The Sheiks Don't Shriek

Why the Saudis can live with cheaper oil

Unbelievable as it may sound, Saudi Arabia is practically applauding the 22% plunge in global oil prices since July. On Sept. 19, Saudi Oil Minister Ali Naimi called a price of about $60 per barrel "reasonable." Some think the Saudis could live with even lower prices. "They are still happy at $50 per barrel," says David Kirsch, an analyst at PFC Energy in Washington.

Why would the kingdom, which boasts the world's largest oil reserves, cheer a price slump? In fact, the Saudis never felt comfortable with $70 oil, fearing that sky-high prices might kill off the global appetite for their single source of wealth. "There is concern that the volatility in the markets is so beyond anyone's control that it could cause severe damage to the world economy," says Sadad Al Husseini, the retired exploration and production chief of Saudi Aramco, the national oil company. The Saudis, he says, "are determined to try and manage better."

That's not to say the Saudis want to see prices continue to drop. In the short term, they're trying to keep them from crashing far below $50 per barrel by gradually withdrawing oil from the market. But they're also investing tens of billions of dollars to build spare capacity. At a September OPEC meeting in Vienna, Naimi said Saudi Arabia plans to expand production in seven fields to add 2.4 million barrels per day of capacity, boosting its total to about 12.5 million barrels per day by 2009. Then on Oct. 1, the Saudis announced they would start work early next year on a new field called Moneefa, which will add another 900,000 barrels of capacity.

The Saudis want to be able to pump more so they can manage prices by adding supply when markets are tight and removing it when inventories fatten. Of the major OPEC producers, only the Saudis have significant spare capacity. But their buffer dwindled to around 700,000 barrels per day in 2004. That has since risen to about 1.5 million -- still sizable but not enough to cover an outage in an another big producer. Like the rest of the industry, the Saudis were caught napping by the surge in demand that triggered a doubling of prices between 2004 and 2006.

The new production won't come cheap. The cost of expanding capacity will exceed $24 billion, figures Nawaf Obaid, managing director of the Saudi National Security Project, a Riyadh consultancy. He says the Saudi leadership under King Abdullah wants to "decouple energy and foreign policy" by building up enough capacity to make up for a cutoff of crude from Iran as well as another major producer such as Venezuela or Nigeria.

For now, Venezuela and Nigeria are cooperating with Saudi Arabia's short-term goal. Oil ministers from the two nations in late September promised to cut production by 170,000 barrels per day, which should help the Saudis steady prices without reducing their own 30% share of OPEC production. But some market watchers think the Saudis will have to shoulder cuts of 1 million barrels per day or more to keep oil above $50 per barrel. "We have seen the peak [in prices] for a while unless something blows up," says Leo Drollas, an analyst at the Center for Global Energy Studies in London. Even so, the Saudis want an insurance policy of extra capacity in case prices spike again.

By Stanley Reed

    Before it's here, it's on the Bloomberg Terminal.