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Saudi Arabia remains the supply-side optimist

New upstream developments and a transition away from crude-dependent power generation are essential if the kingdom is to maintain its oil-export strategy

Brazil's ultra-deep waters, Canada’s oil sands, North America’s tight oil and Iraq’s mega-projects: if the world is to avoid an oil-supply crunch, runs the prevailing narrative, these are the regions to watch. More important, though, remains Saudi Arabia, where projects under way now – from tricky offshore gas to ambitious plans for diversification in power generation – will decide whether the world’s biggest producer and exporter can avoid falling into a trap of rapidly rising energy consumption and fast-disappearing export capacity. The kingdom’s liquids output averaged 11.1 million barrels a day (b/d) last year (9.3m b/d excluding natural gas liquids). This year, Saudi crude-oil production has hovered around 10m b/d, part of the kingdom’s plan to keep global markets balanced and its customers well-supplied.

Saudi Arabia’s ability to keep pumping oil at these levels is scarcely in doubt. It claims reserves of 265 billion barrels, or about 16% of the world’s total, and unlike other ambitious producers, such as Iraq, the infrastructure to keep the oil flowing is in place. Peak-oil theorists have long questioned the reliability of those numbers. But even if the true reserves figure is 100bn barrels less, points out Robin Mills, head of consulting at Maneer Energy, a consultancy, Saudi Arabia’s trove still carries a reserves-to-production ratio (about 43 years) almost double that of Russia (23.5), the world’s second-largest producer. The problem, believe some analysts, is not the reserves – it is Saudi Arabia’s rampant domestic demand. Saudis are among the world’s largest per-capita consumers of energy and the economy and population are both growing rapidly. Already, a quarter of state company Saudi Aramco’s production is consumed domestically. Demand growth of 7-10% a year will begin to erode the volume of oil the kingdom can export.

Citigroup, a bank, crystallised these fears in a lengthy report published in September. Its alarming conclusion was that Saudi Arabia’s consumption trajectory would turn the kingdom into a net oil exporter within 18 years.

The issue is residential energy consumption, which soaks up about half of the kingdom’s demand. Within that segment, air conditioning is the real culprit — in peak summer months, it accounts for about 70% of residential consumption. And peak electricity demand, growing at about 8% a year, is a drain on the oil sector, which provides about half of the feedstock for the country’s generators. Crude-oil burn for generation hit new records of around 743,000 b/d in June and July this year, according to data from the International Energy Forum’s Joint Oil Data Initiative. “Assuming no change to its electricity fuel supply mix, we estimate Saudi Arabia would be a net importer of oil by 2030,” Citigroup bank concluded.

Other analysts are not quite so alarmed. For one thing, energy demand growth depends in large part on economic growth. For now, the kingdom is going along at a good clip. The economy grew by 5.2% in the second quarter (year-on-year) and will come in just beneath that level this year, reckons Jadwa, a Riyadh-based bank. The IMF’s most recent forecast suggested the Saudi economy would keep expanding similarly next year, too. Over the longer term, though, the kind of depletion in oil exports seen by Citigroup would hit GDP and undermine energy-demand growth rates, too, says Mills.

In any case, Saudi Arabia thinks a combination of upstream development and power-generation diversification should keep its oil-export prowess intact. Aramco is spending $35bn on oil exploration and development in the next five years alone. “We… know that preserving our spare production capacity is crucial to maintaining oil-market stability because it plays a pivotal role in protecting the world’s economic health,” its chief executive, Khalid Al-Falih, told an audience in Oxford in September. “It’s a responsibility we have faithfully and reliably discharged over several decades, despite its high cost to us; and will continue to do so.” Output capacity, now at 12.5m b/d, would be maintained. So would spare production capacity of 1.5m to 2m b/d, he said.

Key to this strategy are new upstream developments. Manifa, an offshore oil- and gasfield in Saudi Arabia’s northern Gulf waters, should be on stream in the first half of 2013, delivering 500,000 b/d before ramping up to 900,000 b/d in 2014, says Aramco. The project was postponed after the slump in global oil demand following the 2008 financial crisis. Its acceleration now tallies with the kingdom’s efforts to assure customers that supplies remain ample. Manifa’s heavy oil, to be refined in Saudi Arabia, will maintain, not increase, capacity. But the oil ministry has also made clear that substantial capacity expansions could come from other fields: as much as 2.5m b/d from the Zuluf, Safaniyah, Berri, Khurais and Shaybah.

Gas developments, essential to Saudi Arabia’s burgeoning petrochemicals business and its campaign to shift away from crude oil feedstock in power generation, are just as significant. New exploration has expanded the reserves base, which Aramco says has risen from 240 trillion cubic feet (cf) in 2005 to 283 trillion cf last year. Production has risen from 7.87bn cf a day (cf/d) to nearly 10bn cf/d in the same period. But that level is still more than a third beneath Aramco’s ambitious target to increase output to 15.5bn cf/d by 2015 (and add another 50 trillion cf to reserves) – critical to meeting pent up demand.

Between them, two major offshore projects in the Gulf should account for most of the increment: Karan, Aramco’s first non-associated gas development, which came on stream this year and should reach plateau output of 1.8bn cf/d in 2013; and Wasit, which will process 2.5bn cf/d of gas from the Arabiyah and Hasbah fields. Wasit is due on stream in 2014, though some analysts are sceptical. Associated gas from Manifa will also chip in. Less known is whether unconventional gas will enter the fray. Aramco believes its tight- and shale-gas resources could be 10 times greater than its conventional gas endowment.

The state company has been hoovering up engineers and geologists with experience garnered in the US’ unconventional sector. Salah Saleh, the company’s chief explorationist, said in September that Aramco was working with Schlumberger and Halliburton, two services firms, to train 50 people to tap the kingdom’s unconventional reserves – part of a two-to-three-year programme to identify prospects. Efforts will focus on areas around south Ghawar, the kingdom’s elephant oilfield, the northwest deserts near Iraq and Jordan, and the Jurassic and Cretaceous reservoirs in the Empty Quarter.

Even less conventional, in the Saudi context, are the kingdom’s new plans to deploy nuclear and renewable technology demand. The goal, declared in a 2010 royal decree, is ambitious. The World Nuclear Association, an industry body, says the kingdom wants to spend $80bn to build 16 reactors in the next two decades – giving 17 gigawatts (GW) of capacity, or a sixth of projected demand.

Solar power plans are even greater in scope. The King Abdullah City for Atomic and Renewable Energy (Ka-Care), charged with overseeing this nuclear era, intends to add a further 40 GW of solar capacity in the same time period. Riyadh already boasts one of the world’s largest solar thermal plants. While solar producers elsewhere run into a sticky patch, deep-pocketed Saudi Arabia has emerged as a potential boon to photo-voltaic exporters. Of the two, nuclear will be more difficult. Keeping reactors cool will be one problem, predicts Citigroup. Cost-overruns, the bane of the industry worldwide, are also likely. No one expects the Saudi plans to deliver the capacity the kingdom wants within its projected timeline. Delays are already envisaged in the UAE’s nuclear programme, and Saudi Arabia’s is even further behind. The political prospect of more civil nuclear facilities in the Gulf has also not yet been tested.

Better idea? Fix demand

The solar, nuclear and hydrocarbons ambitions have something in common: all of them see more supply as the solution to rising electricity demand. Yet Saudi Arabia may run into obstacles of its own making, especially in its gas plans. Unleashing private firms – and capital – on prospects such as those in the Empty Quarter, a campaign under way since the turn of the century, has yielded little. Subsidised natural gas prices in the kingdom, where industrial users can pay as little as $1 per 1,000 cf for the feedstock, are a loss-maker for any foreign firms, which could tap far higher international prices elsewhere.

The subsidy problem remains fundamental to Saudi Arabia’s supply-demand picture. Forecourt gasoline prices of around $0.16 a litre do little to dampen soaring consumption. Power generators pay the equivalent of $5-15/b for their oil feedstock. Subsidised by high international oil prices, Aramco’s upstream plans do not depend on cash raised locally. And cheap domestic pricing for its oil is not necessarily an opportunity cost, says Maneer’s Mills, because if that oil did not go to the utilities it would stay in the ground. But it is hardly an efficient way to use the kingdom’s hydrocarbon riches, either. Ending energy subsidies would stimulate investment and encourage efficiency. Some Gulf leaders have begun the process, with little pain so far. In Saudi Arabia, though, it may be different. Poverty remains a problem in the kingdom (see Backpage) and the Al Saud ruling family, troubled by revolts elsewhere in the region, has showered hundreds of billions of rials on its restive population in the last eighteen months. Taking money away with the other hand, by lifting fuel prices, hardly seems a likely strategy.

That doesn’t mean a supply crunch is inevitable. The politics may eventually change. Alternative energy sources could be as fruitful as Ka-Care expects, even if nuclearisation comes more slowly than it wishes. And Aramco is no flake in the upstream. Its campaign to increase oil output capacity to 12.5m b/d succeeded, on schedule, against a backdrop of scepticism outside the country. If its gas plans pan out, Aramco can help defer the harder questions, about subsidies and consumption, for a little while longer.

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