LONDON, 12 August 2004 — Since Sept. 11, 2001, there have been growing misconceptions about Saudi Arabia’s key position in the oil market. These misconceptions, though most of the times are politically motivated, have become part of the conventional wisdom. Unfortunately, this new “conservative”’ wisdom is beginning to dictate US energy policy and its political and strategic agenda.
After the Sept. 11 attacks, many US analysts doubted whether Saudi Arabia can still play the role of the swing producer. Matthew R. Simmons, the chairman of Simmons & Co. International, claims that Saudi Arabia’s oil sector is extremely fragile and could witness a severe decline in production in the few coming years.
This was echoed in The New York Times which claimed that Saudi Arabia’s oil fields are now “in decline, prompting industry and government officials to raise serious questions about whether the Kingdom will be able to satisfy the world’s thirst for oil in coming years.”
These assertions are usually followed by suggestions that the US no longer need to rely on the Kingdom as a swing producer. Instead Russia, the emerging energy giant, can assume this role.
Surely, these dooming predictions mean that Saudi Arabia is becoming less important to the oil market. “Nonsense”, says the Economist. “Ignore the headlines and look instead at geological and market realities and it quickly becomes clear that Saudi Arabia remains the indispensable nation of oil. The Saudis not only export more oil than anyone else, but they also have more reserves than anyone else — by a long shot.”
This growing skepticism toward Saudi Arabia as a key supplier of oil is unwarranted. After all, the Kingdom’s record as swing producer has been highly reliable in filling the oil gap at times of disruptions and moderating oil prices. The Economist points out that Saudi Arabia has done this at various times: “During the Iran-Iraq war when output from both countries was disrupted; during and after the first Gulf War, when output from Iraq and Kuwait was lost and last year, when civil strife in Venezuela and Nigeria curbed output from both countries on the eve of last year’s invasion of Iraq, which itself disrupted Iraqi output”.
Also, there are many reasons why no country, including Russia, can ever become a swing producer. As J. Robinson West explains in his Washington Post article, “the first reason is the weather. Should Russia bring the wells on line, constant production would be necessary or they would freeze and explode. It rarely freezes in Saudi Arabia. Likewise, no matter what the government might want, Russian companies and their investors seek a high return at all times on their most important assets: Producing wells. Only governments can afford to have assets that do not perform.”
Another tenet of the conventional wisdom is that by exporting to the US, Saudi Arabia subsidizes American consumers in return for US protection. Edward Morse and James Richard make this point in Foreign Affairs arguing that “Saudi Aramco, the state oil company, earns about $1 a barrel less on sales to the United States than on sales to countries of Europe and East Asia. That discount translates into a subsidy to US consumers of $620 million per year. In return, the United States deploys military forces in the Gulf which is of course also expensive.”
This simplistic view of a bazaar-type exchange of money for protection is flawed. Even if Saudi Arabia does not export a single barrel of oil to the US, it is impossible to conceive a situation in which disruption of Saudi oil supplies to the rest of the world would not influence prices in the US market. Thus, US strategic interests will always dictate defending and securing flow of oil from the Kingdom regardless of whether Saudi Arabia increases or decreases its share in the US market.
Another related misconception both among some Western and Arab observers is that Saudi Arabia possesses an “oil weapon” by which it can punish the US or any other nation. These observers point to the 1973 oil crisis as evidence of the existence of such a weapon. However, like the Iraqi weapons of mass destruction, this oil weapon is also a myth. Professor Adelman from MIT points out that “whether a supplier loves or hates a customer does not matter because in the world oil market, a seller can’t isolate any customer and a buyer can’t isolate any supplier.”
This leads us to refute a related misconception: The US should aim at achieving “energy independence” from the Kingdom at any cost. This issue has been raised repeatedly, especially during election campaigns. In his acceptance speech on July 29, Sen. Kelly told his audience,”we value an America that controls its own destiny because it’s finally and forever independent of Mideast oil. What does it mean for our economy and our national security when we only have 3 percent of the world’s oil reserves, yet we rely on foreign countries for 53 percent of what we consume? I want an America that relies on its own ingenuity and innovation — not the Saudi royal family. And our energy plan for a stronger America will invest in new technologies and alternative fuels and the cars of the future — so that no young American in uniform will ever be held hostage to our dependence on oil from the Middle East.”
Such calls within the US and elsewhere for “energy independence” are just political slogans based on flawed reasoning. Energy policy aimed at increasing domestic production and reducing or diversifying the sources of imports is both wasteful and ineffective. The reality remains as Professor Adelman notes “that every barrel in the world competes with every other” regardless of where this barrel is produced.
Another tenet of the conventional wisdom is that even if Saudi Arabia has the vast reserves it claims to have, without opening the oil sector to foreign investment it will not be able to boost its production capacity and generate the required additional spare capacity to meet growing demand. This argument is usually coupled with skepticism on whether Saudi Aramco has the financial capacity and the technical experience to deliver the goods.
So far there is nothing to indicate that Saudi Aramco suffers from the problems that cripple other state-owned institutions, mainly the common problem of being squeezed for funds for furthet investment and development or the lax attitude. In fact, recent record suggests the opposite. Just consider the impressive development of the Shayba field that started production in 1998. Saudi Aramco financed and managed the Shaybah field, including the planning, design, construction, drilling, development and production of the field.
With the improvement of Saudi Arabia’s financial situation, it is not very clear the advantages of foreign investment in the upstream oil sector. If it is technology, “there is no technology for upstream developments that Saudi Aramco either does not possess or is unable to acquire from sources other than the international oil companies”, notes Professor Robert Mabro of Oxford University.
It is also not clear whether inviting foreign investment is less costly. Professor Mabro argues that this all depends on two set of factors: “First, the size of the differentials between the rates and terms at which the country can borrow in the international capital market and the cost of capital to the foreign firm. For Saudi Arabia this differential is much smaller than for many developing countries.”
More important, it is not necessarily true that the lower capital costs of the foreign investor will be passed to the country. “On the contrary, the foreign company will ask for a return on its investment that includes compensation for a wide range of risks. This compensation is likely to be greater than the above-mentioned differential in the Saudi case.”
Unfortunately, these and other misconceptions that dominate the oil debate are having their impact on oil prices through speculation in the futures markets. Saudi Arabia’s only weapon is its spare capacity through which it can send signals to the futures market. If speculators are bearish, Saudi Arabia can announce production cuts. If the market is bullish, it can announce production increases to lower prices. However, as these misconceptions become more dominant, the Saudi weapon is becoming less effective in calming the oil market.
— Dr. Bassam Fattouh is lecturer in financial studies, the School of Oriental and African Studies, University of London.
