SAUDI ARABIA AND THE NEED FOR $75 OIL
By John Sfakianakis
Published: January 20 2009 15:59 | Last updated: January 20 2009 15:59
Not long ago, when oil prices were at historically high levels, there were calls from within the Organisation of the Petroleum Exporting Countries for production cuts to keep them there. These efforts failed, and Saudi Arabia was responsible for unilaterally increasing supplies to try to calm the market. In fact, the Kingdom saw that while extremely high oil prices may be good for the short-term budgetary needs of oil producing states, they are not good for the global economy. Oil prices have fallen dramatically and oil consumer nations should recognise Saudi Arabia’s long-standing defence of “fair” oil prices and stable production, and realise that just as unrealistically high oil prices are unadvisable, so too are unrealistically low prices. The Kingdom has called for a “fair” price of $75 and, considering the global economic climate, that is an appropriate number.
Crucially, the next few months will be among the first in Saudi Arabia’s history where more than 35 per cent of its oil production capacity is likely to remain idle – far above the historical norm of 15-20 per cent. That comes at an enormous cost, estimated to be more than $15m per day. No other country has the discipline to maintain that much idle capacity. By the end of next year, Saudi Arabia’s oil capacity will reach 12m barrels per day, the result of an estimated $60bn in expansion investments. While this spare capacity will be painful for the Saudi government to carry, it highlights the ever-growing power that the Kingdom maintains over energy security and global prices. With millions of barrels in spare capacity, Saudi Arabia will continue its traditional role of stabilising prices and it will continue to be an essential buffer against any unforeseen supply disruptions.
However, the drive for oil supply security cannot include only the security of reasonable prices but the security of demand. Energy security cannot be achieved when prices are either too low or too high. After the precipitous drop of the past few months, the pendulum has swung to the other extreme, and that carries significant dangers. First, at these low prices “difficult” oil becomes economically unviable to extract. This will have a negative impact on producers with high extraction costs (such as Angola and Brazil), potential new sources (such as the tar sands in Canada), as well as undermine long-term research into alternative fuels and policies promoting energy efficiency. Second, lower oil prices do not generate predictable revenue flows, undercutting the ability of oil producers to make necessary investments in sustainable development and diversification.
There is a subtle expectation that Middle East sovereign wealth funds should do their best to purchase assets in the US and Europe. It seems that most regional sovereign funds will have to re-prioritise and look for investing within their respective local economies.
Close to two-thirds of Saudi Arabia’s more than $550bn in central banks’ total foreign assets are invested in the US and more than $12bn of goods were imported from the US and another $33bn from Europe in 2007. This “petrodollar recycling” has been longstanding policy for Saudi Arabia, as well as the rest of the Gulf oil producers. For every $72 a barrel of oil Saudi Arabia exported in 2007, close to $40 was recycled abroad. Saudi Arabia’s oil wealth is also felt intra-regionally in the form of remittances and investments within the Arab world. Both these investments and those abroad are falling commensurately with the price of oil; thus, Saudi Arabia’s financial well-being has a wider wealth effect. Over the course of the latest oil boom Saudi Arabian private intra-regional investments are estimated to have amounted to more than $40bn.
Due to effective investment of recent oil profits, Saudi Arabia is better equipped today than a few years ago to weather the global economic crisis. Saudi Arabia will continue to spend in key strategic sectors of the economy: education, employment, infrastructure and healthcare. But resources are finite. Foreign assets would be deployed, if necessary, along with raising debt from the domestic market. It can also decide to spend less until prices reach a more sustainable “fair price “ level.
Saudi Arabia cannot be blamed in the years to come if oil markets are under-supplied with non-Opec oil. Saudi Arabia’s growth is a security concern for all. There should be a realisation that a “fair price” for oil is essential for oil producers and recipients of recycled petrodollars alike. One of the most important things that oil-consuming nations can do is to realise this fact, and note that as the world’s “central banker of oil,” the Kingdom has played, and will continue to play, an instrumental role in ensuring global prosperity. With oil at $75 a barrel, the Kingdom would be positioned to continue this role for at least another generation.
The writer is chief economist, Saudi British Bank (SABB)
