SAUDI ARABIA - The Oil Market Perspective.

It was in late 1979 that world crude oil prices hit a real record high of $109/b, in today's money adjusted for inflation. So when WTI now hits $85/b, or $90-100/b by end-2008 as some predict, people should remember that crude oil and other sources of energy are still considerably cheaper than they used to be three decades ago. One should see things also in relation to project costs, which have risen sharply since 2002, and the value of the US dollar which has fallen as sharply since then.

However, perceptions of costs still have not caught up with such realities, and this is causing a problem with serious global implications. Perceptions of high project costs are causing under-investment in capacity expansions badly needed in the petroleum sector, all the way from the upstream down. Many projects across the whole chain have been cancelled, or shelved, in recent months because of this.

Global equities on Sept. 19 surged, oil prices rose and the euro has since hit its highest-ever level against the US dollar. Around the world, stock market investors cheered the Fed's Sept. 18 decision to cut the federal funds rate by a half-point to 4.75% to boost the flagging US economy and ward off the global credit squeeze. European stock markets on Sept. 19 soared after bumper gains overnight in New York and earlier in Tokyo as investors welcomed the US move, which was the first cut in the Fed's benchmark rate in four years. Analysts at the Sucden brokerage in London were on Sept. 20 quoted as saying: "The general consensus was for a 25 basis point cut, even though some analysts were predicting a 50 basis point move".

The US rate cut has boosted other commodity prices. Copper on Sept. 21 rose to eight-week highs. Gold reached a 28-year peak of $739/ounce, gaining from the dollar's slide to record lows of over $1.41 to the euro. November WTI on Sept. 21 fell 60 cents to $81.18 as oil firms returned workers to the Gulf of Mexico after a storm triggered evacuations earlier in the week. On Sept. 20, October WTI hit $84.90.

Barclays Capital on Sept. 21 said: "Although the macro-economic environment remains uncertain, forward looking market balances look extremely tight especially for oil and base metals". But Ed Meir at MF Global said: "fear is overriding fundamentals, thus feeding the upward frenzy. However, such a market mindset is not sustainable, and could trigger a rather severe correction once the music stops".

Energy experts are divided over whether crude oil prices will crash back to $50 before they break $100. Texas oilman and investor T. Boone Pickens on Sept. 21 was quoted as saying: "The trend is up, and if your supplies are 85m...[b/d] globally, and you look at what demand is predicted to be for the fourth quarter, it is 88m [b/d]. I don't think you'll hit $100 this year unless you have some kind of geo-political event that causes that to happen, but you're going to get to $100 at some point". Ed Morse, chief energy economist for Lehman Brothers, said: "On a pure fundamentals basis the oil market is likely to see $100 long before it again sees $50, whether from a weather or a politically engendered spike... The market has for the time being a floor price that is in the $60 range because of falling spare capacity, higher finding and development costs, the weaker dollar and OPEC objectives".

Iranian government spokesman Gholam-Hossein Elham on Sept. 19 told reporters: "Only around 30% of the world's oil comes from OPEC and there is no need to impose pressure on OPEC countries. Many OPEC states in the region rely on oil income and the hike in prices is a suitable thing for these states". Elham's comments came a day after the new head of IEA Nobuo Tanaka of Japan urged OPEC to raise production further if oil prices remained at their current levels.

While the Middle East petroleum industry is enjoying one of the most prolonged booms in its history, the economic case for investment in energy is becoming more perillous each month as labour and material costs soar. Estimates of Kuwait's 615,000 b/d al-Zour refining project has risen from $2 bn in 2002 to over $17.5 bn now. In February ExxonMobil pulled out of a GTL project with Qatar Petroleum because its costs had risen from $5 bn in 2002 to $18 bn. Alan Gelder, vice-president for downstream oil at energy consultant Wood Mackenzie, warns: "For a refinery project to be viable, it needs...double-digit returns. If the project is only returning 6%, you can expect IOCs to question what they are doing. You get 5% putting your money in the bank".

The future of a 400,000 b/d Yanbu' refinery in Saudi Arabia is in doubt. The Fujairah refinery project could still go ahead but in a significantly altered form; it is likely to be built over two phases, with a single-train hydrocracker rather than the two originally planned, and final capacity of 230,000-250,000 b/d. The client, IPIC, is tendering a feasibility study contract, with a consultant to be appointed by end-2007. Khaled al-Bu'ainain, senior VP of refining, marketing and international at Saudi Aramco, faces a similar decision on Yanbu' - designed with ConocoPhillips to process Arabian Heavy crude from the 900,000 b/d offshore Manifa field, and must be operational by 2011. Production at Manifa requires the 400,000 b/d Jubail-II refinery to go ahead; it is under pressure. The developer, Total, denies any problems, saying: "The front-end engineering and design (FEED) is under way and we are on schedule, at the end of the year or the beginning of 2008, to take the final investment decision". Riyadh is struggling to attract IOC interest in a new refinery at Jizan.

Saudi Petroleum and Mineral Resources Minister Ali al-Nai'mi on Sept. 11 got OPEC's 145th ministerial conference in Vienna - despite opposition from Iran, Venezuela, Algeria and Nigeria - to raise the group's crude oil production by 500,000 b/d from Nov. 1 to 27.2m b/d. OPEC in 2006 lowered output by 1.2m b/d from 1 November and by a further 500,000 b/d from Feb. 1, 2007. But the new increase will not be enough to offset the impact of planned refinery outages and a rise in world oil demand.

OPEC's actual output is set to fall in November because of heavy field maintenance in Abu Dhabi, where Lower Zakum and Upper Zakum work will cut production by 600,000 b/d for two to three weeks. Additional reductions from Umm Shaif are to bring the peak reduction in Abu Dhabi's output up to 800,000 b/d.

By Sept. 11, crude oil prices since 2003 had risen 150% in US dollar terms but just 78% in euros and 87% in pounds sterling. The EU is a growing trading partner for OPEC members, especially those in the Middle East and North Africa, displacing the US. OPEC's crude oil income is in dollars while a growing share of its spending is in euros. Saudi Arabia imports about 26.5% of its goods and services from the eurozone and another 5% from the UK, while the US only accounts for 12.2%. A 10% drop in the US dollar against leading currencies cuts OPEC's Middle East members' crude oil purchasing power by about 5%.

OPEC members' revenues in real terms, adjusted for inflation and currency movements, are no higher than they were in the early 1980s. The decline in the value of the US dollar cushions the impact of high oil prices in some countries, including the eurozone, helping sustain demand even as the price rises above $80/b.

In its September oil market report, OPEC maintained its outlook for healthy world economic growth and oil demand for this year and 2008. It said: "It is expected that the fallout from financial market turmoil will impact US and world economic growth in the second half of 2007 and 2008, although it [is] still too early to gauge the size of the effect". It said it expected world economic growth of 5% for 2007 and 2008. That is unchanged from OPEC's August report.

World oil demand for this year was unchanged from OPEC's previous report for the third and fourth quarters and for 2007 overall. Demand this year is to rise 1.28m b/d, or 1.5%, from 2006. World oil demand in 2008, which closely tracks economic growth, was projected at 1.35m b/d, or a 1.6% rise from this year, also unchanged from August. In its latest monthly oil market report released on Sept. 12, the IEA said OPEC's combined crude oil production capacity would rise 4.68% by end-2008 to 35.8m b/d from the current 34.2m b/d. It said Angola, Saudi Arabia and Qatar underpinned this year's capacity growth, with Saudi Arabia, Angola, Kuwait and the UAE responsible for the bulk of 2008's increase. OPEC's capacity is expected to rise to 34.5m b/d by end-2007, adding: "If OPEC production tracks the expected 'call on OPEC crude and stock change' through the fourth quarter of 2007, spare capacity is likely to temporarily decline from effective levels around 2.7m b/d now".

On Sept. 11, OPEC's communique said the group will continue to monitor the supply/demand situation over coming months and affirmed that an extraordinary meeting will be held to reassess the market situation on Dec. 5 in Abu Dhabi.

Concerns that the market is running away from OPEC - as it did in 2004 when prices pierced the $40/b barrier and never looked back - lifted WTI futures to a fresh intra-day high of $80.70/b on Sept. 17. Goldman Sachs on Sept. 17 raised its forecast for WTI to $85/b by end-2007 from $72 and said it expected $95/b by end-2008.

OPEC added a further incentive as its Secretary-General Abdullah al-Badri of Libya on Sept. 14 said the group was to bring Angola into its output quota system from Jan. 1, 2008. The IEA, which says OPEC is not producing enough to supply the market's needs this winter, on Sept. 17 estimated OPEC's spare capacity at 2.7m b/d. The vast majority of the spare capacity is held by Saudi Arabia. The IEA on Sept. 17 estimated Saudi crude oil output in August at 8.7m b/d.

Saudi Aramco says the Khursaniyah field will add 500,000 b/d of light crude oil to its output capacity by December. The IEA estimates Angola's output capacity, now put at 1.62m b/d, will reach 1.79m b/d in the fourth quarter. Tightening inventories in the US, Asia and Europe are crimping that effort, while a busy Atlantic hurricane season is making trouble for attempts to get gasoline and heating oil stocks back up to more typical levels.

Shrinking oil production capacity makes the market vulnerable to the impact of severe hurricanes or other operational outages. If tight fuel supplies are behind a price surge, all the oil from OPEC or from government-held crude oil stockpiles, such as the US Strategic Petroleum Reserve (SPR), would not help staunch prices or fuel demand.

Apart from a market-crashing change of heart by commodity funds and other speculative investors, only a slide in world oil demand would reset oil prices at lower levels. The impact of the crisis in the US sub-prime lending market is so far unclear, but it is considered unlikely to strike a major blow like the Asian currency crisis did in late 1997, when OPEC raised its oil output quotas by 2m b/d in Jakarta. Back then, warm winter temperatures across the Northern Hemisphere slashed deeply into oil demand, accelerating a 50% price fall.

Traders will be watching weather forecasts closely, with the National Oceanic and Atmospheric Administration (NOAA) indicating that at least the early part of the season will see above-normal temperatures in the US north-east, the world's largest heating oil market. The IEA noted in its Sept. 12 report: "winter temperatures can have a significant impact on demand".

The exceptionally mild winter of 2006-2007 trimmed oil demand in the Northern Hemisphere by 900,000 b/d. The IEA forecast world oil demand in the fourth quarter to rise 2.1m b/d to 87.8m b/d, followed by an additionally 400,000 b/d rise in the first quarter of 2008.

The IEA said high oil prices will have little impact on demand in Asia, the region which uses a third of world oil production. Demand from China and India, two of the world's fastest growing oil importers, remains elastic. IEA's Deputy Executive Director William Ramsay said: "Oil demand in Asia remains resilient and will continue to rise, driven by growth in China and India as big importers".

The IEA expected Asia's average demand growth for oil products to reach 788,000 b/d over the next five years, up from an average of 727,000 b/d during 2002 to 2007. Ramsay said: "The growth of Asia's demand will account for 47% of total demand by 2012". He said investment in oil and gas projects was likely to be delayed as costs rise, but new upstream investment during 2006-2010 would be $306 bn.

Saudi Aramco on Sept. 18 announced a year-long programme of exciting celebrations throughout Saudi Arabia and various countries around the world to mark the company's 75th Anniversary in 2008 under the theme "Energy for Generations". A significant focus will be the role Saudi Aramco plays in contributing to the economic development of the kingdom and in global economic stability. The celebrations will involve and honour Saudi Aramco's present employees and retirees, as well as the local communities in which the company operates.

The programme will begin with celebrations for employees in the first quarter of 2008. Minister Na'imi on Sept. 20 was quoted by Arab News as saying: "I am already experiencing all the joys of preparing for and anticipating the company's 75th anniversary of the signing of the Concession Agreement in 1933 when the Kingdom's founder, the late King Abdul-Aziz, gave the nod to his minister of finance, Shaikh Abdullah al-Sulayman, to sign the articles of agreement. This far-seeing decision ushered in the historic Saudi oil and development legacy, which thrust the Kingdom onto the world stage and ultimately made it an influential global force".

Saudi Arabia is setting up a 35,000-strong force to protect its oil infrastructure from potential attacks. The move underlines growing concern about its oil sites after threats from al-Qaeda to attack facilities in the Gulf, and rising tensions between Iran and the US - main factors behind the rise in oil prices in recent weeks (see news13-IranUnderNewPressrSep24-07; see also ood3-IraqGetsCostlierSep24-07).

The special security force now numbers about 5,000. They are trained in the use of new surveillance equipment, counter-measures and crisis management under a programme managed by LockheedMartin. The recruits are learning about laser security and satellite imaging from Lockheed on behalf of the Sandia National Laboratories' Defence Systems and Assessments Unit - a US government run unit in New Mexico. The kingdom is investing about $4-5 bn in the new equipment and the force. The force is to reach 35,000 within two or three years. Saudi Arabia has a 75,000-strong army, an air force of 18,000, a navy of 15,500 and an air defence force of 16,000. Its oil installations are also protected from within by 5,000 agents employed by Saudi Aramco.

Saudi Arabia is a leading member of the six-state Arab Gulf Co-operation Council (GCC). In late 2006, the GCC summit said would study the nuclear option. An official at the GCC secretariat in Riyadh was recently quoted as saying: "Domestic [energy] consumption in the...[GCC] is moving ahead and we need a plan to deal with that". The GCC secretariat recently met with an IAEA delegation and the official said: "The IAEA is drawing up a preliminary report, which will take into account demand for electricity and fresh water up until 2025. We will...consider how an oil and gas downturn could affect the region and where a nuclear capability would help us stand".

OPEC says a total of 336 oil rigs were in operation within its member-countries in 2006, up 11.5% from 2005. This rig count was the highest since the peak recorded by OPEC in 1982, when the crude oil price, measured today's value, was about $90/b. Saudi Arabia in 2006 drilled 382 new wells, the highest number for any year since 1980. The number of rigs in operation in the kingdom by end-2006 was around 120.

Saudi Aramco is trying to reach more extensively than ever into oil bearing formations through Extreme Reservoir Contact (ERC) wells. This entails a quantum leap in multi-lateral drilling. Other OPEC members have embarked on big capacity expansions, despite a rapid rise in project costs, to ensure adequate oil supplies. In the medium term, over 100 projects with costs of $130 bn are being undertaken by OPEC countries (excluding Iraq). These are in addition to all energy infrastructure projects, such as pipelines, export terminals and downstream expansion. As a result of these projects, OPEC's crude oil output capacity is to reach 39.7m b/d by 2010.

OPEC posted a record revenue of nearly $650 bn in 2006. However, in view of ongoing rhetoric in the market of finding alternatives to crude oil so as to lessen dependence on the Middle Eastern, Saudi Arabia and others are being forced to look at their expansion programmes closely once again. Capacity expansion is a very costly affair.

The Geo-Political Perspective: Since President Bush, in his 2002 State of the Union address, designated Iran, Saddam's Iraq and North Korea as an "Axis of Evil", Tehran has felt threatened. It intensified its military build-up, formulated alliances with Syria and groups having similar interests in the region, and accelerated its nuclear programme. At first, the GCC states saw these actions as part of legitimate defence. With the 2003 US invasion of Iraq, Iran felt more threatened and started to oppose Washington's agenda for freedom and democracy.

Iran and Syria now meddles in Lebanon, Iraq, and Palestine - posing a threat to peace in the area. This arouses the fears of the GCC leaders. The US-Iran standoff forced Saudi Arabia to play an active role to reduce tensions; it held a summit in Makkah so the various factions in Iraq could work out their differences. It sponsored the Makkah Agreement between Fatah and Hamas which ironed out their differences. But Iran and Syria helped Hamas take the Gaza Strip on June 14, 2007. Saudi Arabia worked hard to ease off disagreements between opposing parties in Lebanon by encouraging its leaders to resume a "National Dialogue", interrupted by Hizbullah's 2006 war with Israel.

Sunni-Shi'ite tensions have surfaced for the first time in many centuries. Iran and Syria are accused to helping al-Qaeda, a Neo-Salafi/Sunni network threatening all regimes in the Muslim world which are allied with the US. A fatwa by Saudi/Wahhabi scholar, Shaikh Saleh al-Fowzan, that liberals are not Muslims has inflamed debate over reforms in the kingdom, with liberals fearing they will be attacked. Responding to an online request for a fatwa, Fowzan recently said: "Calling oneself a liberal Muslim is a contradiction in terms...one should repent before God for such ideas in order to be a real Muslim". He said liberal meant "freedom which is not subject to the bounds of Shari'a". Fowzan was later forced to issue a clarification in al-Riyadh after Islamists hailed the fatwa as a declaration that liberals were infidels.

The Saudi authorities are holding more than 3,100 Neo-Salafi suspects, many linked to a campaign by al Qaeda launched in 2003 to overthrow the royal family. Riyadh has foiled at least two plots since 2006 to hit major oil facilities in the kingdom. Saudi Interior Minister Prince Nayef recently said of 9,000 suspected militants seized since 2003, 3,106 remain in detention.

Wahhabi scholar Salman al-Awdah recently issued his "open letter to Osama bin Laden" on his website (www.islamtoday.net) and read it out on a show he presented on Saudi-owned pan-Arab TV channel MBC. This was highlighted on Sept. 18 by Reuters, which noted that Western and Arab critics of Saudi Arabia's hardline Wahhabi religious establishment had often criticised the kingdom's senior scholars for having failed to unequivocally distance themselves from the mastermind of the 9/11 attacks in the US which killed 3,000 people. Awdah asks: "Brother Osama, how much blood has been spilt? How many innocents among children, elderly, the weak and women have been killed and made homeless in the name of al-Qaeda?" He said: "The ruin of an entire people, as is happening in Afghanistan and Iraq,...cannot make Muslims happy", attacking al-Qaeda's policy of revolt across the region. Awdah asks: "Who benefits from turning countries like Morocco, Algeria, Lebanon or Saudi Arabia into places where fear spreads and no one can feel safe?" Awdah said al-Qaeda's actions had led Western governments to rein in Muslim charity work around the world and Arab governments to jail thousands.

The letter came just days after a threat from Saudi-born bin Laden - said to be hiding in a frontier area between Pakistan and Afghanistan - to mark the sixth anniversary of 9/11. Bin Laden used to single out Awdah as an independent scholar worthy of respect; but Awdah - jailed in the 1990s for criticising the US-allied Saudi royals over corruption and pro-West foreign policy - has since toned down his rhetoric.

Reuters quoted a "Riyadh-based diplomat who follows Islamic affairs" as saying this lessened the impact of Awdah's words. In an article in the pan-Arab Saudi daily asharq al-Awsat of Sept. 17, Saudi commentator Tareq al-Homayed said the letter was six years too late. Addressing Audah, he wrote: "Why now, oh Shaikh?... He is distancing himself from bin Laden at a time when those who do so have nothing to lose and no price to pay". Awdah was one of 26 Saudi scholars who called resistance to US forces in Iraq "jihad" during the US siege of Falluja in late 2004.