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July 7, 2008 No.
452

Saudi Arabia's Waning Influence On the Oil Market

Introduction

In the 1970s, particularly during the oil embargo of 1973, the oil market was almost single-handedly dominated by then-Saudi Oil Minister Sheikh Ahmad Zaki Yamani. "For more than two decades," writes Pamela Sherrid, "Ahmed Zaki Al-Yamani's commands boosted or battered personal pockets books and national economies around the world."[1] Today, when Saudi Oil Minister Ali Al-Naimi talks, the market yawns, and when his king announces in an international conference that Saudi Arabia will increase crude production, the price of oil goes up.

Overview of Oil Pricing and Supply

The price of crude oil has skyrocketed in recent months, inching toward $150 a barrel, with the Organization of Petroleum Exporting Countries president Chekib Khelil warning that the price could rise to $150-$170 a barrel in the summer. Opinions vary on the reason for the mounting price. Producers argue that supply and demand are in equilibrium and the chaotic oil market is a result of high-powered speculators who seek to make a quick profit by generating artificially high demand and hence higher prices. The rapid depreciation of the U.S. dollar against other major currencies is another reason for higher oil prices. By contrast, oil companies maintain that the failure of supply to match rising demand is the reason for the high prices. Oil companies have long complained that resource nationalism is preventing them from exploring new oil fields in oil-rich countries such as Saudi Arabia, Russia, and elsewhere.

According to the 2008 BP (British Petroleum) Statistical Review of World Energy, the Middle East's proven oil reserves stood at 755 billion barrels at the end of 2007, or 61% of the world total, equivalent to 82 years of production at current levels. Global proven oil reserves amounted to 1.24 trillion barrels, sufficient to meet current worldwide production for more than 41 years. In addition, the Middle East contains 41% of the world's gas reserves, with regional reserves standing at 2,585 trillion cubic feet at the end of 2007. The vast majority of the region's gas reserves are found in Iran and Qatar, respectively, home to 15.7% and 14.4% of the global total. The world's largest gas reserves, a quarter of the global total, are found in the Russian Federation.[2]

The six members of the Gulf Cooperation Council (Saudi Arabia, the United Arab Emirates, Kuwait, Bahrain, Qatar and Oman) earned $364 billion in 2007, but they are projected to earn $639 billion in 2008 and $657 billion in 2009. Saudi Arabia alone is projected to earn about $700 billion in 2008-09, following earnings of $194 billion in 2007.[3]

The Jeddah Oil Summit

Following a plea to the Saudi monarch by President George W. Bush during their summit meeting in Riyadh on May 16, 2008 to increase production in an effort to bring down prices of crude, King Abdullah called for oil "summit" of oil producers and consumers to meet in the port city of Jeddah on June 22. President Bush made no statement about his discussion with the Saudi king on the subject of oil; it was left to United Nations Secretary-General Ban Ki-Moon to declare that King Abdullah considered the current prices of oil "abnormally high" and that he was willing to do whatever was in his power bring them down. Ki-Moon said that Saudi Arabia, the largest producer of crude, was considering seriously countering the price spike by increasing production by 300,000 b/d (barrel/day).[4]

The following day, May 17, oil prices eased slightly, following a wild, record-setting session of weighed expectations of higher Saudi Arabian output against the market's ability to quench soaring global demand.[5]

Saudi Oil Minister Ali al-Naimi sent invitations to OPEC countries as well as to leading non-OPEC producers such as Russia, Norway, Mexico, and Brazil to attend the Jeddah conference. Top executives from investment banks as well as the major international oil companies were also invited. Altogether, representatives from 36 developing and developed countries, 22 major oil companies, and seven international organizations attended the conference.[6]

The international oil meeting, which was meant to be a "summit," and indeed was referred to as such in the Saudi media, failed to meet Saudi expectations in terms of the level of political representation. With the exception of the British and Australian prime ministers, and perhaps one or two more heads of governments, other countries, such as the U.S. and all other members of the GCC were represented by ministers or senior officials. Venezuela, a major oil producer, did not participate.

The communiqué issued at the end of the conference called for greater transparency and more investment in production to deal with the current oil prices, and adopted the producers' mantra that a) there was no shortage of crude supply, and b) speculators were playing a key role in the dramatic rise in crude prices.

The communiqué was hardly reassuring for the oil market, which ignored it completely. One should keep in mind that the Jeddah conference, whether it was labeled "summit" or not, was not an OPEC gathering and the participating countries were not expected to announce new levels of production, either upward or downward. Table 1 shows the price of crude before and after President Bush's meeting with King Abdullah and before and after the Jeddah summit:

Table 1: Settlement Crude Price Patterns

Nynex WTI ($/bbl)

OPEC Basket ($/bbl)

May 15

124.12

118.95

May 16

126.29

119.27

May 19

127.05

119.24

Nynex WTI ($/bbl)

OPEC Basket ($/bbl)

June 23

134.80

130.70

June 25

134.55

129.87

June 26

139.64

130.27

Sources: Wall Street Journal Online, accessed July 3, 2008; Middle East Economic Survey, May 26, 2008 and June 2, 2008; OPEC website http://www.opec.org/home/, date accessed July 3, 2008. WTI stands for West Texas Intermediate crude, the highest grade. OPEC basket represents the average prices of more than 10 grades of crude, from very light to very heavy.

The UAE Gulfnews concluded its coverage of the meeting with the phrase, "…Other ministers dismissed the need for the summit."[7] This statement contrasts sharply with the view of Saudi diplomats, who expressed the Kingdom's expectation that heads of states and governments would attend the meeting.[8] In fact, even before the meeting was to take place, analysts were skeptical as to whether the conference could reach an agreement on new production ceilings or find magical solutions to the spiking oil prices. A Kuwaiti analyst said Saudi Arabia was trying "to lower the negative psychological impact [in the consumer countries and particularly in the U.S.] by engaging in a transparent dialogue which would focus on the roots of the crisis in the oil market."[9] The Iranian representative at OPEC, Muhammad Ali al-Khetaibi, said that any increase in oil production must be approved by the prime ministers of OPEC, and that the Saudi decision to increase production was "a mistake."[10]

Joint Paper at the Jeddah Conference

A paper prepared jointly by Saudi Arabia, the International Energy Agency, the International Energy Forum and OPEC said that global oil demand, although slower, is continuing to grow steadily, driven by non-OECD (Organization of Economic Cooperation and Development) countries, where GDP growth is a much more important determinant of demand than price. According to the preface of the paper, this growth "has been reinforced by the fact that oil demand is occurring basically in the price-inelastic sectors, such as transportation and petrochemicals, and is being influenced by the effects of subsidies and taxes."[11]

The joint paper says the causes of the recent oil price behavior "are multiple and complex," and that a host of factors have been contributing to it, and their exact respective weights are difficult to assess. The following is a summary of these factors:

· Lower crude oil spare capacity, in the face of the projected rise in demand, has made markets wary of the availability of future supplies. (In a presentation to an oil conference held in Madrid on July 1-2, 2008, Nobuo Tanaka, executive director of the International Energy Agency, emphasized that market fundamentals were the main underlying factor behind high prices. "OPEC production is at record highs and non-OPEC producers are working at full throttle, but stocks show no unusual build. These factors demonstrate that it is mainly fundamentals pushing up the price," he added.[12])

· Limited refining capacity in oil product markets, due to a constrained refining investment, environmental standards, cost-inflation and stringent laws and regulations, has led to poorer refining margins. (The U.S. is a case in point. No new refinery has been built in almost two decades.)

· There is a growing mismatch between the quality of crude supply on the one hand and the demand for lighter products and tighter specifications on the other. (Much of the available spare capacity is heavy crude while there is shortage of light or sweet crude. Iraq could fill the gap with its Basra light when its effort to double its production to 4 million b/d materializes. But this may be a number of years off.)

· There are fears of supply disruptions, driven by geopolitical concerns, technical shut-ins, accidents, and weather-related events, as such as hurricanes (threats of military conflict in the Middle East, sabotage of pipelines in Nigeria Iraq and severe weather conditions that interrupt or heavily damage the many off-shore rigs).

The joint paper also mentions investment inflows from financial institutions, pension and hedge funds, and private equities into the oil futures and over-the-counter markets due to the relative weakness in the value of the dollar and the lower returns on other assets.[13] Normally, most of the players in the futures markets are industry players – largely shippers and refiners – who simply are planning ahead. But many of the players today in the futures markets are investors who have no intention of ever taking delivery of any shipment. Instead, they play the market in a bid to profit from price fluctuations. These speculators used to be marginal players but recent estimates put them at more than two-thirds of total traders by volume. The jump is partly a result of the subprime lending chaos. When the mortgage market disintegrated in late 2007, many of those who traded in mortgage securities and property fled into the energy markets.[14] It is this speculative fervor that has had devastating effects on the price of oil, causing it to double in one year.

The Depreciation of the Dollar

At the same time, the U.S. balance of trade and federal budget deficits, coupled with excessive levels of debt throughout the American economy, have convinced the market that the dollar also can move in only one direction: downwards. Indeed, the depreciation of the U.S. dollar against major currencies has been used by the producers as one of the main reasons for rising oil prices. The world economy, and certainly the U.S. economy, is moving in a vicious circle – lower exchange rate for the dollar drives oil prices higher, and higher oil prices drive the dollar further down. One way of breaking the vicious circle is to reduce demand through conservation or even higher tariffs.

Implications for Rising Prices

On July 1, the International Monetary Fund released a study on the implications of the surge of oil price on living standards globally. In introducing the study, IMF Managing Director Dominique Strauss-Kahn said, "Some countries really are at a tipping point." He added that "[I]f food prices rise further and oil prices stay the same, some governments will no longer be able to feed their people and at the same time maintain stability in their economies." The key findings of the study are the following:

· The effect of rising oil prices on 59 low-income net oil importers was $35.8 billion, or 2.2 percent of their gross domestic project (GDP)

· Annual food price inflation for 120 low-income and emerging market countries rose to 12 percent at the end of March 2008 from 10 percent three months earlier, while fuel prices accelerated to 9 percent from 6.7 percent in the same period. Data indicate that the problem is worsening

· Poor countries that are highly dependent on food imports are particularly vulnerable to rising food prices. The share of undernourished in developing countries could rise rapidly above the current 40 percent of total population.[15] There have been many reports from Egypt in recent months about shortages of bread, causing social and political dislocation. The Egyptian government called on the army to engage in the production of bread to overcome supply shortage.

The big rise in the price of oil will also have a long-term impact on the lifestyle of the American people, whose love affair with their automobiles and their expectation of low energy costs may soon be relegated to the collective memory. Studies in the U.S. suggest that every cent added to the price of a gallon of gasoline would mean additional expenditures of $1 billion, calculated on an annualized basis.

Impact on Poor People

According to a study by the International Energy Forum, (IEF) 1.6 billion people in developing countries still lack access to electricity and are thus suffering from permanent blackout. While people in developed countries are concerned about price of gasoline and natural gas, 2.5 billion people in developing countries still rely on traditional biomass for cooking. IEF noted that "this perpetuates the poverty cycle and inhibits economic development, availability of clean water and food while preventing training and acceptable health standards."[16]

The Introduction of Nuclear Power

One of the unintended consequences of the steep rise in the prices of crude oil and natural gas is the emergence of nuclear energy as the inevitable alternative. Countries in the Middle East and North Africa appear to be on the verge of introducing nuclear energy for peaceful purposes. With the help of France in North Africa, the U.K. and Canada in Jordan, and the U.S. in Saudi Arabia, efforts are underway by many Middle Eastern countries to acquire nuclear reactors. Egypt appears to be the most advanced in this regard, as it has recently asked for international bids for the construction of the country's first nuclear reactor.

While the use of nuclear energy for peaceful purposes, such as generating electricity or desalinating water, is legitimate, there is always the concern that nuclear energy could be turned from peaceful purposes to lethal ones. Iran's situation is a case in point. One should heed the warning of former Moroccan foreign minister Mohammad bin 'Issa, who told the Institute for Strategic Studies in Paris that "without peace, it will not possible to prevent the Middle Eastern countries from acquiring nuclear weapons."[17]

Conclusion

The question of whom to blame for high oil prices remains open to debate. Unfortunately, as noted by Stratfor (an intelligence company): "Oil is scarce, oil is needed, oil has no obvious substitutes, and there is nothing that anyone can do to bring more of the stuff onto the market quickly. That is a perfect storm for expensive crude, and no amount of regulatory change is going to alter this bottom line."[18]

Clearly, there are many factors contributing to the sustained rise in crude price. Further, no single country – not even entire OPEC – is currently in a position to influence events other than on the margin. Until the large consumers, and particularly the United States, bring their insatiable thirst for oil under control, the risks remain that oil prices will continue to rise in the foreseeable future. The real danger is that much higher oil prices could plunge the world economy into a global recession with painful consequences for everyone.

Table 2: Basic Figures on Key Middle Eastern Countries

Population (July, 2008 est.)

GDP (ppp, 2007 est.)

GDP per capita (ppp, 2007 est.)

Household Consumption by Percentage Share

Bahrain

718,306 (includes 235,108 non-nationals)

$24.5 billion

$32,100

--

Egypt

81,713,517

$404 billion

$5,500

Lowest 10%: 3.7%; Highest 10%: 29.5%

Jordan

19,747,586

$87.09 billion

$4,500

--

Kuwait

2,596,799 (includes 1,291,354 non-nationals)

$130.1 billion

$39,300

--

Oman

3,311,640 (includes 577,293 non-nationals)

$61.61 billion (2007, est.)

$24,000

--

Qatar

928,635

$57.69 billion

$80,900

--

UAE

4,621,399

$167.3 billion

$37,300

--

Saudi Arabia

28,161,417 (includes 5,576,076 non-nationals)

$564.6 billion

$23,200

--

Syria

19,747,586 (excluding 40,000 in Golan)

$87.09 billion

$4,500

--

Source: CIA World Fact book, https://www.cia.gov/library/publications/the-world-factbook/, last updated June 19, 2008.

*Dr. Nimrod Raphaeli is the Editor of The MEMRI Economic Blog, www.memrieconomicblog.org

Endnotes:

[1] U.S. News and World Report, February 15, 1988.

[2] BusinessIntelligence Middle East, July 1, 2008.

[3] Al-Mada, Iraq, June 22, 2008.

[4] Al-Quds Al-Arabi (London), June 16, 2008.

[5] Gulfnews.com (Dubai) June 17, 2008.

[6] Al-Sharq Al-Awsat (London), June 22, 2008.

[7] Gulfnews.com (Dubai), June 23, 2008; Al-Hayat (London), June 23, 2008.

[8] Al-Sharq (Qatar), June 12, 2008.

[9] Al-Ittihad (UAE), June 20, 2008.

[10] Al-Sharq Al-Awsat (London), June 20, 2008.

[11] Al-Khaleej (UAE), June 27, 2008.

[13] Al-Khaleej (UAE), June 27, 2008.

[14] BusinessIntelligence Middle East, June 27, 2008.

[15] International Monetary Fund, "Price Surge Driving Some Countries Close to Tipping Point," IMF Survey Online, July 1, 2008.

[16] Quoted by Middle East Economic Survey 51:21, May 26, 2008.

[17] Al-Sharq Al-Awsat (London), June 22, 2008.

[18] Stratford, "Geopolitical Diary: Oil, speculation and politics," BusinessIntelligence Middle East, June 27, 2008.