powerful Oil Minister Ali Naimi has at times emphasized price moderation, he hasn't been as vocal as some predecessors on the worry that high prices threaten the long-term viability of Saudi Arabia's core asset.



Interpreting Saudi Arabia's strategy is challenging, in part because Naimi and other top petroleum officials don't often speak publicly and choose their words carefully when they do. Saudi oil ministry officials declined to comment for this article.



Still, some leading energy and Middle East experts perceive a Saudi shift towards greater acceptance of high prices amid surging demand from China and other developing economies. Next to these new sources of demand there is diminished concern about high prices creating greater incentives for competing sources of energy.



"Many years ago, before the demand side of the equation became so dominant, the view that if prices were lower, alternatives could not survive was accepted," said James Oberwetter, former U.S. ambassador to Saudi Arabia. "But the dawning of these huge new markets has really dimmed the prospect for lower prices."



Rice University analyst Amy Myers Jaffe said Saudi Arabia may be unleasing a dynamic that could harm its long-term interests.



"They might have been right at $50 oil, but not at $100- and $200-oil," said Jaffe, a fellow at the James Baker Institute, a Rice think tank. "They're not right because at $200, almost everything works."



Thinking Long-Term?



The Saudi national most vocal in outliningthe potential threat of renewable energy has been former petroleum minister Sheikh Ahmed Zaki Yamani, who held Naimi's job from 1962 to 1986. Perhaps Yamani's most oft-quoted statement was his prediction that "The Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil." The comment has been cited as early as the 1970s, but Yamani has continued the mantra.



Speaking last week, Yamani said his advice to OPEC is "to increase production and lower prices because this is harmful midterm (and) long term to OPEC itself," according to a report in Energy Intelligence. "It will increase the activities to find alternative sources of energy, and OPEC will remain helpless at that time."



Yamani was unavailable for an interview, but the Centre made available its Executive Director, Fadhil Chalabi, who was Acting Secretary General of OPEC in 1983-1988. Chalabi said leading OPEC producers are being short-sighted in seeking ever-higher oil prices. While demand growth has been impressive in developing countries so far, Chalabi warned that China's use of coal, nuclear energy and other sources will displace oil.



"It's a matter of time," Chalabi said. OPEC officials "don't care what will happen in 10 or 20 years or more. They are politicians. They care only about what will happen today."



"Even Saudi Arabia with these huge reserves is now more concerned about maximizing oil revenues than it is about maximizing long-term recovery of its oil," said Chalabi.



Crude oil futures prices surged Monday to top $120 a barrel for the first time amid fresh anxieties about oil supplies at a time of rising seasonal demand. June light, sweet crude was trading at $120.07, up $3.75 in early afternoon trade on the New York Mercantile Exchange.



OPEC supplies one in four of every barrel of oil consumed globally, which reached about 87 million barrels of a day in the first quarter. After slicing oil production in late 2006 and early 2007, the cartel has kept its daily output unchanged even in the face of oil prices that first breached triple-digit territory on Jan. 2. The group says speculators and a weak dollar

are behind the latest move higher in prices.



Saudi Arabia is the world's only true custodian of spare capacity. The kingdom is currently pumping a little over 9 million barrels a day, according to Dow Jones Newswires estimates.



No More 'Good Sweatings'?



If the fear of high prices is one of the defining axioms of the oil market psyche of the recent past, then the nature of Saudi influence is also being redefined. While spare capacity still gives Saudi Arabia unique power to sway the market, the structural shift in global energy demand limits its ability to conceivably push oil prices down to historic lows. This shift towards a higher price floor creates openings for competing energy sources.



Saudi Arabia's role in the global oil market has sometimes been likened to the Federal Reserve, calibrating its output depending on market signals. Critical to this unique standing has been Saudi maintenance of a cushion of "spare capacity," now estimated at about two million barrels a day. For much of the recent period, the kingdom has refrained from tapping into all or most of its spare capacity.



Within oil industry circles in places like Houston, the Saudi power has also carried a somewhat ominous connotation. Faced with growing production from the U.K., Mexico and other non-OPEC countries in the mid-1980s, Saudi Arabia flooded the market in an effort to drive out high-cost production and reassert its dominant market share.



The 1986 oil price crash ushered in more than 15 years of mostly-lower crude prices, instilling a memory of economic hardship on the western oil industry that continues to be reflected in Big Oil's caution during these heady times. The shift to lower petroleum prices also impeded the development of renewable energy for about two decades.



In his book, The Prize, Daniel Yergin compared the Saudi tactic in the 1980s to power plays by John Rockefeller and other heavyweights in the history of oil who have used a "good sweating" to drive out competitors.



"No one is worrying about over-supply," Yergin said in an interview. Instead, the market is preoccupied with meeting growth in China, India and other fast-developing economies.



"What (the Saudis) have discovered is that the tolerance level in consumers is higher than they thought," said Thomas Lippman, an adjunct scholar at the



Middle East Institute, a Washington research institute.



Given the specter of higher demand in Asia and the increased cost of bringing on new oil production, many analysts believe the long-term price of oil is in the $45-$60 a barrel range. Recent comments by Naimi suggest the Saudi official sees an even higher floor than that.



"A line has been drawn now below which prices will not fall," Naimi said in March in an interview with PetroStrategies, a French energy publication. Citing the marginal costs of biofuels and Canadian tar-sands, Naimi defined the floor as "probably between $60 or $70."



Naimi in April said Saudi Arabia was putting off a plan to expand oil capacity beyond 12.5 million barrels because of concerns about demand growth. "Unless we see really genuine demand, we have to pause right now and see what happens," Naimi told Petroleum Argus.



Some energy analysts say the Saudi move suggested a more sober outlook on oil prices. "If they see a lot of risk on the demand side then you could see very low prices and potentially a lot of underutilized capacity down the road," said Ken Medlock, a fellow at Rice's Baker Institute.



But former U.S. Ambassador Oberwetter said the pause in the expansion may reflect Saudi Arabia's view of the limitations in its own supply at a time when all companies, including Saudi Arabia Oil Co., have been forced to spend record amounts to raise volumes.



"They can do more, but it certainly raises the question of 'How much more?'" Oberwetter said.


Source: Gregory Meyer in New York and Spencer Swartz in London contributed to this report.)