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Saudi Arabia faces an oil dilemma

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Saudi Arabia faces an oil dilemma

Published: June 19 2008 03:00 | Last updated: June 19 2008 03:00

Saudi Arabia has elected to pump more crude oil. The decision, to be announced this weekend at a summit in Jeddah with consuming nations and international oil groups, will test Riyadh’s power to move the market. With crude surging to record highs of almost $140 a barrel, the increase in Saudi output is a welcome – and necessary – step if prices are to fall. But, on its own, it is unlikely to reverse supply tightness and its effect on inflation.

That the kingdom has signalled it will try to bring prices back under control is a modest diplomatic victory for the US and other consuming countries. It is an admission by the Saudis that they were partly to blame for the run-up in the first place. Riyadh’s insistence that market speculation and a lack of refining capacity accounted for high prices ignored the impact of its own recent policy of cutting supplies to drain world oil inventories.

Saudi Arabia has exacerbated a market squeeze caused by rising demand in the fast growing economies of China and India. In trying to protect itself against the risk of price falls, it relinquished its role as the voice of the Opec producers’ cartel. Hawkish members eager to fan market expectations of higher prices have filled the vacuum.

Yet Riyadh’s new-found display of leadership involves risks. The Saudis’ status as a swing producer – they hold almost all spare Opec capacity – makes them a powerful force. Nevertheless, it is far from certain that the predicted Saudi rise of about 200,000 b/d (to 9.7m b/d) will have any effect at all on prices.

That will depend on the type of crude Saudi Arabia offers and the price it demands. There is no point in Riyadh pumping more low quality crude if there is a shortage of refining capacity to process this grade – unless it is offered at tempting discounts to benchmark crudes, something the Saudis are reluctant to do.

There are doubts, too, over the extent of Saudi capacity. The secrecy surrounding its reserves gives Opec leverage and consuming nations hope. It has served Riyadh’s interests to keep everyone guessing. But this increase leaves little in the tank for when the next hurricane hits the Gulf of Mexico or Nigeria’s oil workers go on strike.

If the Saudis act and achieve nothing, they will lose their influential aura. Their status in Opec and with the US will diminish. That looks likely since this latest increase will be too small to bring prices down. Investment in Middle East refineries is needed. But, with the Saudis fearful that would lead to a price collapse, do not expect relief soon.

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