Thursday, May 15, 2008

Saudia Arabia's fine balance

US-Saudi oil axis faces day of truth

By Ambrose Evans-Pritchard
May 15th, 2008

When President George Bush went to see Saudi Arabia's King Abdullah in January to plead for higher oil output, he was politely rebuffed. The rematch is likely to be a great deal more strained.

If the Saudis deny help once again, they risk incalculable damage to their strategic alliance with Washington. The price of crude has rocketed by over $30 a barrel since that last fruitless meeting, briefly touching the once unthinkable level of $127.

Goldman Sachs fears a "super-spike" to $200 a barrel this year. Asked what he would tell King Abdullah this time, Mr Bush said caustically: "the price is even higher." Indeed, it is, especially the political price.

The US-Saudi tango has been on thin ice ever since the terrorist attacks of 9/11. Sixteen of the hijackers were Saudi nationals. The Bush family has cleaved closely to the Saudi monarchy, but strong factions in Washington see Riyadh's Wahabi monarchy as part of the Mid-East problem-- not the solution.

Saudi Arabia's one saving grace -- in the eyes of US critics -- is that it has over the years been willing to cap extreme surges in the price of oil, deploying its power as the world's swing producer. This time Riyadh is giving no ground.

Oil minister Ali al-Naimi insists that there is plenty of oil about, blaming the latest spike on "the internal logic of the financial markets”, meaning hedge funds and speculators. The US Congress gave its riposte this week.

New York Senator Charles Schumer is pushing for sanctions against Saudi Arabia, targeting $1.4bn in sales of bomb kits, light armoured vehicles, as well as gear for AWACS aircraft and F-15 fighters. "You need our arms, but we need you to cooperate and not strangle American consumers. "Saudi Arabia could do a lot more than they have done," he said.

The Democrats are also pushing legislation that would penalize the OPEC producers cartel for "anti-competitiveness practices". The Bush White House has rolled its eyes in exasperation at such blunt methods, but hot feelings are aroused in American public discourse.

There have been calls for a food blockade of the Arabian peninsular on the US talk radio circuit. "Let them eat sand", has been the rallying cry of the shock-jocks. OPEC has -- in effect -- cut production repeatedly.

The Saudis have let their output fall from 9.5m to 8.5m bpd over the last two years, camouflaging the move behind the accession of Ecuador and Angola to the group (which boosted nominal supply). OPEC failed to compensate for a 330,000 bpd drop in Nigerian production in April, allowing the market to tighten further.

Dr Fadhil Chalabi, a former OPEC secretary-general and now director of the Centre for Global Energy Studies, said the Saudis have roughly 2m barrels per day of scare capacity. Three quarters is heavy sulfurous crude that requires special refineries, which are already working flat out.

"They have about half a million barrels a day of good crude that they could put on the market. The puzzle is why they are not doing it. The soaring price is obviously telling us that the world needs more oil,"he said. "I can't understand why the Saudis would risk their strategic relationship with the US over this.

"They need the US more than ever given the growing influence of Iran in the region," he said. One clue comes from the March bulletin of OAPEC, the Arab sub-group of the OPEC producers' cartel. It notes sourly that President Bush is aiming to reduce US dependency on oil imports "particularly from the Middle East”, by 75pc by the year 2025.

"This has created some ambiguity in the US position on the future of oil consumption," it said. Touchee. King Abdullah's retort to the Bush speech was to announce that Saudi Arabia would stop developing big projects after the Khurais field comes on stream in next year with 1.2m bpd, leaving the country's oil in the ground for future generations.

Chris Skrebowski, Editor of Petroleum Review, said the awful truth is that Saudi Arabia cannot raise oil output much even if it tries. "The myth of Saudi spare capacity is convenient for everybody: it gives OPEC leverage, and it gives the West hope. "But Saudi reserves are secret. They have never been verified," he said.

Mr Skrebowski said oil is soaring because output is falling in Mexico, the US, and the North Sea. Russia stunned the markets with a 1pc fall in first quarter in Russia. "We are running the system flat out,"he said. The jury is out on the durability of this oil rally.

Bulls bet that roaring Chinese demand growth of 400,000 bpd each year will keep going, while fuel subsidies in much of Asia and the Mid-East insulate users from the real cost of crude.

But if the downturn spreads from North America to Europe, Japan, and even China, it could upset with the delicately balance forces of supply and demand. The International Energy Agency (IEA) says demand will cool to 86.8m bpd this year, falling below supply for several quarters.

"Even if they increased supply today, it would not hit the market until June or July, just as demand slows. They are bad memories from past cycles. Some of these countries are spending so much that they can barely get by with prices at $125, so they are very worried about losing revenues. Iran and Venezuela are textbook cases," he said.

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