Changing of the Guard
The attention focused on the death of King Fahd and the ascendance of Crown Prince Abdullah, the de facto ruler since Fahd's stroke in 1996, reflects both the ongoing importance of Saudi oil and the durability of the dynasty founded against the odds by ibn Saud. Whatever your views on the role the Kingdom has played in events ranging from OPEC and the 1973 Embargo, the Middle East peace process, the expulsion of the Soviets from Afghanistan, the Gulf War, and the War on Terror, we all have a stake in a smooth transition. There's little reason to think it will be otherwise, since the much more interesting transition from the aging sons of ibn Saud to his grandsons' generation remains years off. In light of this, it's worth spending a moment thinking about the future energy role of Saudi Arabia.
Despite widespread assumptions that the Saudis, who have the world's largest reserves of crude oil, must bear the lion's share of future production increases, there's little indication of this from Saudi Aramco, the state oil company. In fact, the company has suggested (FT subscription may be required) that they will only be able to increase capacity to 12.5 million barrels per day by 2009, and to 15 MBD eventually. That could be as much as 4 or 5 MBD less than the world will need, unless other producers can make up the slack. (The CERA study I referred to the other day provides some reassurance in that regard.)
Pronouncements like this only serve to bolster the arguments of those who believe the Saudis have consistently exaggerated their reserves and hidden signs of imminent decline in the country's largest oilfields. I see a simpler explanation. Saudi Arabia suffers from the same problems as many other countries that rely on oil exports for their income, such as Venezuela and Algeria. A growing population with high, unmet expectations has forced the government to siphon off much of its oil earnings to pay for social programs and job creation, instead of developing more oil. The current price spike has been a two-edged sword, enabling them to stave off social unrest, but also allowing them to postpone urgently needed reform. At some point, though, even these inflated revenues won't be adequate, and the Kingdom will have to consider allowing in foreign investors, as an alternative to domestic chaos.
The flip side of this argument includes various scenarios for the overthrow of the Saudi royal family and revolution of some sort, whether democratic or Islamist. These predictions have been around for longer than I've been in the industry, and they've usually underestimated the tenaciousness of the al Saud clan, as well as their savvy political sense. But if something like this did occur, our Iraqi experience suggests we'd be unable to intervene effectively. We would have to ride out the storm, which would blow oil prices through any ceiling we can imagine, especially if it started with prices as high as they are now.
At the same time, though, the combination of less ambitious future production expectations and the advent of new energy technologies such as hybrid cars and gas-to-liquids plants suggests that the importance of Saudi Arabia's oil to the global economy may not grow as much as conventional wisdom would suggest. The longer the Kingdom resists opening its doors to foreign investment, the likelier this view will prove to be correct.
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