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SAUDI ARABIA - The Oil Market Perspective.

World crude oil prices will rise sharply in the event of a cold winter in the northern hemisphere. As with its gasoline market in the driving season, the US will be the main factor for world crude oil prices during winter. No longer a major factor is OPEC's position, despite the group's Sept. 20 offer of 2m b/d extra output made at the end of its ministerial meeting in Vienna. OPEC said its 2m b/d production increase for three months will begin on Oct. 1; but offering its entire spare capacity does not help as the market is glutted with heavy/sour crude oils and urgently needs distillates and gasoline - especially in the US. OPEC is no longer relevant to rising oil prices, pushed up by hurricanes on the US Gulf Coast - accounting for a major part of American oil and gas output.

As Hurricane Rita approached the Gulf Coast, Venezuela's populist President Hugo Chavez offered to bring low-cost fuels to the poor of the US, including Indian tribal communities. Venezuela decided to ship an extra 1m barrels of gasoline to the US, with the first shipment of 240,000 barrels of Venezuelan gasoline to arrive in the US by Sept. 25. The Chavez regime's fully-owned US unit CITGO was to distribuite the fuel immediately.

Venezuelan Ambassador to the US, Bernardo Alvarez Herrera, said: "As a Hemispheric neighbor and business partner, we are pleased that we are able to provide immediate relief by increasing gasoline supplies available in the United States in the aftermath of this devastating natural disaster. We are sending additional barrels of gasoline that otherwise would have gone elsewhere, and we will continue to do whatever we can to help alleviate energy shortages and the dislocations faced by the people of the United States as a result of Hurricane Katrina".

Three other 240,000-barrel shipments will arrive at regular intervals on the heels of this first shipment. The entire 1m-barrel allocation will be in the US distribution system no later than Oct. 31.

(PDVSA is the fifth largest provider of petroleum products in the world and the third largest provider to the US. During the last year, Venezuela has at times been the largest supplier of oil to the US, surpassing Saudi Arabia, Canada and Mexico. It exports 95% of its hydrocarbons, 57% of which are earmarked for the US. PDVSA'S oil refining capacity worldwide is 3.3m b/d).

Robert Free Galvan, who was contacting Indian tribes in the US with Venezuela's offer, was on Sept. 21 quoted as saying: "There is an offer on the table for low-cost heating oil and gasoline for poor communities... Hopefully, Indian tribes and Native entities will take advantage of this opportunity to become stronger..." Galvan's comments came after he attended the 16th World Festival of Students and Youth in Caracas on Aug. 7-15, attended by 40,000 people. He said: "I was amazed at 12-cent-a-gallon gas[oline]". Galvan said he fell in love with the beauty of the green mountains and blue ocean waters in Venezuela.

Whether this was an act of charity or otherwise, the fact remains that Chavez has been scared of "a US conspiracy to invade Venezuela". He sent hundreds of thousands of barrels of oil to the region hit by Hurricane Katrina. CITGO has eight refineries in the US, and has set aside up to 10% of its refined oil products to be sold directly to organised poor communities and institutions in the US without intermediaries. Galvan said Chavez and his revolution for indigenous rights gained the respect of people at the world gathering in Caracas. Calvan said the US government was "very racist", adding: "Chavez is indigenous and part black, and is in control of one of the world's largest oil reserves".

Galvan said he decided to attend the Caracas event after hearing of the movement for "fair trade", as opposed to "free trade", which is igniting the indigenous rights movement in Bolivia, Ecuador and Peru, where the majority of the population is indigenous. The economic alliance promotes fair trade as an alternative to the World Trade Organisation, North American Free Trade Agreement or Central American Free Trade Agreement. Galvan said: "These trade agreements seem to favor the rich and powerful corporations. Chavez has spent billions of US oil dollars on education, feeding and housing the people of his country in order to rebuild the situation in his government which was inherited from the previous government that had channeled much of the country's resources into a few hands".

On supply concerns as Hurricane Rita threatened oil production in the Gulf of Mexico, WTI on Sept. 19 rose $4.39 to $67.39/b. But it fell later and the week on Sept. 23 closed at $64.19, down $2.31 from the Sept. 22 level, and spot WTI settled at $64.09. At the IPE Brent closed at 62.44, down $2.6 from the Sept. 22 level, and Dated Brent fell to $61.55. Front-month WTI hit a record high of $70.85 on Aug. 30, when Hurricane Katrina hit the Gulf Coast. At the IPE November Brent on Sept. 19 rose $3.80 to $65.61. Prices fell after OPEC's Sept. 20 offer but rose again on storm fears as the National Hurricane Centre warned that Rita was likely to become a major hurricane. But WTI and Brent fell later as Rita weakened.

Spot LNG in the US rose above $14/m BTU, with the price of natural gas at NYMEX on Sept. 23 closing at $12.32/m BTU, while the Henry Hub spot price closed at $14.50/m BTU. The New York City Gate price of gas then closed at $15.15/m BTU. LNG plant problems in Trinidad, Australia, Nigeria and Egypt meant 22-24 cargoes had been lost in August-September, equivalent to nearly 1.6m tons of LNG. Japanese utilities were willing to pay $13/m BTU, about double the price they paid for cargoes in July as they looked to replace Australian LNG. Japan had nuclear problems and hydro-power was down. Burning gas at $13/m BTU in an efficient Japanese power plant was seen better than oil

OPEC's oil ministers agreed to lift all restrictions on output and exports for the next three months, a move designed to reassure edgy markets about the security of energy supplies. But OPEC cannot rein in prices, which have doubled since the beginning of 2004. Saudi Arabia rallied OPEC members to support its effort to sell as much oil as consumers asked for, saying too-high prices could eventually hurt demand. The group's Sept. 20 decision effectively freezes OPEC's two-decade quota system, originally designed to prevent prices from dropping too low.

Because of shortages in US refining capacity, Saudi Oil Minister Ali al-Naimi admitted there might be few takers, but said: "OPEC went out of its way and offered all the spare capacity...recognising that maybe there is no demand, but offering it so that consumers can feel comfortable that the supply is there". He said OPEC's extra oil would be made available immediately at existing commercial conditions. Asked whether Saudi Arabia would lower its prices to bring more oil on the market, Naimi said there would be no discounts, adding: "I don't want to bring it unless the consumers want it. If the people don't want the crude, it is better for it to stay underground".

The US is the third of three wild cards on the oil market, the other two being China and OPEC. There are at least four areas where oil-importing nations can dampen the effects of a rise in oil prices, but the US has fallen short in anticipating all four:

US oil firms want to make money with refineries. They did not want to get excess capacity by over-investing - having lost in refining for many years, as has been the case with European and Asian refiners. The problem is twofold: US refiners' lack of capacity to handle the extra load, as well as technical problems with the types of heavy/sour crudes produced in much of the Middle East. US firms are expected to rectify these shortcomings, but it will take years. Supplies of refined product are so tight that the US is importing gasoline, not just crude oil, from Canada and Europe.

In the 1970s energy crisis, which included an Arab oil embargo, Congress got tough with actions which included creation of the SPR, minimum gasoline-mileage requirements for cars and trucks (CAFE standards), and "double nickel" (55 mile-per-hour) speed limits. By comparison, this Congress and President George W. Bush took less decisive measures. They have subsidised alternative energy and passed an energy bill this year. The White House has proposed raising CAFE standards slightly. But it was too little, too late to head off the price spike. Both branches of the federal government could become more active if prices keep moving up.

The Big Three US automakers - General Motors, Ford, and DaimlerChrysler - have made the bulk of their profits in recent years with not fuel-efficient trucks and SUVs. Often technical improvements to engines, which could have been used to boost gasoline mileage, went instead to increase horsepower and speed. There were exceptions to the trend, especially among Japanese automakers Toyota and Honda. Both developed hybrid-model cars (the most popular of which is the Toyota Prius) which combine gasoline and electric engines to increase mileage into the 47-to-66 miles/gallon range. Detroit is stepping up efforts to get hybrids on the road, including the Ford Escape SUV hybrid, which is popular. But if prices for fuel stay high, Detroit will have once again come in second in an important new market which Japan managed to exploit.

Government and private officials did not foresee the current oil squeeze. They did not promote policies for new refineries, training of more E&P experts, and a reversal of a recent fall in the fuel mileage of US car and truck fleets. In the 1980s, when E&P in the US went into sharp decline, about 1m people, many with valuable knowledge, were let go by the industry. Even now, Americans seeking advanced degrees in skills valuable to this industry are few and far between. With specialists in demand in US oilfields, some majors are having trouble getting geologists and petroleum engineers.

The most crucial factor affecting US gasoline is the price of crude oil. OPEC is doing little to meet rising demand. In 1975, OPEC could produce 30m b/d. Now it has the capacity to produce less than 31m b/d for a sustainable period. There is a risk in this tight market strategy by OPEC. In the second oil crisis in 1980, when gasoline shortages rippled across the US, prices went up swiftly. As a result, many firms and individuals sought other sources of energy, such as natural gas and coal. Eventually, OPEC lost crude oil sales of 10m b/d, because prices went too high. OPEC officials insist that current prices are too high and worry about an oil glut next spring. "That's the period we have to watch", warns Dr. Edmund Daukoru, Nigeria's state minister

for petroleum who will become OPEC president for one year from Jan. 1, 2006.

China has suffered from lack of electricity because of a slowdown in construction of power plants during its fiscal crisis of 1998-02. When China's economy took off again in 2003-04, brownouts and blackouts hit the nation. To keep factories going at full speed, firms installed diesel generators, which helped boost oil use by 16% in 2004. Those effects still linger. China accounted for 40% of the growth in world energy demand from 2000 to 2004, according to Cambridge Energy Research Associates (CERA). If that continues, it will have a "heavy long-term impact" on prices, says a CERA report.

In a report this summer, CERA predicted oil production will rise in and out of OPEC at least through 2010. If so, that will be good news for the world's economies - and for the SUV drivers. But the head of the IMF, Rodrigo Rato, on Sept. 22 warned that soaring oil prices were posing a major threat to the global economy.

Rato was speaking as the cost of crude oil approached record levels on fears Hurricane Rita would ravage damaged refineries on the Gulf Coast. Unrest in Nigeria on Sept. 24 threatened the supply of much needed light/sweet crude. Rato said: "We now see that price rises in 2005 are no longer related to a rise in demand but...supply constraints and...refining capacity. That is worrisome regarding the future of world growth, and policymakers and central bankers and monetary regulators will have to take it into account".

In its World Economic Outlook, the IMF says: "Based on current investment plans, [oil] production capacity is unlikely to grow enough to outpace future growth in consumption and create adequate spare capacity". Published on Sept. 21, it now expects oil prices to average $54.23/b in 2005, not $46.50 as previously forecast, and $61.75 in 2006 instead of $43.75.

The IMF says the situation is unlikely to improve in the next five years, although OPEC has begun to boost investment. It chastises oil firms for being too conservative when deciding whether or not to invest in new refining or E&P. Most oil majors say they only invest in projects which would be profitable if prices fell to $20-$25/b.

At the end of its ministerial meeting in Vienna on Sept. 20, OPEC announced plans to add about 4m b/d of oil refining capacity in member-countries and abroad. If such plans come to fruition, the US, Europe and Asia will increasingly look to the Middle East not only for supplies of crude but also for gasoline, diesel and other fiels.

OPEC's current President and Kuwait's Energy Minister Shaikh Ahmad al-Fahd al-Sabah told reporters: "In the downstream we're doing more than is our responsibility. We're doing our homework very well. There are 10 [OPEC] members building new refineries. This is an integrated approach". OPEC was stepping in where big oil firms were reluctant to tread. Among OPEC plants on the drawing board is a 200,000-250,000 b/d Kuwait-backed refining project in the US and new ones in Qatar and Saudi Arabia. Shaikh Ahmad urged Western states to do more to encourage construction of refineries.

National Geographic's cover story last month examined how the world might survive "After Oil". The Economist magazine asks, "Is the age of oil drawing to a close?" With the discomfort growing, consumers are considering fuel-efficient cars. Industry has become more serious in its search for alternatives. New efforts are focused on wind, solar, nuclear, and even old, reliable coal (in a cleaner version) for the future. But is the world really running out of oil? The short answer is no.

Earth is swimming in oil. What has changed is that the era of cheap oil - a period which has lasted 150 years. Only a dramatic breakthrough - either in technology or consumption patterns - can forestall its conclusion in a decade or two. If it happens, the end of cheap oil would have a profound effect: stunting world economic growth, constraining China's rise, and challenging Western lifestyles.

The Christian Science Monitor on Sept. 20 quoted an "analyst close to the oil industry who asked not to be named", as saying: "The US has 2% of the world's proven oil reserves. But it burns 25% of the world's transportation fuels. This isn't going to work out in the long run". The problem is not apparent from a supply viewpoint.

When the world's first oil well was sunk in Pennsylvania in 1859, the Earth contained at least 6 trillion barrels of oil. So far, we have used only about 1 trillion barrels. Part of the worry has to do with access.

Of the original 6 trillion to 8 trillion barrels in place, the industry is capable of extracting only about 3-4 trillion barrels. A lot of oil is locked in difficult underground formations which are hard, if not impossible, to exploit using current technology. Those first 1 trillion barrels were among the easiest to reach.

Where underground formations are highly favourable, as in the Gulf of Mexico and Saudi Arabia, oil drillers can often retrieve 60% of the oil. But in marginal formations such as some found in Oklahoma, the average rate of recovery can be as low as 8 to 10%. Worldwide, the average is about 35-40%, according to the EIA. Only 2-3 trillion barrels may remain for use.

It took 146 years for the world to use the first 1 trillion barrels. The next trillion barrels will be gone by around 2030. After that, as little as 1 trillion or 2 trillion barrels of conventional oil will be left. Some experts who follow these issues closely are getting worried. One big change, particularly in the past two years, has been increasing international competition for oil supplies.

During most of the past century, it was mainly the US, Japan, and Europe which vied for the world's petroleum supplies. Now other nations like China and India are developing their own needs for oil to fuel their factories and their rapidly expanding fleets of automobiles, trucks, and airplanes. That will set off a scramble for world oil reserves.

While the nations with the largest reserves, mostly in the Middle East, have periodically offered to increase production, there is concern that they have showed few signs of boosting their output capacity.

Even industry leaders do not always see eye to eye. There is no impending worldwide supply crisis, according to Rex Tillerson, president of ExxonMobil, the world's largest company. Oil and natural gas "are likely to remain the primary energy source through the middle of the century", he said in a speech this year. A recent ExxonMobil study of world energy resources found that oil should remain plentiful and affordable at least through 2030, which was the time limit of the report.

Rising world demand will be met primarily by increased production in the Middle East, the study concludes. We already face "a new energy equation", counters David O'Reilly, CEO of Chevron.

Three factors are squeezing oil supplies - globalisation, economic growth, and falling oil output in several nations, including the US. "Oil is no longer in plentiful supply", O'Reilly said in a speech this year. "The time when we could count on cheap oil and even cheaper natural gas is clearly ending".

When it finally comes, the end of cheap petroleum would be felt nowhere more keenly than in the US, a nation built on low-cost, plentiful energy, and cheap oil in particular. Long, leisurely Sunday drives and Saturday night cruising down Main Street in hot rods with 25-cent-a-gallon gasoline were traditions fused into the American psyche in the era after World War II. Today's suburban American lifestyle - built around long commutes to work and large, energy-hungry houses - assumes that low-cost fuel will be available indefinitely. But this now seems to be coming to an end.

US output of crude oil and gas liquids hit a peak of 11.3m b/d in 1970. Then the slide began. By 2004, US production had slumped to just 7.2m b/d, even though US consumption had climbed to more than 20m b/d. Nor is domestic production likely to spike up on new find. Some 80% of all the wells ever drilled in the world have been in the US. Because of all this, the US is now dangerously dependent on other nations for its fuels.

In its February 1920 issue the National Geographic Magazine wondered in an article by George Otis Smith, the director of the US Geological Survey: "Where will our Children Get It When American Wells Cease to Flow?" By then, only 60 years after the world's first oil well came on stream at Titusville, Pennsylvania, the magazine estimated: "we have already reached the point where we are consuming more oil than we produce". Of course, technology and oil discoveries enabled the US to continue producing at far greater levels for several decades more.

Nevertheless, that old article shows that there is nothing new about the concern regarding depletion of a commodity on which the industrialised world, and rapidly developing great powers such as China and India, are so heavily dependent.

With WTI on Aug. 30 having peaked at $70.85/b, a record high even though not the highest in real terms after inflation, politicians and industry analysts are asking whether the world itself has reached a similar tipping point - the point at which consumption starts exceeding production and prices rise inexorably. French Prime Minister Dominique de Villepin is one of those who believe we have reached such a point. The time has come to prepare for the "post-oil era", he said in a recent radio interview, adding: "We must all incorporate this change in our behaviour and reduce consumption". Venezuelan President Hugo Chavez has put it more bluntly: "The world should forget about cheap oil".

There is, according to Swedish scientist Kjedll Aleklett, a major difference between the current oil crisis and the earlier oil shocks. There was a political reason for them - war, revolution - but today the crisis is caused by a combination of unprecedented demand, a shortage of refining capacity and the fear of strategic shortages to come. AFP on Sept. 20 quoted Aleklett as saying: "We are at the top of a bell curve marking the transition point when consumption gradually starts to outstrip supply. And the ride will be quite bumpy".

Aleklett is president of the Association for the Study of Peak Oil and Gas (ASPO), a network of scientists interested in determining the date and impact of the peak and decline of the world's production of oil and gas due to resource constraints. The top of the bell curve is named after US geophysicist M. King Hubbert, who predicted in a paper to a 1956 meeting of the American Petroleum Institute (API) that oil production in the continental US would peak between 1965 and 1970 and that world production would peak around now.

US production peaked in 1971. Until now, many oil analysts have argued that advances in technology enabling more oil to be pumped out of old wells and new oil finds will delay the oil peak for some time to come.

Hurricanes have demonstrated that there is little or no margin in today's energy markets. Any disruption of the market immediately causes steep price rises. Aleklett said: "Crude oil availability is one thing. Another is quality". Brent, the benchmark light/sweet crude oil produced in the North Sea, is headed for depletion much faster than reserves low in gravity and high in sulphur which are more difficult to refine and tougher on the environment.

A study by Barclays Capital investment bank indicates that the output fall in the British North Sea has been sharper than anywhere else in the world. Britain is pumping 1m b/d less than it did in 1999, and OPEC has stepped up production to make up the difference. The study adds: "This is why (British) Chancellor of the Exchequer Gordon Grown has stirred some astonishment among OPEC producers in accusing them of being responsible for the increase in the price of crude and demanding that they increase their production".

To Aleklett, it would be folly to think there are big oil deposits awaiting discovery. He said improvements in technology and finds were no more than a stopgap, at most delaying the impact of the Hubbert Peak. He pointed to the relatively recent oil find in Kazakhstan. "With 10 bn barrels of reserves, it will supply world oil needs for four months at current rates of consumption", he said.

Americans may be reeling from the realisation that it now costs more than US$100 (80) to tank up their SUVs, but the conservation message has yet to strike home. Europe has been living with much higher motor fuel prices for a long time, and this has not curbed the passion for ever more powerful and big four-wheel drive vehicles.

German Environment Minister Juergen Trittin recently slammed his country's auto industry for turning out "big fuel guzzlers".

One in every seven cars sold in London is a so-called Chelsea Tractor, and in Paris a mysterious gang called the degonfleurs (deflators) has been going around the posher districts letting the air out of the tires of big SUVs in an attempt to discourage the popularity of the gas guzzlers.

The Political Perspective For Saudis & The Neo-Wahhabi Factor: Many things have changed around the world since 9/11, when 19 hijackers including 15 Saudis destroyed the World Trade Centre in New York and hit the Pentagon in Washington. The US response has been a world war being fought in ways different from previous conflicts. The war will lead to a change in the political map of the Muslim World, with Iraq now having become a central front against global terrorism, and will affect Saudi Arabia (see this week's APS Diplomat in news13cAfghanSep26-05 and ood3bbIraqWarSep26-05).

The problem for the kingdom is that Osama Bin Laden - Enemy No. 1 to the US and who has vowed to topple the Saudi royal family - became a hero to Saudis soon after his videotaped message was broad-cast late on Oct. 7, 2001 by al-Jazeera (see background in Vol. 61, No. 13 - and in this week's Diplomat Package: news13cAfghanSep26-05 and rim3bbIraqWarSep26-05).

King Fahd died on Aug. 1 and was succeeded smoothly by his half-brother Abdullah, with his powerful full-brother Sultan now being the crown prince and first deputy prime minister. Abdullah is yet to appoint a second deputy PM - with the candidate, powerful Interior Minister Prince Nayef being another full-brother of Fahd and Sultan. But the presence at the top of Foreign Minister Prince Saud al-Faisal is a reassuring sign as he has been a long-standing aide to Abdullah.

In a lecture on "Saudi Arabia and the International Oil Market" at the Baker Institute on Sept. 22, Prince Saud blamed high oil prices on lack of refineries and growing consumption, warning: "The current world energy crisis has become very dangerous and it cannot be left to the market laws of supply and demand. It has to be promptly tackled".

The current crisis, he said, has different aspects: Production, consumption and political aspects, adding: "Shortage of crude oil supply in the world market is not one of its reasons. Producers and consumers should engage in discussions to evaluate the situation and work on developing the fuel industry in all sectors".

The lecture was at Rice University in Houston, parts of which were in the process of evacuating ahead of Hurricane Rita. Prince Saud said Saudi Arabia was a willing and eager partner with potential investors interested in building new refining capacity, particularly in the US.

Prince Saud said: "The consumers are clamouring for more fuel, which cannot be supplied due to a lack of refining capacity. We are in the process of establishing two new refineries with capacity of 800,000 b/d [of crude oil processing] in Saudi Arabia. We invite all investors to join with us to build additional refineries and expand existing ones".

Motiva Enterprises, a US JV of Shell Oil and Saudi Refining, on Sept. 22 said it was considering options to boost capacity. It said it was looking at ways to increase production of fuels at its network of refineries in the US Gulf Coast. Projects under consideration include those that would yield 100,000 to 325,000 b/d, the company said. Motiva's refineries are in Port Arthur, Texas, and Convent and Norco in Louisiana.

"We are ready to join in any efforts in building facilities in the US", Prince Saud said, stressing that additional oil production will do little to quell prices unless refined product bottlenecks were resolved. He said Saudi Arabia was the only country in the world currently with a spare oil production capacity of 1.5-2m b/d. He emphasised the kingdom's efforts towards meeting world oil needs, saying: "We have raised average production by 700,000 b/d since the start of the year..."

Prince Saud pointed out: "The basic problem of the current energy crisis...is that the...refineries are incapable of meeting demand... There is shortage of storage capacity and restrictions have been imposed on the oil industry, preventing it from building more refineries.

"Not a single refinery was built in the United States in the last three decades, while the difference in standard requirements on oil products from one [US] state to the other...particularly due to environmental concerns...greatly worsened the energy crisis".

Prince Saud added: "Quick measures should be taken to deal with all related problems and unify production standards of [US] refineries". He referred to a proposal made by King Abdullah to set up a secretariat for the World Energy Forum in Riyadh to protect the interests of both producers and consumers.

Prince Saud emphasised the need for finding a just and lasting solution to the Arab-Israeli conflict to reinforce peace and stability in the Middle East and ensure stable oil supply and prices.

The Saudi foreign minister reaffirmed the Arabs' desire to have peaceful co-existence with Israel, saying the Arab peace plan initiated by Abdullah when he was crown prince and endorsed by the Beirut summit conference in late March 2002 offered normal relations with the Jewish state in lieu of its total withdrawal from the occupied Arab territories.
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Publication:APS Review Oil Market Trends
Date:Sep 26, 2005
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Previous Article:SAUDI ARABIA - Part 1 - The Prospects & Geology.
Next Article:SAUDI ARABIA - Part 2 - The Oil Production Profile & Fields.


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