The Saudis Defend Their Slippery Turf

But keeping oil prices high for the long term may be difficult

When Saudi Oil Minister Ali Naimi arrived in Vienna two days ahead of the Jan. 17 OPEC meeting, he was as blunt as any straight-talking Texan: He told journalists that OPEC would be taking 1.5 million barrels per day of oil off the market. In December, oil prices fell almost $10 per barrel, dipping below the $22 that OPEC says is the bottom of its range for its own market basket of crudes. That plunge prompted fears of a return to the $10 oil of two years ago. And so Saudi Arabia, which is trying be a kind of central banker of oil, decided to send a strong signal to the markets that it would shore up the price of crude. "This is the first big test of whether they can defend a relatively high price," says Gary N. Ross, CEO of PIRA Energy Group, New York-based consultants.

It is likely to be an easy test in the short run. But keeping prices so high could eventually undermine OPEC by helping to depress world economic growth and encouraging investment in non-OPEC production. And it is far from clear that the oil markets can be micromanaged to the extent that the Saudis are attempting.

But if the Saudis and other OPEC players are worried about such eventualities, they are not saying so. They think that the experience of last year, when the world economy showed strong growth despite an average of $28.40 per barrel for the benchmark Brent crude, proves that the global economy can handle stepped-up prices. "The goal is now to keep the price at $25 at least," says a Gulf source at the meeting, referring to OPEC prices. Western consumers will be paying several dollars more.

Working in the Saudis' favor are tight crude and product inventories--the legacy of strong economic growth around the world and underinvestment in new production capacity. That means, says Ross, who is observing the conference, that a little bit of OPEC trimming should go a long way to keep prices close to current levels for the rest of the year.

The big danger, of course, is that this latest gambit will further depress an already faltering world economy. But the Saudis don't see it that way. They blame the economic jitters that the U.S. is experiencing on stock-market speculation, not high fuel prices. And they view the fact that oil consumption didn't grow in the U.S. last year as a reason to cut production, not add supply. They wave off suggestions that continued high prices could tip the U.S. into recession. "The U.S. economy got used to these prices last year," says one Saudi. "They aren't likely to go higher."

And the Saudis are not reaping as hefty rewards from today's oil as American consumers might think. The differential has widened between West Texas Intermediate, the benchmark American crude, and the crudes that big OPEC producers pump out. WTI is usually a few dollars more than the Arab crudes because it is easier to refine. But now that gap has expanded to $8-$9 per barrel because of bottlenecks in the U.S. and higher freight costs. The Saudis now are getting only in the high teens to low $20s per barrel for their crudes.

THE IRAQ CARD. The wild card is Iraq. The Saudis are assuming that Iraq, which is now holding more than 1 million barrels per day off the market in a dispute with the U.N., will resume normal production. But if the Iraqis continue to be difficult and OPEC goes ahead with production cuts, there could be a crunch. The Saudis say in that case they will add production. The Saudi camp is also already discussing increasing output in June if the U.S. and Asian economies prove resilient.

The high prices could be laying the foundation for an eventual crash in demand. High oil prices could further quash Asian growth that is already being dampened by the U.S. slowdown. If so, OPEC would lose the main sources of new demand. At the same time, there are finally signs that high prices are prompting an increase in investment in finding new oil. Long-depressed drilling-rig counts are beginning to rise, and companies are on the hunt in non-OPEC countries. For the Saudis and other producers, that is too far away to worry about. Better to focus on spinning out the big profits as long as they can.

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