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Saudi Efforts to Correct Oil Prices   

Al Hayat - 28 March, 2012
Author: Walid Khadduri

Last Monday, Saudi Arabia reaffirmed that it will work both on its own and in cooperation and coordination with GCC countries and other oil-producing countries in OPEC and outside, to restore oil prices to fair levels for both producers and consumers, as well as the oil industry overall. The Saudi cabinet, presided over by the Custodian of the Two Holy Mosques King Abdullah bin Abdul Aziz, confirmed at the end of its latest weekly periodical meeting that the Kingdom is committed to work with consuming countries and through the International Energy Forum to provide adequate petroleum supplies and to stabilize the markets.

Then in Doha last Tuesday, Saudi Oil Minister Mr. Ali al-Naimi said that there are no problems in oil market fundamentals, in the sense that the supplies available are adequate to meet demand, even surpassing the latter by about 1.5-2 million barrels per day. This means that there is no cause for high prices, despite geopolitical developments and speculation. Mr. Naimi also stressed that Saudi Arabia is ready to increase its output by nearly 25%, reaching the maximal productive capacity of 12.5 million barrels per day, in addition to tapping into millions of barrels of its oil reserves located all around the world, close to consumer markets.

The ministerial statement as well as the statement of the Saudi Oil Minister raises important questions. First of all, why is Saudi Arabia taking the initiative to restore prices to fair levels?

The rapid and unnatural hike in prices has big downsides for the major oil producing countries themselves, as it leads to the promotion of alternative energy sources, hurting producers in the long run. The evidence for this is clear. The United States, for instance, the largest importer of oil, is now exporting both oil and natural gas, both from shale sources. So with the consuming countries investing in these industries when prices skyrocket, the alternative energy industry continues even when prices fall again in the future. This is an extremely important challenge for oil-producing countries with very large reserves, which want to see oil continue to play a large role in the world energy basket.

The attempt to curb the rapid and dramatic rise in prices is necessary to help the process of recovery of the world economy, especially in developing countries. It is therefore not in the interest of oil-producing countries for the global economy to suffer more collapses, or for the global economic crisis to endure for years to come. Such a scenario would mean the possibility of a collapse in demand for oil and, consequently, a collapse in oil prices. The oil industry, along with producing countries, faced serious difficulties when prices collapsed to $ 30 and even $ 10 per barrel. It is therefore wiser for the producing countries to rush to calm the markets before they spiral out of control. Developing countries also face challenges. Indeed, many Arab non-oil producing countries and their citizens are suffering from the current rise in prices, and the same goes for many non-oil producing developing countries.

Add to this the issue of the people’s aspirations in oil-producing countries. To be sure, their vision has been obscured by a dense cloud arising from the rapid rise in prices, and their false belief that they have the right to receive unreasonable increases in wages and government handouts, as though oil prices will only rise and would not fall in other periods. This makes it impossible for the state treasury to fulfill obligations in such an eventuality.

There are concerns as well, especially in producing countries that lack rigorous financial control, of rampant corruption, with embezzlement and bribes of billions of dollars without any accountability, as a result of the uncontrolled flow of money, as is the case in many Arab countries.

This raises a second question: What is meant by ‘fair prices’?

There is no particular fair price for oil. Instead, this price is determined by comparing oil prices to the prices of alternative energy sources in the market. For some countries, what they consider a fair price is what the state’s budget requires in terms of oil revenues, and is therefore a justifiable price for a particular function (but this, naturally, cannot be considered a fair price). Some oil experts believe that the current fair price is about $ 100 per barrel.

The third question concerns the damage that the global economy may sustain as a result of high oil prices. Focus is once again on oil prices, especially with their recent dramatic increase, and at a time where the European sovereign debt is seeing some breakthroughs. In this context, the IMF managing director Christine Lagarde has warned that oil prices may rise 30 percent further should there be shortages in Iranian oil supplies, and that such an increase in prices will lead to ‘serious consequences’ for the world economy. There are widespread fears at present that the European economic crisis, if not addressed quickly, may spread to other parts of the world, including emerging countries (China, Brazil and South Korea), which have managed to avoid recession so far. However, it is very possible that these emerging nations may see a recession during the coming period, as a result of a decline in their exports, and the same applies to oil-producing countries, as demand for their oil is expected to fall in tandem with increased oil prices. Also pertinent of course are the U.S. presidential elections this autumn, and the concerns of the Obama administration regarding the implications of rising local gasoline prices for the electorate.

Is it possible to curb the record rise of oil prices?

Oil prices have fallen gradually from about $ 127 per barrel to about $ 124 per barrel after the recent statements. However, it is important to underscore the fact that the attempt to correct oil prices comes at a difficult time for the oil industry, as many countries have begun to reduce or halt their imports of Iranian oil. Furthermore, there have been unconfirmed reports that both the United States and the United Kingdom have begun tapping into their strategic oil reserves to curb the high gasoline prices in the two countries.

So what might help achieve a significant fall in oil prices?

The markets expect a significant increase in the commercial inventories of the oil companies, and also that OPEC will maintain a spare productive capacity of about 4 million barrels per day, rather than the 2.5 million barrels per day currently available. Of course, this is no easy matter. Indeed, the higher the production of oil countries is, the lower their spare productive capacity becomes. The markets are also concerned that the increase in production may be used in the summer to meet the high demand in the Gulf countries in the summer, instead of making their way to the global markets.

* Mr. Khadduri is a consultant for MEES Oil & Gas (MeesEnergy)
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