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THE BACKGROUND the Crude Market from As Recently As 2015, Saudi Energy Officials Competing Suppliers” Dismissed Suggestions That the Kingdom

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THE BACKGROUND the Crude Market from As Recently As 2015, Saudi Energy Officials Competing Suppliers” Dismissed Suggestions That the Kingdom FEATURE ENERGY ENERGY FEATURE BEYOND What are the implications of an increase in Saudi crude oil production capacity? BY JIM KRANE COMBINATION OF FACTORS IS encouraging Saudi Arabia A to consider raising crude oil production capacity beyond the current ceiling of 12.5 million barrels per day. The kingdom has managed to maintain a constant share of global crude oil markets, even as it copes with growing domestic demand for oil and a spate of investments in refineries, inside and outside the kingdom. Longer term, the threat of peak global oil demand – perhaps in response to climate change “Saudi Arabia finds itself – enhances the attractions of a shorter time horizon to depletion. However, an oscillating between increase in Saudi crude oil production cutting crude oil would have consequences for markets and competing forms of energy, as well production to prop up as for the kingdom's geopolitical stature. prices and maintaining The wide range of potential outcomes suggests that a major capacity increase is high levels of exports a risky strategy. to defend its share of THE BACKGROUND the crude market from As recently as 2015, Saudi energy officials competing suppliers” dismissed suggestions that the kingdom 40 Vol. 18/31, September 2017 anbusiness.com 41 FEATURE ENERGY ENERGY FEATURE would seek to raise its crude oil production “Even though costs based on what we see as projection and capacity above its theoretical maximum are among the world’s call on Saudi oil, we don’t see anything of 12.5 million barrels per day (m b/d). like that, even by 2030 or 2040. So the However, that stance has evolved. Public lowest, Saudi Arabia has need to build the facilities and drill wells to statements from officials at Saudi Aramco pursued a long-term produce 15 million or have the capability – operating since May 2016 under a new for 15 million is not there,” Al Naimi said oil minister – indicate that the company depletion strategy that during a speech in Washington. expects to increase oil production above was designed to promote “Based on all projections that I have recent historic highs. Further ahead, the seen, including ours, there is no call on company is considering investments to domestic fiscal and us to go past 11 (million), 11.5 (million) increase its capacity beyond the current political stability” by 2030 or 2040.” maximum 12.5 m b/d threshold. Three years on, Al Naimi has retired and Saudi Arabia finds itself in an energy been replaced by former Aramco CEO demand quandary. At home, the kingdom Khalid Al Falih, who heads an expanded needs oil and natural gas for transporta- Ministry of Energy, Industry and Mineral tion, industrial production and electric- Resources. Shortly after Al Falih’s ascen- ity generation. Each of these sources of sion, Aramco’s new CEO, Amin Nasser, domestic demand is increasing, propelled publicly stated what Aramco officials have by rising populations, growing incomes long said in private, that the 12.5 m b/d and subsidized end-user prices that, MSC would be maintained “for now,” but despite a recent adjustment, remain could be expanded in the future. among the lowest in the world. Internationally, Saudi Arabia also faces A MONTH LATER, AL FALIH SAID MUCH conflicting priorities for its crude oil. It finds itself oscillating between cutting THE SAME THING. crude oil production to prop up prices Sources of pressure on Saudi production and maintaining high levels of exports capacity include the following: to defend its share of the crude market • An increase in global demand in from competing suppliers. Meanwhile, response to the sustained period of low the kingdom’s national oil company, oil prices since late 2014. Saudi Aramco, is in the midst of doubling • The perception that non-OPEC produc- a crude oil refining business that could see ers have deferred so much capital it compile ownership stakes in as much investment since late 2014 that, without as 10 m b/d of capacity. That amount is sufficient Saudi spare capacity, future roughly equal to all of Saudi Aramco’s tightening in oil markets could trigger a current oil production. damaging price shock. As the kingdom endeavors to satisfy • The kingdom’s limited ability to these competing demand sources, it constrain growth in domestic hydro- increasingly sacrifices one of its most carbon consumption. Recent subsidy important strategic assets, the spare oil reforms and an emphasis on substitut- production capacity that it uses to balance u Aramco pumps around 10 million barrels of oil per day (bpd) ing natural gas for oil in the domestic markets in times of disrupted supply. economy appear to have slowed, but not Saudi Aramco’s spare capacity has most “Global efforts to makers believed that threats to monetiz- in 2008, then-Oil Minister Ali Al Naimi ing for rising domestic consumption. Al eliminated, demand growth. likely slipped below 2 m b/d in recent ing oil reserves will grow stronger in the announced the kingdom’s intent to raise Naimi rejected the notion. He said Saudi • The erosion of spare production capac- years. An increase in Saudi oil production reduce fossil fuel future, they may opt to increase oil output oil production capacity to 15 m b/d. Al Aramco had no need to move beyond the ity, in particular via recent downstream could also be incentivized by expectations use in response to in the present, a phenomenon described Naimi reversed course a few months later maximum sustainable capacity (MSC) of investments that, combined with other that restrictions on burning of fossil fuel as the “green paradox”. when prices plummeted amid the global 12.5 m b/d, a level that the company deter- demand sources, could challenge the will intensify in the future, as importing climate change are a In other words, if the long-term outlook financial crisis. Since then, suggestions mines it could sustain after a six-month kingdom's capability to continue as states impose policies aimed at mitigat- major worry among for fossil fuels looks risky, a short-term that the kingdom might move beyond period of capital and operational invest- dominant global supplier of raw crude. ing greenhouse gas emissions causing strategy becomes more attractive. Thus its long-time 12.5 m b/d maximum have ment. Saudi Aramco declared that it had • Longer term, future demand could be climate change. oil producers” the kingdom’s energy policymakers find been rejected. achieved the 12.5 m b/d MSC under the undermined by climate-driven disincen- The Saudi government has announced themselves revisiting a pressing question: In 2013, a senior member of the ruling late King Abdullah, who approved invest- tives to oil and the emergence of substi- plans to diversify its economy, thereby Should Saudi Aramco invest in oil produc- Al Saud family, the former intelligence ments to raise capacity from about 9 m tute fuels and technologies. Worries about reducing its exposure to climate risk, by tion capacity beyond 12.5 m b/d? chief and US ambassador Prince Turki b/d at the beginning of his tenure. premature peaking of global oil demand selling a 5% portion of Saudi Aramco, via Al Faisal, said that the kingdom planned “I don’t know what (Prince Turki) could incentivize stepped-up production an initial public offering (IPO) of owner- $100bn A CHANGE IN THINKING to increase capacity to 15 m b/d by 2020. means by 15 million. He may be think- and shorter-term depletion strategies. ship shares. Climate risk could also weigh The capital Saudi Aramco could raise in its During the period of tight oil markets that He said the increase was needed to raise ing… that Saudi Arabia is capable of doing In summary, if Saudi Aramco intends into a decision to raise output. If policy- initial public offering (IPO) by end-2018 saw prices reach an all-time high of $147/b export levels to 10 m b/d while allow- it, building capacity to 15 million. Now, to maintain all of its commitments to its 42 Vol. 18/31, September 2017 arabianbusiness.com 43 FEATURE ENERGY ENERGY FEATURE to producing and selling it at times when returns in financial markets are low. The result could be manifested in a green para- dox scenario, where producers accelerate extraction so that resources can be mone- tized before value is lost. Such price war behaviour implies an increase in supply and reduced prices, which winds up enhancing the attractiveness to consum- ers of the restricted product. Climate-focused scholars have sought to quantify the amount of potentially stranded resources by calculating “burn- able” fossil fuels as a portion of global reserves, measured by the carbon param- eters implied by limiting climate change to 2 °C. McGlade and Ekins find that some 431 billion barrels of global oil reserves, 33% of the total, must remain unburned – along with even greater proportions of natural gas and coal – for humanity to adhere to the 2° limit. The authors forecast that the Middle East will see a greater-than-aver- age proportion rendered unburnable, 38% or 263 billion barrels, due to the modest pace of Middle Eastern oil extraction rela- tive to reserves. From this perspective, Saudi prudence looks risky. However, few forecasts of climate effects find that oil demand will be displaced without concerted policies that use legal or economic means to constrain consumption. Such policy action is diffi- cult to predict. Without it, oil substitutes in transportation will be held back by short- comings in energy density, cost per mile, range, and even carbon content. While u Low oil prices might also enhance oil dependence among emerging economies electric vehicles and battery technologies are improving, so are internal combustion myriad demand sources – while protect- at balancing an oversupplied market and tion over the optimal pace of depleting some future point, when Aramco can no gence of threats to the long-term value of engines.
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