US and Saudis Together Again, Rule World Oil Market

Oil prices zoomed up to $58 per barrel in early April then plunged $10 dollars six weeks later. At their peak, various pundits grimly warned that too-high oil would precipitate a world slowdown.

DEBKA-Net-Weekly’s strategic analyst seeks firstly to define “too high.” There is no question that prices doubled in less than two years. But that does not prove that the April peak was too high. By the same arbitrary standard, would not the $25-28 per barrel two years ago be judged too low?

In the years 1979/80, Khomeini’s Islamic revolution in Iran pushed prices up to $40 dollars, equivalent in current real terms to $80. According to the scale of comparison in those years, $58 dollars seems moderate. The real problem – then as now – is how to decide what governs the real price of a barrel of oil. Is it determined purely by supply and demand? Or must the price be adjusted according to costs such as developing new fields, transport, refining and the price of money? Current world prices certainly embody all these expenses and have long since abandoned supply-and-demand as the sole price regulator.

Equally debatable is the linkage between rising oil prices and worldwide economic slowdown. The counter-argument is that although oil prices doubled in less than two years, Asian economies expanded without missing a beat, and heavily oil-dependent nations such as China and India enjoyed roaring growth rates. Even Japan which imports every drop it consumes was able to emerge from its decade-long recession and only last week declared a more than 5% growth. Oil prices defined as “too high” are therefore seen to have had only a marginal impact on these nations’ growth rates.

High Vs cheap oil controversy is still alive

Our strategic analyst maintains that oil prices are set primarily by international oil politics rather than economic criteria. Oil and politics were ever intertwined. From the end of World War II until the early 1970s, oil policy was set in the corridors of ARAMCO and the White House. Their overriding strategy then was to bring the Western world a ready supply of cheap oil to stimulate post-war recovery. Not everyone accepted this policy. European oil companies like Royal Dutch Shell tried to derail the strategy by cutting down on production in their countries of operation. They failed because Saudi oil deposits were vast enough to keep the ARAMCO-White House cheap oil policy afloat against all opposition.

But the argument between the cheap oil and the high-price advocates persists even now.

Unlike his predecessor, President George W. Bush wants to keep prices high – although not high enough to jeopardize world economic growth at large. His goal is a price level that is realistic and which makes it worth while for oil companies to develop new fields and be able to recover their investments in the shortest possible time. The new fields envisaged are chiefly in Saudi Arabia, Iraq and Alaska. Developing them in Saudi Arabia and Iraq would be cheaper than Alaska, but face impediments.

Saudi Arabia’s de facto ruler for the past decade, Crown Prince Abdullah, is a staunch opponent of cheap oil.

This community of interests between Bush and the Saudi ruler generated the price spiral of the last eighteen months and paved the way for the Texas understandings. They occasioned the crown prince’s promise to expand Saudi production capacity to 12.5 million barrels a day – up from the present 11 million. This undertaking is already going forward.

Preparing for surging world demand

But according to DEBKA-Net-Weekly‘s intelligence sources, the scope of those understandings, as approved by the Saudi government on May 23, went much further than immediate, hard-and-fast figures. Indeed, in the last two weeks, the Saudis have launched on high-profile American platforms an image-lifting drive that aims to restore them in the long term to their old favored position in the international oil league. Riyadh is building on new Bush-Abdullah accord which jumps forward to stamp its strategic imprimatur on long-term world trends and affirms the rebirth of their partnership.

For a decade, the US energy department has been predicting that world demand for oil and its products would climb far beyond their current level in the years 2020-2025 and called for forward planning to meet this contingency.

Expanding demand is already discernible today. Although Saudi Arabia is not the only producer called upon to make adjustments, it is the most important. Therefore, the US energy department fixed in advance a Saudi production “quota” of 20-25 million bpd for those critical years.

Following the Bush-Abdullah summit, Riyadh issued a series of commitments for the short and the long term. Officials promised to keep prices stable and the world oil market steady, to continue to reserve the kingdom’s spare capacity of 1.5-2 million bpd and raise production capacity in accordance with market needs. The Saudis also promised to expand refining resources at home and overseas.

Most important, government officials began citing the short-term production figure of 15 million barrels per day and 22-23 million for the long term in public statements. One came from Saudi petroleum and minerals ministers Ali al-Naimi in a speech he delivered in mid-May at the Industry Conference in Washington and on May 23 at the World Affairs Council of Northern California. Another from Aramco’s president and chief executive officer, Abdallah Jum’a, in an address to Rice University’s James Baker III Institute for Public Policy at Houston, Texas, on May 16.

Caspian producers must play second fiddle to Saudis

US secretary of energy Samuel Bodman, who took part in the Industry Conference,

promised matching American concessions. He was referring mainly to the administration’s bid to enact new energy legislation in Congress for easing restrictions on oil prospecting as well as major tax breaks for the industry.

The US secretary then set out for talks in Russia, Ukraine and Azerbaijan to promote high oil production and bring these producers in line with the US-Saudi strategic understandings. Bodman was present at the inauguration near Baku Wednesday, May 25, of the giant $3.6bn Caspian pipeline to the Turkish Mediterranean port of Ceyhan.

The understandings reached at the Bush-Abdullah summit therefore put global oil policy back where it was fifty years ago – in the US-Saudi domain – in contrast to the Clinton administration’s policy, which marginalized the Saudi role in the hope that favoring the development of Caspian resources would reduce international reliance on Saudi goodwill.

The question now is: at what level will oil prices settle? It stands to reason that as long as Bush is president and Abdullah's throne is stable, oil prices will not revert to the $20-25 per barrel which preceded the current hikes. They are most likely to settle at around $40-45 in the foreseeable future.