How Saudi Arabia Can Dash Iran's Oil Hopes

The kingdom should open its exploration and production industry to foreigners.

Saudi Arabia needs to open up a little. If it wants to ensure its own low-cost oil gets to market before higher-cost crude from elsewhere, it should allow foreigners to invest directly in its oil industry.

Oil's Decline

The price has tumbled by more than half in the past 18 months

Source: Bloomberg

Speaking before last week’s OPEC meeting, Saudi Arabia’s new oil minister, Khalid Al-Falih, said the kingdom was concerned about how future oil production could be affected by a lack of investment. Given the falling price of crude has forced oil companies to cut spending for two years running, that's understandable.

Letting overseas oil companies from ExxonMobil to China's CNPC invest directly in exploration or production in the kingdom would ensure that the diminished pot of investment capital is put to the most efficient use -- and diverted away from rivals like Iran.

It's always a big step for producers like Saudi Arabia who nationalized their oil industries at time when they were fighting the dominance of international oil companies.

But many scary things turn out to be less frightening than they appear in contemplation. Times have changed: the oil companies don’t possess the political power or cartel-like relationships that they did in the past.

The contracts would have to be attractive enough to lure international companies. But their terms wouldn't have to give away the family (black) gold in decades-long concessions that give foreigners the right to do pretty much what they like. Agreements can be constructed in ways that allow title to the oil in the ground to remain with the host government, yet give the companies the incentives they need to invest. They can offer partners minority shares in joint ventures with state-owned Saudi Aramco, combining the benefits that each can bring.

The kingdom wouldn't be alone in taking this step. Mexico and Iran -- both vociferously opposed to foreign investment in their upstream oil industries in the past -- are in the process of opening up their long-closed industries. They are following a path trodden by Iraq a decade ago and by Venezuela in the 1990s. Both those countries saw considerable benefits from their openings.

Venezuela's "Apetura Petrolera" gave international oil companies access to the least attractive of the state company's producing fields, as well as to exploration acreage and joint projects to develop the country's extra-heavy crude. Production capacity rose by around 50 percent over the five years after the policy was adopted -- although that growth came to an abrupt halt, then went into reverse after the election of Hugo Chavez in 1998. He subsequently altered the terms of the contracts and appropriated the assets of those who didn’t accept the changes.

Venezuela Rising

Production rose more than 50% in five years of "apertura petrolera" - until OPEC output cuts in 1998

Source: Bloomberg

Iraq saw the biggest output increase of any oil-producing country last year, with output rising 740,000 barrels-a-day in 2015. That's all the more impressive given the collapse in the oil price and a costly war on Islamic State insurgents forced the country to ask investors to slash spending on oil-field development because the government couldn't afford its own share.

Iraq's Output Surge

Oil output soared last year as foreign investors brought new projects into production

Source: Bloomberg

For Saudi Arabia, such a policy could have added fringe benefits: Inward investment by U.S. oil companies would put the kingdom back at the heart of that country’s policy in the region. Furthermore, every dollar that oil companies invest in Saudi Arabia is a dollar that they can't invest in the industries of rival producers.

Taken a step further, what better way would there be to crimp the ambitions of regional rival Iran than by offering companies a choice between investing there or investing in the kingdom?

Faced with that choice, European and Asian companies beating paths to Tehran might think twice about where to spend their diminishing upstream investment budgets.

-- Gadfly's Elaine He contributed graphics.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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