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Saudi Arabia
Crude Oil Production and Pricing Policy
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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