Saudi Arabia’s New Oil Balancing Act
By Andrés Cala
Saudi Arabia is facing a tough oil balancing act in 2013 and the remainder of the decade to preserve its geopolitical and economic clout, as it adapts to increasing global supply -mainly from US and Iraq- and increasing government spending and energy demand.
Saudi global clout and internal stability lies in its ability to regulate global oil prices through its unrivalled production spare capacity. This leverage is illustrated by Saudi Arabia’s current ability to offset stagnant OPEC supply (with the exception of Iraq) and falling non-OPEC supply (with the exception of North America), on top of an oil embargo on Iran, all while keeping oil prices at a comfortable level for both consumers and producers.
But as the world emerges from its worst economic crisis in decades and policy makers start changing gears, the US resurgence as an oil power and the expected Iraqi production gains are blunting the Saudi’s ability to open and close the oil tap at its convenience.
Additionally, rising domestic consumption from a heavily subsidized and rapidly growing population, on top of internal political stability concerns, are increasing the Kingdom’s public spending and the need to burn more of its oil for power generation and desalination.
Indeed, Saudi Arabia naturally will remain the top oil market regulator as its biggest supplier, but its de facto monopoly on influencing prices will diminish in coming years.
Put simply, Saudi Arabia relies heavily on a subsidized economy to achieve the political stability that is vital in this juncture and on its oil market leverage to gain geopolitical clout, but rising domestic oil demand and global output gains will undermine its ability to wield the same power.
Riyadh has tough decisions ahead. As global output and downward price pressure increase, it will see its global clout diminish, but it’s politically hamstrung domestically to implement unpopular policies to reduce domestic energy demand.
The Kingdom will have to factor the new landscape to balance its domestic political concerns with the need to cut production in order to keep global prices at a range it’s comfortable with.
The biggest game changer for Saudi Arabia is rapidly rising oil production in the US as new technologies allow for the development of massive shale oil reserves. In fact, the IEA forecasts the US will replace Saudi Arabia as the world’s biggest oil producer by 2020. Its output will continue increasing, while its imports fall, while Canada, as expected, will continue developing its own oil sands.
Meanwhile, emerging economies –including those in the Middle East- will continue to increase demand rapidly, led by China. But US oil production has reversed years of insufficient net loss and for the first time in years global production gains will outpace demand gains in 2013 and inventories will build.
“The mounting pressure of accelerated stock-building will probably force Saudi Arabia to trim output to pull stock-building back to seasonally normal levels and prevent a sharp drop in prices, possibly with some cooperation with other Gulf Arab producers,” according to risk consultancy Eurasia Group.
As the economy strengthens, demand will pick up, but new North America and Iraqi supplies will boost output significantly throughout the decade and space capacity will increase.
Prices won’t plummet as they have support from the higher costs of production associated with the new output that will gradually come online over this decade, whether its shale oil, unconventional oil, or deepwater. And energy demand will inevitably pick up and bring oil markets back into synch.
Most other Opec nations are already pumping at maximum levels, but there could be unexpected production gains from Venezuela and Africa, which would further pressure Saudi output reductions to prevent prices from falling.
That means Saudi Arabia will carry most of the burden of Opec production cuts as the cartel struggles to protect its price-fixing ability. Iraq will not accept a quota below its potential; Iran will eventually find markets for its oil and a diplomatic solution to lift sanctions on its energy sector is inevitable, even if not forthcoming.
“There is the looming prospect of Saudi Arabia having to absorb output cuts to offset gains in production capacity elsewhere in OPEC, particularly Iraq,” Eurasia Group said. And “any reversal of sanctions against Iran which would put substantial additional Iranian volumes on the market would serve to intensify and accelerate this effect,” Eurasia Group said.
Saudi rising demand
Meanwhile in Saudi Arabia, energy demand continues to soar, as its heavily subsidized population increases and its industrial activity and investments is buoyed. Around a quarter of Saudi Arabia’s oil production of nearly 10 million bpd is consumed domestically, more in per capita terms than any industrialized nation. Its oil use in relation to its economic output is twice the global average.
What’s more, lack of viable electricity generation alternatives and the need to increase water desalination plant capacity, as well as heavily subsidized energy consumer and industrial costs for political purposes, will continue to diminish the Saudi oil export potential in coming years.
A crucial concern is internal stability as the Arab Spring continues to spread. King Abdullah also committed $130 billion in subsidies and $500 billion in infrastructure projects to stimulate the economy. Saudi’s are also investing heavily in containing Iran’s geopolitical ambitions, from the war in Syria to protecting Bahrain.
By posting your comment, you agree to abide by our Posting rules