Help from the House of Saud

Why the leading oil producer wants to cool off the market
King Abdullah: Are the price runups beyond Saudi control? Hasan Sarbakhshian/AP Photo

The Saudis, the world's largest oil exporters, are as stunned as anyone by black gold's rocketlike rise in price. Just a decade ago, Saudi Arabia nearly was brought to its knees by prices averaging $14 a barrel. While their coffers have since filled to overflowing, the Saudis worry about the impact of $130-per-barrel oil on their customers' economies as well as the opening that high prices are giving to alternative fuels. "We don't like it," says a Saudi source, of the recent, fevered market.

The Saudis want to cool the red-hot oil market and are investing heavily in new fields to meet future demand. They already plan to increase production by 300,000 bbl. per day in June, to 9.45 million bbl. This decision is more a response to customer orders than to President George W. Bush's recent pleading for more oil (the government of King Abdullah sees Bush as a lame duck and believes his Iraqi foray has been a disaster). In a move that's as much psychological as practical, the Saudis also are telling customers they will supply them with all the oil they want.

That will help a little, but for now the Saudis maintain there is only so much they can do to lower prices. They have 2 million bbl. of daily production capacity held in reserve: Saudi policymakers figure this oil has to be kept back from the market in case a drastic emergency (such as a U.S. strike on Iran) threatens world supply.

In addition, analysts such as David Kirsch of Washington (D.C.) oil consultants PFC Energy think that, with so much investment money sloshing around in the commodities markets, the Saudis calculate they have no hope of controlling short-term price fluctuations. They blame the recent price runups on speculation and fear of shortages, factors they say are beyond their control.

In reality, the Saudis add, there is plenty of oil on the market. Iran has put some 30 million barrels of oil that it can't sell into floating storage. "If we produced more oil, it wouldn't find buyers," says the Saudi source. "It wouldn't affect the price at all."

The longer term is a different story. The general hand-wringing over future oil supply may be off-base when it comes to Saudi Arabia. The Saudis have embarked on an ambitious expansion program that should see more than 2 million barrels of new production capacity come onstream by the middle of next year. One new field, called Khurais, may at 1.2 million barrels per day even exceed next year's global growth in demand.

Nansen G. Saleri, a recently retired chief of reservoir management at Saudi Aramco, the national oil company, is confident that the Saudis can reach 12.5 million bbl. per day of capacity—or even 15 million bbl.—vs. their 11.4 million now. "The resource base is there," says Saleri, who now is CEO of Quantum Reservoir Impact, a Houston startup.

Just having that much additional capability should dampen prices, "whether it goes into [reserve] capacity or production," says PFC's Kirsch. Edward L. Morse, energy economist at Lehman Brothers (LEH) in New York, thinks a sharp correction could begin late this year as demand slows and the market recognizes that the Saudis really are serious about adding capacity. He is forecasting an average price of $83 per barrel for 2009. The Saudis could pay their bills with oil as cheap as $60 per barrel. Whether they have the ability to persuade OPEC to accept much lower prices is the big question.

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