Saudi 'Political' Agenda Aside, Oil Soars

by Masood Farivar
Feb 23, 2007

NEW YORK - So much for Saudi Arabia trying to squeeze Iran's economy by knocking down the price of crude oil.

For weeks, Washington has been abuzz with speculation that oil giant Saudi Arabia, in an effort to counter Iranian influence in the Middle East, has started to drive down the price of oil to deprive Tehran of badly needed revenue.

The seed of the theory was planted in a provocative opinion piece by a one-time consultant to the Saudi government, Nawaf Obaid, that appeared in November in the Washington Post. In it Obaid argued that Saudi Arabia could devastate the Iranian economy by boosting its crude production and cutting the price of oil in half.

With oil prices falling sharply in early January amid warm weather across much of the U.S., the mainstream press picked up on the idea, with the New York Times reporting that the oil kingdom had resolved to keep prices close to $50 a barrel and a prominent Times of London columnist calling the alleged effort part of a U.S.-led "economic pincer movement" to thwart Iran's hegemony in the Persian Gulf.

The reports caught the attention of Iranian President Mahmoud Ahmadinejad. After unveiling a draft budget last month and being forced by lawmakers to base it on $30 oil prices, he managed to put a political spin on it. "We assume our enemies want to damage us by decreasing the price of oil," Ahmadinejad said. "So we have reduced dependency on oil revenue."

But Saudi officials have denied any political agenda to drop the price of oil. To drive home their point, they even severed their ties to Obaid. If that's not enough for skeptics, consider recent Saudi actions and their consequences in the oil market: Thanks in no small measure to an aggressive Saudi effort to remove "excess supply" from the market, oil prices have climbed from a January low of less than $50 a barrel to a high of almost $62.00 a barrel on Friday.

"They're definitely not trying to drive prices lower," said Phil Flynn, an oil analyst at brokerage Alaron Trading Corp. in Chicago. "Whenever the Saudis speak, people look for a conspiracy. If the Saudis are trying to push down prices, they're going about it the wrong way."

Saudi officials have long called for "moderate" prices, although they have studiously avoided outlining a desired price level. But Saudi production policy decisions over the past year have aimed to keep prices somewhere around $60 a barrel. Last year, Saudi Arabia not only reduced its own output by about 800,000 barrels a day to 8.8 million barrels a day, but also engineered two agreements by OPEC to cut production by a total of 1.7 million barrels a day. The result: prices averaged $66 a barrel last year. OPEC's most recent output cut of 500,000 barrels a day, the bulk of which came from Saudi Arabia, went into effect Feb. 1 and contributed to the recent rebound in oil prices.

"These policy actions were clearly intended to put a floor under prices, not yank the rug out from beneath them," said Tim Evans, an energy analyst at Citigroup in New York.

Saudis Need Oil Revenue Too

As OPEC's de facto leader, Saudi Arabia is certainly in a position to influence oil prices and indeed uses that leverage every day. On the other hand, Iran, OPEC's second-largest producer, is in a shaky economic position even with high prices, struggling with high unemployment, spiraling inflation and a young and restive population heavily dependent on cheap government-subsidized gasoline. A plunge in oil prices could add to the country's economic malaise and destabilize it politically.

But Saudi Arabia is no less insulated from sharply lower oil prices. While clearly in better economic and financial shape than it was just a few years ago, the country remains just as dependent on oil revenues to support one of the world's fastest-growing populations with double-digit unemployment rates. And it is just as vulnerable to an extended period of lower prices, as underscored by the economic havoc brought about by the collapse of oil prices in the late 1990s. A $10 drop in the price of oil, for example, costs Saudi Arabia more than $30 billion in lost annual revenue (by contrast, Iran loses only $9 billion).

Even if Saudi Arabia wanted to, it is simply not in a position to engineer a price collapse by flooding the market the way it did in the mid-1980s. In 1985, faced with an eroding market share and falling revenue, Saudi Arabia decided to tap its 5 million barrels a day in spare capacity to boost its production by 40%. The result: prices plunged from nearly $32 a barrel to less than $10 a barrel within months.

Not The 1980s

Saudi Arabia's ability to drive down prices has since waned, thanks to a sharp decline in its spare production capacity. The EIA estimates Saudi Arabia's current unused capacity is just 1.7 million barrels a day to 2.2 million barrels a day, up nearly 800,000 barrels a day from a year ago. The kingdom plans to add another 500,000 barrels a day in capacity next year and to raise total capacity to 12.5 million barrels a day by 2009.

But with production on the rise to meet growing world demand, the kingdom's spare capacity is expected to remain around 2 million barrels a day, a fraction of the 86 million barrels a day in world oil consumption. What's more, half the spare production, defined as capacity that could be brought on line within 90 days, is of the hard-to-refine "heavy sour" variety, considered less desirable by many refineries.

"The 1980s were different from the present period because there was an oil glut and lower global demand," said Steve Yetiv, a political science professor at Old Dominion University in Norfolk, Va., and an expert on energy security. "With demand still high, it is much harder to flood the market. The Saudis, however, could try to affect the psychology of the market but that is a hard game to play."