TheBusinessOnline: Saudi Arabia lays plans to cover Opec shortfalls

By Nawaf Obaid in Riyadh

17 September 2006
* Iran and Venezuela ready to withhold oil * Iraq and Nigeria hampered by saboteurs
 
As Iran seems likely to flout any United Nation Security Council resolution regarding its uranium enrichment program, sanctions against Tehran could soon become a reality. And even if they aren’t initially applied to the country’s oil exports, they will have a major effect on energy markets, because Iran has threatened to cut oil supplies in retaliation.

To confront this challenge – as well as that from potential disruptions elsewhere – Saudi Arabia has embarked on a strategic energy initiative with the explicit objective of maintaining enough spare oil capacity to compensate for the loss of oil from two of Opec’s major oil exporting countries.

Phase One of this effort extends until 2009, and will allow the Kingdom to replace all of Iran’s exported oil, if necessary. Thus, if Iran responds to UN-imposed sanctions by cutting its oil exports – which its foreign minister implicitly threatened to do this month when he said that the “first consequence of these sanctions would be an increase in the price of oil to around $200 per barrel” – the impact won’t be as severe as many think. In fact, the Kingdom has largely already succeeded in achieving this goal. Iran currently exports between 2.2 to 2.4m barrels of oil per day (mbd). Saudi Arabia exports nearly four times as much (approximately 8.5 mbd) and its spare capacity is 1.8-2 mbd.

Thus, the Kingdom is currently just short of being able to fully offset Iran’s oil exports. And this relatively small gap will be closed by early 2007, when the Khursaniyah oil field goes onstream, adding an additional 500,000 barrels of lighter grade oil to the Kingdom’s sustained capacity.

Unfortunately, the problems afflicting oil markets today are not transitory. In addition to Iran, Venezuela is another potential trouble spot. To advance his “Bolivarian” revolution, President Hugo Chavez has nationalised privately-owned oil fields, unilaterally rewritten contracts requiring foreign oil companies to pay the state higher royalties than they originally agreed to, and has prioritised politics over competence in the management of the country’s oil. In addition, Chavez has threatened to use the oil weapon against the US.

Unrest also threatens the supply in countries such as Iraq and Nigeria, where saboteurs have put a considerable dent in oil production. In Nigeria, oil production is down by around 550,000 barrels a day, because members of the Movement for the Emancipation of the Niger Delta – which seeks to “emancipate” this oil-rich region from allegedly exploitative foreign oil companies, and return the country’s oil wealth to the people – are attacking pipelines and kidnapping foreign oil workers. And in Iraq, depending on the month, oil production is at least 500,000 barrels per day lower than the 2m produced when Saddam Hussein was in power. This is because US and Iraqi militaries can’t stop saboteurs from blowing up pipelines as soon as they have been repaired from the previous crippling attack.

For these reasons, Phase Two of the Kingdom’s oil production expansion schedule calls for increasing capacity between 2010 and 2012 to approximately 13 mbd (with 3.5 mbd of spare capacity). At this level, the Kingdom will be in a position to make up for all of Iran’s exports plus those of either Iraq, Nigeria or Venezuela. Each of these countries is susceptible to supply disruptions, and the Kingdom is dedicated to ensuring that even in the worst case scenario, global oil demand can be met.

Sceptics argue that Saudi Arabia will not be able to boost its production capacity by these amounts. While they are right that these targets are ambitious, they ignore the fact that Saudi Aramco, the state-owned oil company, has announced equally lofty goals throughout the past decade, and it has achieved them all. In the past three years alone, Saudi Aramco has increased its sustained capacity by 800,000 barrels a day. And it is investing heavily to reach its goals: between 2004 and 2009, the Saudi government will have spent over $17bn to increase its upstream capacity.

A disruption of Iranian (or Venezuelan, Iraqi or Nigerian) oil exports would undoubtedly push oil prices – currently hovering at an astronomical $73 a barrel – even higher. But the consequences will not be as calamitous as many think. King Abdullah has decoupled politics from energy policy in the Kingdom and expedited its oil production expansion schedule as an insurance policy against potential instability in Opec oil exporters. The Kingdom realises its long-term interests are best served by a stable energy supply. This stands in contrast to the position of Iran and Venezuela’s leaders, who are threatening to use their oil as a political weapon. Fortunately, the world’s central bank of oil is not located in Tehran or Caracas, but in Riyadh.

Nawaf Obaid is managing director of the Saudi National Security Assessment Project in Riyadh

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