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The Saudi way

By ring-fencing its oil sector from royal influence, Saudi Arabia has minted a successful template for resource-rich NOCs, writes James Gavin

SAUDI Arabia's King Abdullah bin Abdulaziz made a rare intervention into the kingdom's oil policy during the summer, ordering a halt to oil exploration to save hydrocarbon wealth for future generations.

Saudi Arabia is pumping around 8.3m barrels a day (b/d), but has expanded its headline production capacity to near 12.5m b/d over the past five years. When rampant global crude demand was pushing prices to stratospheric levels in 2008, the kingdom attempted to reassure consumers that it could – if need be – expand its capacity still further, to as much as 15m b/d.

The global recession and retreat in oil prices from mid-2008 put paid to that ambition. Yet King Abdullah's public pronouncement on 5 July about the need for careful stewardship of Saudi Arabia's most critical resource was interpreted in some quarters as an unexpected shift in policy and a signal to the national oil company (NOC), Saudi Aramco, to rein in its drilling rigs.

Such a move would be out of kilter with Saudi policymaking in its most critical economic sector. More likely, the king was giving voice to a broad consensus among the Saudi elite that the kingdom's production capacity is now at a level that is comfortable for both the country and its customers, granting a substantial spare-capacity cushion in excess of 4m b/d. Unlike many other resource-rich economies, Saudi Arabia has for the past four decades managed to achieve a rare unity of purpose about how its massive oil reserves, estimated at 265bn barrels, should be managed (see Figure 1).

The ruling family and the NOC are not in conflict about the core principles of Saudi oil strategy: to maintain stability of supply and support an oil price that allows the kingdom to sustain domestic economic harmony and underpin its regional influence. "When the King says we'll stop at 12.5m b/d, that is not in conflict with what the oil minister and Saudi Aramco chief executive are already saying," says David Kirsch, director of PFC Energy's Market Intelligence Service. "They have already said that they don't see demand growth out there."

This consensus reflects a broader understanding about the roles of the NOC and of politicians in Saudi Arabia. Compared with Mexico's state-owned Pemex, plundered as a cash cow to service state spending requirements; or Venezuela's PdV, an overt instrument of President Hugo Chavez's political designs; or even – closer to home – Kuwait Petroleum Corporation (KPC), an example of how even the best-endowed Middle East hydrocarbons producers can struggle to deploy their resources effectively, Saudi Aramco has set the bar high.

It is known to be a company where operations are ring-fenced from political influence, amid a strict division between the day-to-day running by company technocrats and strategic decision making, which is the preserve of the petroleum and mineral resources ministry. And the ring-fencing goes beyond the demarcation between NOC and oil ministry – the Al-Sauds have ensured that the oil ministry is also kept out of the hands of princes.

The long-term incumbent at the oil ministry, Ali al-Naimi, a former Aramco chief executive, is, like his predecessors, a commoner rather than of royal lineage. There are only two princes at senior positions within the ministry: deputy oil ministers Prince Abdulaziz Bin Salman and Prince Faisal Bin Turki.

The Saudi leadership's long-held view is that allowing members of the royal family to be involved in decision making on hydrocarbons could fatally compromise the country's critical economic sector and create factional tensions within the ruling family. The Saudis have also traditionally kept the main economic roles – the finance minister and the head of central bank – for commoners.

There are two reasons behind this, says Kirsch. First, it enables them to avoid the management problems, political interference and weaker business practices that have plagued other NOCs. "Look at Kuwait and what is happening with KPC – that is a cautionary tale for the rest of the Mideast Gulf about how not to run your oil sector," says Kirsch.

Second, he adds, because oil is so critical to the Saudi economy, and because the resource base is so large, having a commoner there is also an "insurance policy" in case something goes wrong. "You can fire a commoner," he says, "it's more difficult to get rid of a royal."

This strategy has yielded material reward over the past four decades. Steffen Hertog, author of a new book on Saudi Arabia, Princes, Brokers, and Bureaucrats, says that the organisation of the Saudi oil sector today is very different from – and more efficient than – that of most other oil exporters in the developing world.

Whereas other NOCs are politicised, bureaucratic or shells for employing foreign partners, Aramco belongs to a smaller group of NOCs that have proved themselves technologically capable, well-managed and run along economic grounds. Aramco, he argues, has been more consistently insulated from political pressures than any other Opec NOC. This has enabled it to operate as it did before nationalisation in the 1970s, with Aramco largely preserving the managerial structure of the pre-nationalised company.

Efforts to shield it from the rest of the Saudi state have also allowed Aramco to attract the best local talent, serving as the important career vehicle for ambitious young Saudis. This has helped it gain a formidable reputation as a project manager – manifest in the rapid increase in its output capacity from 11m b/d to 12.5m b/d in the past five years.

In the past year alone, it has brought on stream large new projects such as the 1.2m b/d Khurais field, the 100,000 b/d Nuayyim field and the Shaybah field's expansion to 0.5m b/d. It used the economic downturn to stagger and delay expansion projects where necessary, saving billions of dollars as labour, materials, and engineering, procurement and construction costs fell.

Aramco is not the complete master of its destiny. There are formal institutions through which Saudi royals are able to influence decision making in the oil and gas sector. The Supreme Petroleum Council (SPC), chaired by King Abdullah, retains the final say in Saudi hydrocarbon strategy. The SPC sanctions Aramco's five-year plan and capital investments, and approves the senior leadership of the company.

Nonetheless, the Saudi modus vivendi – the ruling family framing the broad policy, technocrats taking operational decisions – is set in stone. This insulation of vital economic sectors has another benefit, in helping to defuse wider succession issues.

Succession is a live issue in an hereditary monarchy where the leadership is made up of a handful of elderly men. King Abdullah is in his 80s and his likely successor, the conservative interior minister Prince Nayef, is also reputed to be an octogenarian. Other senior members of the Al-Saud elite make up a virtual gerontocracy and some important figures are reported to be in poor health: both Crown Prince Sultan, the powerful defence minister, and Riyadh governor Prince Salman have both been hospitalised recently.

Speculation: a popular sport

Speculation about which faction of the leadership is poised to take over from King Abdullah remains a popular sport (see box). Yet concerns about the succession have been blunted in recent years. The king, who himself appears in rude health, has forged a wider consensus about the future direction of the kingdom. And that is why, despite the inevitable gossip over the succession, economic and oil sector planners appear confident of long-term stability.

Although there is debate over how various policies should be pursued, the overall strategic framework has been set, and personalities are less important. "Now, more than ever, there isn't a big succession issue. You will get a different flavour with a new king, but as opposed to the mid-1990s, when there was heated debate about where the kingdom was headed, now, they are agreed on future economic trends," says PFC's Kirsch.

Yet tensions could still arise as the leadership faces up to new energy challenges. Al-Saud rule, stretching back 80 years, is grounded in a social compact with the population, vesting substantial power in the hands of a dynastic lineage in return for a consensual form of government that ensures the oil bounty is spread as widely as possible. And king Abdullah has revived that compact under his watch.

In the late 1990s, the regime came in for unprecedented criticism over Al-Saud princes' accumulation of personal wealth, at a time when low oil prices were pushing the Saudi state into debt, the economy was stagnating and ministries were struggling to pay bills. Many ordinary Saudis suffered genuine hardship.

Since Abdullah became king in 2005, his focus on investment in services and improving transparency has strengthened the credibility of the Saudi state in the eyes of the public.

Yet Abdullah and his successor will also have to confront some tough decisions that threaten that consensus – one is over how the kingdom should develop its natural gas sector. A heavily subsidised domestic gas price, capped at $0.75/m British thermal units (Btu), has discouraged exploration and production investment, leaving industries and power stations starved of feedstock. But removing subsidies, leading to higher electricity prices, would prove controversial among the wider Saudi public.

A balancing act

"They understand that they are playing a balancing act," says Kirsch. "To take the example of gas, they would argue that $0.75/m Btu is not a sustainable price, but at the same time they realise the landed price of liquefied natural gas in Tokyo (averaging over $9/m Btu in 2009) is not a benchmark for Saudi customers."

The mediation of social and political tensions has been King Abdullah's task since he took effective control as Crown Prince in 1995. Indeed, he has tried to bolster the effectiveness of the Saudi state in translating petroleum revenue into improving public services, such as a reformed school curriculum or universities in neglected provincial regions.

His focus on technocratic competence has helped lay the foundations for Saudi Aramco to reassert its influence as the world's most important oil company. With financial discipline, his government has moved from boom-bust oil economics to long-term strategic budgeting. The debt-racked country of the turn of the century has morphed into the Middle East's economic powerhouse and a valued member of the G20 group of industrialised nations.

The primary challenge facing future generations of Al-Sauds is to ensure the kingdom's hydrocarbons resources continue to be stewarded so effectively.

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