Saudi’s increasing production?

A piece from Foreign Affairs examines Saudi Arabia’s oil strategy, “The world is already awash in oil, and yet there may soon be more Saudi crude flowing to market. This month, just after scuttling a “production freeze” among major oil exporters, the Saudis fired long-serving oil minister Ali Naimi, who was a rare, reassuring fixture in the unpredictable oil market. Naimi had wanted to retire, but his support for the freeze contradicted the position of his superiors and probably hastened his departure. Along with naming a replacement minister—Khalid al-Falih, the former CEO of the state oil giant Saudi Aramco—the Saudis also announced a significant shift in oil market strategy. The kingdom would not only maintain its brisk pace of oil production of 10.2 million barrels per day but increase it further. Amin Nasser, the current CEO of Aramco didn’t stop there. He said that the theoretical ceiling on Saudi oil production capacity—12.5 million barrels per day—could be expanded in the future. In some respects, signs of the Saudis’ strategy shift were there all along: The country is locked in a battle for market share in the face of a U.S. shale boom, a re-emerging Iran, and a glut of non-OPEC crude. Longer term challenges, such as the threat of hitting a ceiling on global oil demand—perhaps in response to climate change—probably also shape thinking at Aramco headquarters in the eastern city of Dhahran. With 260 billion barrels of proven crude oil reserves still underground, the risk of stranded assets is a scary proposition in Saudi Arabia”.

The article goes on to point out that “Saudi production decisions are subject to painstaking deliberation over the optimal pace for depleting the kingdom’s reserves. Aramco calibrates output from individual fields so that recoverable oil is exhausted gradually, over a minimum of 30 years. This has a constraining effect on the market. Since 2000, the kingdom’s output has hovered at about 13 percent of global supply, a self-imposed limit that has forced oil prices up. This has allowed higher-cost “fringe” producers to meet remaining demand with costlier oil. That calculus could change, however, if Saudi energy policymakers believe there will be threats to the long-term value of crude oil, especially in oil’s viability as a transportation fuel. In such a case, the kingdom could recalibrate its depletion strategy. One threatening scenario stems from efforts to respond to climate change. Some climate-focused scholarship has sought to quantify the amount of “burnable” fossil fuels as a portion of global reserves, given the goal of limiting the rise in temperatures to two degrees Celsius. One recent paper calculates that adhering to the two-degree limit means that the Middle East will see more of its reserves stranded underground—at 38 percent—than the global average of 33 percent. This is due to the large size of Middle Eastern resources relative to its hitherto modest rate of production. By contrast, the United States may find itself with the smallest level of stranded reserves. Only six percent of U.S. conventional crude reserves were estimated as “unburnable,” probably because of the relatively small amount of remaining oil and comparatively high rates of production. From this perspective, Saudi prudence looks risky”.

It points out that “Based on such calculations, it is in producer countries’ interests to beat the trends by stepping up production and shortening the timeframe for converting underground reserves into above-ground assets. This would, if all else held constant, reduce global oil prices and increase demand. For Riyadh, this approach could potentially transfer the risk of stranded assets to higher-cost producers, including those in North America, whose investment plans might be derailed by expectations of low oil prices. Higher production might also allow Saudi Arabia to reduce its risk from a related “peak demand” scenario.  Naimi and other Saudi officials have voiced fears for at least a decade about “security of demand” whether from climate factors or Washington’s rhetoric around “energy independence.” U.S. diplomatic cables released by WikiLeaks revealed some of these concerns, as do Naimi’s public statements and those of an adviser, Mohammed al-Sabban, who predicted that global demand would peak by 2025″.

Interestingly he goes on “By forcing prices down, Aramco might delay the onset of peak demand, prolonging oil’s dominance in transportation while nudging higher-cost producers out of the market. Low prices might also push emerging economies to increase their dependence on oil by making investments that lock in higher levels of long-term demand. That’s because cheap oil also encourages urban sprawl. When cities become less dense, they require more energy: commutes lengthen, homes are more spacious, and private car ownership grows. Politically, Saudi Arabia may also view a more dominant role in global crude oil markets as beneficial to its geopolitical status. It could better hedge against Iran as its cross-Gulf rival emerges from decades of economic isolation. And more oil could even revive Riyadh’s flagging “oil for security” relationship with the United States. Conversely, a declining role in crude markets may diminish the kingdom’s strategic importance“.

Incorporating a domestic view the article notes, “Another reason why Saudi Arabia may be increasing production is due to the dangerous rise in domestic oil demand. If this trend continues, it may force Saudi Arabia to forfeit its spare production capacity and divert oil from export into the domestic market within a decade or two. Saudi Arabia could avoid that outcome by either halting growth in domestic demand or by increasing supply. The kingdom’s recent energy subsidy reforms are aimed at reducing demand. But in the event they don’t succeed, Aramco has prepared for major upstream investment. In 2015, Aramco forecasted on its website that it would make capital investments of about $334 billion between 2015 and 2025, with most of it earmarked for oil and gas drilling. In addition, the government’s recent subsidy reform policies are expected to increase domestic oil revenues, which could be reinvested in raising production capacity. In January, the Saudi government took the extraordinary step of raising prices on natural gas, water, electricity, gasoline, and diesel fuel, which probably represents its biggest reduction in citizen welfare benefits since the current system was established in the 1970s. Although energy prices in the kingdom remain substantially below world market levels, the increase is expected to raise $7 billion while reducing growth in domestic energy demand. Another source of capital could come from the splashiest initiative of all—the unprecedented sale of a portion of Saudi Aramco in an initial public offering next year”.

He ends “most worrying, a rise in Saudi output could trigger a period of global oversupply that would exacerbate climate damage. This could play out in a number of ways. On the one hand, it might unfold in a rational manner, deterring competitors from investing in higher-cost resources and pushing high-cost oil out of the market. On the other, it could cause other producers to panic about stranded assets, triggering a glut of cheap oil that would tempt consumers away from conservation and green technologies. Another scenario could see things swing the other way. By raising production, Saudi Aramco could publicize the kingdom’s fears that the world is preparing to move beyond oil and inadvertently encourage investment in alternate technology such as electric vehicles. Other scenarios are possible as well. In the long term, the oil business is entering an age of increasing risk, since progress on climate change endangers the dominance of fossil fuels in the global energy market. Although no one has yet devised a viable replacement for oil-fueled transportation, governments are increasingly seeking alternate fuels and technologies, regardless of oil prices. This understanding will most likely prompt at least some holders of large reserves, like Saudi Arabia, to move their crude to market before the world moves on.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: