Why the Saudis Fear Pricey Oil

If high prices stunt the recovery and drive customers to non-OPEC sources, the Kingdom will be the loser. That's why the spigots are wide open

By Stanley Reed

Ministers from oil cartel OPEC announced on June 3 that they would lift output ceilings by 2 million barrels per day (bpd) on July 1 and, possibly, another 500,000 per day on Aug. 1. That may seem like a lot of new oil, but it's unwise to take OPEC pronouncements too literally. After all, the big exporters have of late made a laughingstock of quotas. In May, they produced more than 2 million bpd above the ceiling of 23.5 million bpd they set for Apr. 1 (excluding Iraq).

What's important for oil's price is that Saudi Arabia, the world's pivotal exporter, is signaling loudly and often that it's uncomfortable with $40 a barrel. And the Saudis seem determined to increase production until prices soften. That message, along with some evidence of increasing supply stocks in the U.S., pushed prices down to $38.80 a barrel for U.S. light sweet crude after the OPEC meeting. "When the Saudis say they want something, they usually get it," says Adam Sieminski, an oil analyst at Deutsche Bank in London.


  The Saudis have gone to unusual lengths to put the word out. Oil Minister Ali Naimi has promised a big increase in Saudi production, and the country's officials have been privately calling analysts and other market participants to underline that they will deliver the goods. While the conventional wisdom is that OPEC is pumping near flat-out, Sieminski thinks the big exporters may add as much as 1 million bpd in June over May's estimated total of 27.4 million bpd. Much of the additional crude will come from Saudi Arabia, which is taking production from 8.3 million bpd or less in May to 9 million bpd or even higher.

In a world run strictly by the laws of economics, that much more production would likely be enough to gradually fill depleted storage tanks and cause prices to start sinking. Both crude and gasoline stocks in the key U.S. market are rising, according to the latest data from the U.S. Energy Information Administration.

But the real world is a little different. With very little spare capacity in the world, traders are mainly focusing on the possibility of a disruption in Saudi Arabia, Iraq, or elsewhere. Two lethal attacks in May by Islamic militants on Western oil workers in the Saudi Kingdom raised fears that the country's industry could be disrupted -- even though there has been no impact on supply so far. Prices could sink if the attacks halt temporarily or if the market learns to shrug them off. Traders are holding near-record net long oil-futures positions -- and a shift in sentiment could send prices down sharply.


  While high prices may be doing wonders for the Saudi treasury and economy, the Kingdom's leadership is uncomfortable with $40 per barrel oil for several reasons. The Saudis worry that such high prices will crimp the world recovery and eventually slash demand for their oil.

They also fear that soaring energy prices will spur their customers in the West to invest in alternative energy sources and encourage investments in non-OPEC projects. Gasoline costing $2-plus a gallon is bringing unwelcome political attention in the U.S. Presidential campaign to the Saudis as well.

The recent attacks on oil workers and other expatriates in the Kingdom may have been the final straw. On May 1, gunmen stormed a refinery at Yanbu on the Red Sea Coast and killed five workers of Swiss-based oil engineering outfit ABB Lummus. On May 29, militants again went after oil workers, killing some 22 people in an attack on an office and residential complex in Khobar, a city in eastern Saudi Arabia in the heart of its oil industry. In both incidents, the bodies of expatriate oil-industry employees were dragged behind vehicles in an apparent effort to terrorize the large expat community.


  While neither of these killing sprees posed any threat to production, nervous traders were wondering if an attack on a terminal or some other major installation was next. The resulting $42-per-barrel prices seemed to spur the Saudis into action. After all, their economic raison d'être as the holders of some 25% of the world's reserves is to always be there to supply their customers with oil. Fair or not, rampages in the oil regions called their vaunted reliability as suppliers into question. Doubts were already rife, thanks to the extensive individual Saudi involvement in the September 11 attacks on New York and Washington, D.C.

While the billions flowing into Saudi tills provide considerable consolation, the Kingdom doesn't like losing control of oil prices -- even on the upside. The June 3 OPEC meeting was an all-out effort to regain that control. Whether the campaign will succeed depends on many factors, including the outcome of the Saudis' battle with bands of insurgents roaming the Kingdom. But a few months of oil production in the 9 million bpd range or higher should also do a lot to re-establish Saudi clout.

Reed is bureau chief for BusinessWeek in London

Edited by Beth Belton

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