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WEEKLY NEWSLETTER
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Saudi Arabia
Index
The kingdom's oil policy was based on three factors:
maintaining moderate international oil prices to ensure the long-
term use of crude oil as a major energy source; developing
sufficient excess capacity to stabilize oil markets in the short
run and maintain the importance of the kingdom and its permanence
to the West as a crucial source of oil in the long term;
obtaining minimum oil revenues to further the development of the
economy and prevent fundamental changes in the domestic political
system.
Short-term oil policy in the early 1990s has been shaped by
two major sequences of events. The first was Saudi Arabia's
refusal to play the role of "swing producer" in the mid-1980s,
its subsequent bid to maintain its market share, and abandonment
of the fixed oil price system after the 1986 price crash. The
second was Iraq's invasion of Kuwait, the kingdom's replacement
of most of the oil lost from these two OPEC members, and its
ascendance as unchallenged leader within OPEC after August 1990.
Both periods have shaped an oil policy that called for OPEC
decisions to promote moderate and stable oil prices but not
compromise the kingdom's demand for its market share. Before the
Persian Gulf War, Saudi Arabia demanded about 25 percent of the
OPEC production ceiling; after the Iraqi invasion of Kuwait the
share rose to 35 percent.
Saudi Arabia's behavior in the oil market since 1986
demonstrated its attempts to ensure both goals. In the early
1980s, oil prices rose rapidly because of the breakdown of the
old vertically integrated system of multinational oil companies,
following nationalizations by producer governments during the
1970s. Other causes of the price rises were the disruption of
Iranian exports during and after the Iranian Revolution in 1979,
and the destruction of the Iranian and Iraqi oil sectors during
the Iran-Iraq War of 1980-88, which exacerbated an already low
level of spare production capacity. High oil prices in the early
1980s stimulated the rapid growth of non-OPEC oil supplies in the
Third World, in Siberia, the North Sea, and Alaska.
As a result, oil prices began to drop in late 1982, forcing
OPEC to institute a voluntary output reduction system by
assigning individual quotas. The new system failed to stem the
price slide, however. By 1985
spot (see Glossary) oil prices had
fallen to about US$25 per barrel from an average of US$32 per
barrel in the early 1980s.
Saudi Arabia's adherence to an official price system, which
most OPEC members were abandoning, rendered the kingdom the swing
producer. As a result, Saudi Arabia was forced to curtail output
to ever lower levels. Other members "cheated" on their quotas by
offering competitive prices, effectively pushing the entire
burden of adjustment onto Saudi Arabia. In 1979-80, Saudi Arabia
had peaked at a production of more than 10 million bpd; by 1986,
that amount had reached a low point of 3 million bpd.
In early 1986, Saudi Arabia discontinued selling its oil at
official prices and switched to a market-based pricing system
called netback pricing--that guaranteed purchasers a certain
refining margin. In doing so, Saudi Arabia recaptured a
significant market share from the rest of OPEC. The sharp rise in
crude oil supplies precipitated the crash of spot prices from an
average of US$28 per barrel in 1985 to US$14 per barrel in 1986.
The Saudis had used their "oil weapon"--significant excess
capacity combined with adequate foreign financial reserves
cushioning the blow of lower oil revenues--to establish some
discipline in OPEC.
It did not take long before OPEC agreed to a new set of
quotas tied to a price target of US$18 per barrel. By late 1986
and early 1987, prices rose to US$15 or US$16 per barrel for the
OPEC basket (from well below US$10 per barrel in early 1986). To
avoid a swing producer role, the Saudis imposed an important
condition on other OPEC members: a guaranteed quota of
approximately 25 percent of the total output ceiling, correlated
to a US$18 per barrel price objective.
The latter became the center of controversy within the
organization for much of the period before the Iraqi invasion of
Kuwait. A revival in oil demand growth rates in the
industrialized world between 1988 and 1990, partly aided by
several years of low oil prices and double-digit annual
consumption growth in the newly industrializing countries of East
Asia, gave OPEC the chance to induce price increases above US$18
per barrel. Some members called for expanding OPEC's overall
output ceiling by a smaller factor than the growth in anticipated
demand, which would in effect push oil prices up, possibly back
to their early 1980s level.
Whereas Saudi Arabia has always endeavored to maintain
moderate oil prices, regional political and economic concerns
have also motivated the kingdom not to depress prices too far,
the 1986 Saudi-induced price crash notwithstanding. In 1988 and
1989, King Fahd publicly guaranteed that Saudi Arabia would work
to achieve oil price stability at US$18 per barrel. There was one
overwhelming reason for this policy: with the Iran-Iraq War
cease-fire in 1988, the kingdom wanted to maintain oil prices at
levels that would force Saddam Husayn to be concerned with
rebuilding Iraq rather than threatening his neighbors. This
objective was formally registered in the 1989 Nonaggression Pact
that Riyadh signed with Baghdad.
The biggest battles in OPEC prior to 1990, however, were
between Saudi Arabia and two of its gulf neighbors: Kuwait and
the United Arab Emirates (UAE). Both refused to restrict
production to their quota levels, and by early 1990 their serious
overproduction contributed to mounting international crude oil
inventories. By the second quarter of 1990, the oil traders in
New York were pushing oil prices down.
Saddam Husayn's envoy, Saadun Hamadi, toured the gulf in June
1990 and halted the slide in prices as Iraq unveiled its own "oil
weapon": the threat to invade Kuwait. Buttressing this threat by
mobilizing 30,000 troops on the Kuwaiti border, Baghdad dictated
an agreement at the OPEC ministerial meeting the following month.
Although respecting Saudi Arabia's 25 percent market share, and
allowing the UAE to raise its quota to 1.5 million barrels per
day, OPEC set an overall ceiling of almost 22.5 million bpd and a
compromise price of US$21 per barrel.
Saudi Arabia played a largely passive role at the July 1990
OPEC meeting in Geneva and conceded to Iraq's bid for dominance.
Kuwait was clearly cowed: even before the meeting it reduced its
oil output and appointed a new oil minister, Rashid Salim al
Amiri, an unknown chemistry professor, to replace Ali Khalifa,
the architect of Kuwait's downstream projects and its aggressive
oil policies.
When Iraq invaded the invasion of Kuwait, it provoked massive
intervention by the United States into the gulf and ultimately
lost its power within OPEC. Behind direct United States
protection, the kingdom's oil production rose to 8.5 million bpd
or 35 percent of OPEC's total output.
Operation Desert Storm allowed Riyadh to regain its status
within OPEC. At each successive OPEC meeting until the gathering
of ministers in February 1992, Saudi Arabia dictated the final
agreements with virtually no opposition. The eleven active
members were producing at capacity while prices remained
relatively high. Between March and July 1991, both Iran and Saudi
Arabia expertly sequenced the unloading of large stocks of oil in
"floating storage," which had been built up as insurance during
Operation Desert Shield, and prevented an anticipated crash in
oil prices during the spring and summer months of 1991. Part of
the harmony within OPEC resulted from the opportunity Iran saw in
being more cooperative with Saudi Arabia. For the West to see
Iran as a "responsible" member of OPEC could help attract
investment for its oil and other industrial sectors.
Observers of OPEC, however, awaited the revival of the old
dove-hawk battles. The February 12, 1992 OPEC meeting was held to
discuss reinstatement of the July 1990 agreement, temporarily
suspended after August 2, 1990. The hawks wanted to preserve the
quota system and the reference price, which had been neglected in
order to replace lost Iraqi and Kuwaiti output, pushing oil
prices to about US$21 per barrel for the OPEC basket. The
expected return of Kuwait and Iraq to the oil market required a
return to the preinvasion rules if prices were not to fall
sharply.
Saudi Arabia's aim at the February 1992 OPEC meeting was to
eradicate the last vestiges of the 1990 agreement and its quota
shares, especially the kingdom's share of about 25 percent. At
the February 1992 meeting, OPEC members refused to blink at Saudi
pressure. Iran particularly was willing to risk the improved
relations it had forged with Saudi Arabia and absorb the oil
price cut.
Saudi Arabia's income requirement in the wake of the Gulf War
would, Tehran suspected, keep the Saudis from forcing other OPEC
members into accepting its objectives as it did in 1986.
Technically, the final agreement reached was essentially what the
Saudis wanted in the short run: a total production ceiling of
almost 23 million bpd and a temporary quota of 35 percent of the
ceiling and the maintenance of price stability. They did not
achieve their long-term objective: unanimous OPEC recognition of
a 35 percent market share of all future OPEC output ceilings.
Longer-term Saudi policy imperatives for the 1990s were
shaped by structural factors within OPEC and within the
international oil market. Highest on the priority list was the
decision to push domestic oil capacity to more than 105 million
bpd sustainable capacity with a further 1.5 million to 2 million
bpd surge capacity in times of emergency. Three factors prompted
these expansion plans. Growth in world demand for oil over the
preceding several years, combined with the Persian Gulf War, had
pushed the kingdom and other OPEC countries to their production
capacities. Expecting that demand would continue to grow and that
most other exporters were constrained by diminishing oil reserves
or financing problems, a rapid rise in capacity could capture any
increase in demand that might occur. Second, in light of the
post-1986 intra-OPEC market-share competition, oil capacity
expansions have had a direct impact on the ability of individual
members to jockey for quota increases. Third, the ability to
raise output at will, in the event of an unforeseen price
decline, helped stabilize total oil revenues, which constituted
the bulk of domestic budgetary income.
Saudi Arabia's interest in moving downstream was also a
priority of its oil policy. The drive to obtain overseas refining
and storage facilities was designed to further two objectives
related to security of supply. First, the kingdom wanted to
obtain captive buyers of its crude, assuring stable prices and
terms. Saudi Arabia would thus be more receptive to market
conditions in consuming countries and avoid being closed out of
certain countries. Gaining further profits from refining the
crude was an associated reason for the move downstream overseas.
Second, the kingdom sought to provide consuming countries with
"reciprocal security measures," under which it would undertake to
guarantee supply--through capacity additions or stocking
arrangements abroad--in return for consumer countries' decisions
to avoid taxes and import restrictions on oil. Few consuming
countries, however, have responded favorably to such
arrangements.
Data as of December 1992
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