Can the Saudis Step on the Gas?

Plans to open up exploration to foreigners have stalled

It was supposed to be a watershed moment. At a private ceremony scheduled for Dec. 16, Saudi officials and representatives from Exxon Mobil Corp. (XOM ), Royal Dutch/Shell Group (RD ), and other oil companies planned to sign contracts to tap the desert kingdom's vast natural-gas reserves. A handful of successful deals, expected to yield investments of $25 billion over the next decade, would signal to the world that Riyadh was serious about opening up its economy. Instead, the two sides are still haggling over basics such as the quality of the acreage on offer and the price of gas. So when they meet, the only documents that will be inked are progress reports on their talks.

Such setbacks are common in multibillion-dollar energy projects. But if the gas initiative suffers major delays or is sharply scaled back, the weak Saudi economy will suffer. And the Saudis will miss a chance to repair relations with the West, which have been under severe strain since the discovery that most of the hijackers involved in the September 11 attacks were Saudi nationals. Hopes that the oil-rich kingdom was at long last opening itself up to outside capital could be crushed, too.

SCARY PROSPECT. The Saudis could use the money. On Dec. 8, the government announced it would cut spending by 20% next year because of lower prices for oil, the source of most of its revenues. The economy could contract by 6% in nominal terms as a result--a scary prospect since unemployment is already at 15%. "This adds impetus for the government to follow through on needed reforms," says Brad Bourland, chief economist at Saudi American Bank in Riyadh.

The gas initiative is Saudi Arabia's best hope of drumming up new investment. Under the scheme, hatched by Crown Prince Abdullah and Foreign Minister Saud al-Faisal a couple of years back, foreign outfits are being invited to develop natural gas reserves and build facilities to exploit the fuel. The plan calls for petrochemical plants, along with power stations and desalinization plants that will sell their output to local customers. Allowing foreigners to find and exploit gas would be a first since the industry was nationalized in the mid-1970s. The Saudis have tapped the biggest oil companies to participate. ExxonMobil and Shell will head up the three "core ventures." Other investors are BP (BP ), TotalFinaElf (TOT ), Phillips (P ), and Conoco (COC ). Memorandums of understanding were signed in June during a lavish ceremony that featured an appearance by the ailing King Fahd.

But once they started working out the details, the two sides found themselves far apart. The oil companies contend there may be too little gas under some of the tracts to justify the billions of dollars worth of installations that the Saudis want. They also worry that it will cost too much to extract the gas from these difficult fields to then sell it to local customers at the 75 cents per million BTU price set by the government. By comparison the U.S. price is $2.79 per million BTU. The companies would not comment because they have signed confidentiality agreements.

NATIONALISM. The biggest obstacle in the way of an agreement is nationalism. Executives at Aramco, the powerful state-owned oil company, think both oil and gas exploration in the kingdom should be their exclusive preserve. To drive home the point, Aramco recently began drilling on one of the more attractive parcels earmarked for foreign companies. Investors also fret that local electricity and water are now sold far too cheaply for the new plants to pay off. They also say the Saudis have unrealistic expectations about how many people these projects can employ.

To persuade companies to accept lower profits, the Saudis are dangling the prospect of future entry into the far more lucrative area of oil exploration. But investors say that $25 billion is too high an admission price and demand that all gas projects provide a minimum return on investment of 15% to 18%. Once the fallout from the September 11 attacks subsides, Prince Abdullah may intervene to smooth things out. But he will have a lot of work to do to restore the lost momentum.

By Stanley Reed in London

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