THE ROLE OF SAUDI ARABIA IN THE WORLD OIL MARKET 1974-1997 Thesis submitted for the degree of Doctor of Philosophy at the University of Surrey Department of Economics , by Nourah AbdulRahman Al-Yousef April 1998 ABSTRACT The Role of Saudi Arabia in the World Oil Market : 1974-1997 The importance of Saudi Arabia in the oil market is evident, but the motivations that contribute to the making of its oil policy are less clear. The primary purpose of this study is to fmd the framework that accounts for as many facts as possible, and in some cases to determine their influence on Saudi oil policy. This will be done through examining important factors affecting Saudi oil policy in the international market and analysing the oil-related decisions, that were formulated by the Kingdom of Saudi Arabia. These critically important decisions, such as how much oil to produce and at what price, are discussed in the light of views and information from prominent Saudi decision makers, Saudi officials, and international economic analysts, and compared with what has been revealed by the literature and the evidence of the market, to draw a conclusion about the Kingdom's oil policy. A review of the political structure and the process of oil policy decision making is made to provide an understanding of the process in Kingdom of Saudi Arabia. Fundamental changes in the world oil market, have been reflected in oil price volatility. Accordingly, a price that takes these changes into account must be found. Therefore, issues and concepts related to the price of oil are discussed and the time series to be included in the model is determined. By testing hypotheses of the Saudi role in the oil market we have reached a conclusion that its oil policy seeks to maintain oil as a viable longterm source of energy. This comes from the long life expectancy of Saudi oil reserves. Consequently, Saudi Arabia is following an oil policy that optimises the long- term value of its reserves, protects its share of the market and keeps oil prices stable by pursuing an economically rational strategy. Thus, Saudi Arabia played the role of swing producer between 1975 and 1985 to maintain stable oil prices, and by 1987 it had resorted to market sharing behaviour to maintain its share in the market. These two models were tested through multivariate system analysis using the Johansen procedures and testing of the time series properties such as seasonality, stationarity, exogeneity and cointegration. I would like to express my deep and sincere gratitude to His Excellency Sheikh Ahmad Zaki Yamani for his generosity with his time and his explanation of decisions taken when he was the Minister of Petroleum (1962-1986) in the Kingdom of Saudi Arabia. Also I would like to thanks His Excellency Minister of Petroleum in the Kingdom of Saudi Arabia (1986-1995). Sheikh Hisham Nazer, for time and help in allowing me access to information and to interview people in the Ministry. He took the time to answer questions about the period when he was Minister of Petroleum and Mineral resources. Thanks are due to Mr. Suliman Al-Herbish the Saudi Arabian Governor to OPEC, for his comments and suggestions, Mr. Farouk Al-Husseini the advisor to Saudi Arabia's Ministry of ,Petroleum and Mineral Resources from 1957-1996, for his time in providing detailed answers to my questionnaire Mr. Ian Seymour the Editor of the Middle East Economic Survey in Cyprus, allowed the use of the MEES files and answered questions that helped in clarifying some aspects of the oil market. I would like to thank him and also Dr. Walid Khaduri for his time and information and for arranging my visit to MEES. vi My thanks also for His Excellency Dr. Khlid Al-Angary, the Minister of Higher Education in Saudi Arabia for his support for higher education which enabled many Saudi female students from entering different graduate programs both in Saudi Arabia and abroad. Thanks goes King Saud University for granting me the scholarship for my graduate study and to the Saudi education attache in London, Mr. Abdullah Al-Nasser for his concern for students. Many thanks to all my family especially my mother, brothers Fahad and Nasser and to all friends and colleagues who had helped me to accomplish this work also Last but not least, I express my deep gratitude to my husband Professor Saad Al- Rajeh, my children Dalal, Mohammed and Yazeed for their encouragement, support, patience and endurance, during a long and exhausting process. Without them, it would not have been possible to accomplish this work. I dedicated this work to My Husband, Professor Saad Al-Rajeh, and my children Dalal, Mohammed, and Yazeed viii Chapter TABLE OF CONTENTS Page 1 INTRODUCTION 01 -05 1.1 The Methodology 02 - 02 1.1.1 Interviews and Institutional Evidence 02 - 03 1.1.2 Econometric Analysis 02 - 02 1.2 Plan of the Study 03 - 05 2 PETROLEUM POLICY MAKING PROCESS 06 - 35 2.1 Introduction. 06 - 09 2.2 The Political Structure 09 - 13 2.2.1 The King 09 - 10 2.2.2 The Council Of Ministers 11 - 12 2.2.3 Consultative Council 12 - 13 2.3 The Structure of Oil Policy Decision Making 13 - 19 2.3.1 The Ministry of Petroleum and Mineral Resources 13 - 17 2.3.2 Supreme Petroleum Council 17 - 19 2.4 Saudi Aramco 20 - 28 2.4.1 The Development of the Fiscal Relationship Between Aramco and the Saudi Government... 20 - 24 2.4.2 Decision Making in Saudi Armco 24- 27 2.4.3 The Vertical Integration of Aramco 29 - 31 2.5 Other Saudi Oil Related Companies and Organisations 28 - 29 2.5.1 Petromin 31 -32 2.5.2 Sabic 33 - 33 2.6 Conclusion 33 - 33 3 ANALYSIS OF SAUDI ARABIA'S OIL DECISIONS 36 - 84 3.1 Introduction 33 - 38 3.2 Price Fixing Regime, Jan.1974- Feb. 1982 38 - 60 3.2.1 Price Stability from 1974 to November 1978 39 - 44 3.2.2 The Crisis Period 1978-1981 47 - 60 3.3 Fixing Ceilings, Quotas and Prices, March 1982-August 1985 60 - 67 3.4 From defence of Prices to defence of Market Share 1985-1987 67 - 74 3.5 Volume Fixing, Flexible Pricing 1988- Present 72 - 80 3.6 Conclusion 81 - 82 4 ECONOMIC MODELS OF OPEC BEHAVIOUR AND THE ROLE OF SAUDI ARABIA 85 - 126 4.1 Introduction 85 - 87 4.2 Models that do not Recognise Saudi Arabia's Role. 87 - 97 ix 4.2.1 The Monolithic Cartel 87 - 90 4.2.2 The Competitive Model 92 - 95 4.3 Models that Address Saudi Arabia's Role 97- 104 4.3.1 OPEC as a Cartel with Different Groups 98- 100 4.3.2 Dominant Producer Model with Saudi Arabia as the Swing Producer 102-104 4.4 Other Models of OPEC Behaviour 105-115 4.4.1 Property Rights Model. 105-108 4.4.2 Target Capacity Utilisation Model 108-111 4.4.3 The Fiscal Constraint Model 111-115 4.5 Econometric Testing 116-121 4.6 Political Interpretation of Saudi Arabia's Behaviour 122-124 4.7 Conclusion 124-125 5 THE SWING PRODUCER AND MARKET SHARING MODELS 127-139 5.1 Introduction 127-130 5.2 The Swing Producer Model (1975-1986) 130-136 5.3 Market Sharing Model (1987-1996) 136-138 6 OIL PRICES AND PRODUCTION DATA 140-152 6.1 Introduction 140-141 6.2 The Categories of Crude 141-142 6.3 Structure of Prices 142-15 6.3.1 Posted Prices 142-143 6.3.2 GSP Government Selling Prices 143-143 6.3.3 Spot Prices 143-143 6.3.4 Spot - GSP Relation 144-144 6.3.5 Netback Pricing 145-145 6.3.6 OPEC Reference Basket Prices 146-146 6.3.7 Market Related Formula Prices 146-148 6.4 The D'ata 148-151 6.4.1 Oil Prices Data 148-150 6.4.2 Production Data 150-150 7 THE ECONOMETRIC METHODOLOGY 153-176 7.1 Introduction 153-153 7.2 Stationary and non-Stationary Time Series 153-160 7.3 Testing for Unit Roots and Stionarity 157-159 7.3.1 The Dickey Fuller Test 159-160 7.3.2 Structural Change and Unit Roots 157-162 7.4 Cointegration 160-164 7.4.1 Order of Integration 160-161 7.4.2 Error Correction Mechanism 161-163 7.4.3 Cointgration and Granger Causality 163-164 7.5 Seasonality 164-168 7.5.1 Definition of Seasonality 164-165 7.5.2 Test for Seasonality 165-166 7.6 Testing for Cointegration 169-175 7.6.1 Engle and Granger two Step Procedure ....... 169-170 7.6.2 Cointegration in Multivariate Systems 170-170 7.63 The Johansen Approach 171-175 7.7 Conclusion 175-176 8 EMPIRICAL ANALYSIS 177 -201 8.1 Introduction 177-177 8.2 Variables of the Study 177-178 8.3 Descriptive Statistics 178-178 8.4 Testing the Properties of the Time Series 179-182 8.5 Tests for Unit Root and Stationarity 183-183 8.5.1 The Dickey Fuller Test 183-184 8.5.2 Philips and Perron Test 184-184 8.5.3 Test for Degree of Integration 185-184 8.6 The Multivariate Cointegration Model 186-189 8.7 Testing the Swing Producer model for the Period 1976-1986 190-193 8.8 Testing the Market Sharing Model for the Period 1987-1995.. 193-196 8.9 Conclusion 196-196 9 CONCLUSION 201-205 APPENDICIES 207-231 1 The Saudi Ministers of Petroleum and Mineral Resources 207-208 2 The Structure of OPEC 209-210 3 Major OPEC Decisions 211-217 Chronology 4 The Participants in the Decision Making Process in the Kingdom of Saudi Arabia 218-218 5 The London Agreement 219-220 6 Quotas Agreement of OPEC from March 1982- December 1994 221-222 7 Trading Instruments 223-225 8 Markets of Crudes 226-228 9 The VAR Model 229-229 10 Definition of the Polynomial used in Seasonality Testing 230-230 11 Selecting the Order of the VAR Model 230-230 REFERENCES 232-246 xi xii Tables LIST OF TABLES Page 2.1 Saudi Aramco Foreign Downstream Ventures.