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Saudi Arabia gets tough on prices

With both Opec and the US Energy Information Administration (EIA) forecasting a steep fall in oil demand in 2009, Saudi Arabia is cajoling its fellow Opec producers to stick to their quotas. The kingdom has threatened to make large unilateral cuts in output if others fail to live up to their word

The EIA has revised downwards its demand forecast for the year by a further 350,000 barrels a day (b/d) to 0.8m b/d compared with a previous prediction of a 450,000 b/d fall. Opec's January monthly oil-market report projects demand for crude will fall by 180,000 b/d, following the 100,000 b/d decline seen in 2008.

In mid-January, it was rumoured that the kingdom was cutting term allocations to Asian buyers for February cargoes, beyond what was required by its Opec commitments. Industry sources said Saudi Arabia was preparing to cut output by 300,000 b/d below its Opec target, as it became clear a lack of discipline within the cartel on production quotas was contributing to the continued price weakness.

The steep fall in prices seen in the last quarter of 2008 continues, despite Opec's decision to reduce its production by 4.2m b/d from its official September 2008 level, to a targeted 24.85m b/d for January 2009. Crude oil for February delivery on the New York Mercantile Exchange traded at $37.57 a barrel on 15 January, representing a decline of nearly 25% from the previous week. Whatever Opec was doing, it was not working.

As a result, the country has hinted that it may reduce their February loadings by up to 15%, claim some Asian refiners – which might involve the kingdom cutting its output beyond its Opec obligation.

Opec's January Oil Market Report report shows that the organisation's production fell by 0.83m b/d in December (see Figure 1), but a further 2.2m b/d of cuts were due in January. So far, there has been little evidence that such cuts are being made; Nigeria, Iran and Venezuela are thought to be the main overproducers.

However, this seems unlikely: there is, as yet, no evidence that Saudi Arabia is planning to become a more aggressive swing producer. According to Leo Drollas, chief economist at the Centre for Global Energy Studies, the markets may have misread the numbers. He points out that in mid-January, Saudi supply was estimated to be in the range of 8.3m b/d. "The accepted version is to pro-rate the reduction on the September figures published by Opec itself, which would give Saudi Arabia a quota of 8.05m b/d. That's not far off where they are now," he says.

Rather than going it alone, Saudi Arabia appeared to be sending out a message to its Opec partners, says Adam Sieminski, an energy analyst at Deutsche Bank. "They're saying that if Iran, Nigeria and Venezuela come in with acceptable levels of their own reductions, then they themselves might be willing to do a little bit more."

The evidence suggests that these countries are belatedly starting to make good on the promises made in Oran, Algeria, in December. "By December they hadn't done much, but we are hearing that they are getting their act together," said Drollas. "That always happens in Opec – they do nothing at first and then as the price drops you get the action."

For Saudi Arabia, the Opec cuts raise the prospect of substantial spare production capacity by the end of 2009, when the kingdom is due to reach 12.5m b/d through a series of planned expansions. King Abdullah confirmed in December that the country views $75 a barrel as its ideal oil price and that it is prepared to do everything in its power to reverse the slide in oil prices – even, if necessary, delaying the onset of new production, as it has with the Manifah heavy-oilfield development, which was to have added 0.9m b/d by 2011.

Given that Saudi production reached 9.7m b/d in mid-2008, it has already proved capable of reducing output by nearly 1.5m b/d. But the start-up of the Khurais field, due on stream in mid-2009, is reported to be on schedule, which will add 1.2m b/d of new capacity. Project delays have affected the Khursaniyah field, but this is significantly smaller, at 0.5m b/d.

Saudi Arabia has shown it is ready to be hawkish on prices and will pull its weight inside Opec to ensure quota discipline. The danger is that this policy could place additional strains on its own long-term investment plans. These now seems out of kilter with a near-term policy requirement to shore up prices at all costs.

Saudi Aramco can sit on Khurais and other new supply increments for a while longer, but Saudi strategists may now be ruing their decision of three years ago to prioritise field expansions to meet forecast global demand that has now all but evaporated.

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