Saudi Arabia might want to use its weight to force price collapse

The current high oil prices can't last forever. But rather than allow non-OPEC producers to soak up market share, one stratagem Saudi Arabia might consider is an engineered price collapse.
Oil markets remained tight through much of 2003, due to interruptions in Venezuelan and Nigerian exports and Iraqi production running far lower than expected. The OPEC basket price averaged $ 28 a barrel in H1, keeping Gulf budgets flush and ensuring a war dividend that more than compensated for egos bruised by the coalition military presence in the region.

But these robust price conditions look to have a limited shelf life. The same high prices that line OPEC coffers are both attracting non-OPEC producers, who have begun biting into market share, and choking off demand growth. Most analysts now envision the global call on OPEC oil declining, with annual demand growth in the Gulf region dropping to 1.1 mm bpd in both 2003 and 2004, after average annual demand growth of 2 mm bpd during the 1990s.
The Centre for Global Energy Studies (CGES) predicts Iraq's woes will keep oil markets tight this winter, with the OPEC basket staying above $ 29 a barrel unless other OPEC members boost output. Previously, the CGES has talked up Iraq's production potential. Now it says the country is "likely to remain an uncertain source of supply for many months".

Thrust once more into the role of swing producer, Saudi Arabia now faces a stark choice. It may want to continue adjusting output to keep prices above $ 25 a barrel -- but this might allow non-OPEC suppliers to pour oil profits into their own hydrocarbons sectors, and challenge the cartel for further market share.
On the other hand, some analysts suggest, the Kingdom might want to use its weight to force a price collapse that would protect its market share and wipe out non-cartel suppliers at a stroke.

The strong crude prices and robust output enjoyed by major Gulf OPEC producers this year is in large part attributable to the toppling of Saddam Hussein, if not in ways that either OPEC or the new masters of Iraq had intended.
The half-hearted revival of Iraqi production capacity -- thwarted by a mixture of sabotage, looting and poor reservoir management -- left a gaping hole in the global supply picture that OPEC heavyweights Saudi Arabia and Kuwait have been more than happy to fill.

With Iraqi production during August still less than half its pre-war level, estimates from Iraq are proving unreliable guides to the actual output picture. The frequent pronouncements of former acting oil minister Thamer Ghadhban -- now replaced by Ibrahim Mohammed Bahr Al-Uloum, the Governing Council's appointee -- have begun to resemble former information minister Mohammed Saieed Al-Sahaf's wartime boasts of the imminent vanquishing of the US invaders.
According to a sceptical Deutsche Bank report issued in August, actual capacity was well below the official level of 1 mm bpd. The bank's analysts reckoned realistic production was 500,000-700,000 bpd.

Besides non-OPECsuppliers, another threat to Saudi market share could come from within the cartel itself, where rampant capacity growth is already causing urgent problems.
"Non-OPEC output is growing, particularly from Russia and Angola," said Deutsche Bank's Chief Oil Analyst Adam Sieminski. "But if at the same time you have growth in production capacity in places like Algeria, Nigeria and Venezuela, there just wouldn't be enough room for all the oil relative to demand."

PFC Energy Chief Economist Fareed Mohammedi told a London conference in July that the Kingdom would consider a price collapse to cull high-cost production world-wide. He intimated this could be achieved crudely by releasing the taps, but others say Riyadh wouldn't even have to go that far. Sieminski says Saudi Arabia could keep producing at a steady level, say 7 mm bpd, and still see prices likely fall.
The Saudis would pursue this option if demand growth was slow, there was no co-operation from other OPEC producers, and the non-OPEC supply kept growing, according to Sieminski. "All they have to do is not decrease production," he said.

The Kingdom's production rose significantly in the first half of 2003, mostly to replace lost Iraqi, Venezuelan and Nigerian volumes. International Energy Agency data reveals output hit a high of 9.41 mm bpd in April, falling back to 8.68 mm bpd by July. Output is likely to revert to nearer its 8.26 mm bpd OPEC quota by Q4 of this year, though the probability of further Iraqi outages could also see Riyadh releasing the taps once more.
Riyadh's swinging has had other benefits. The policy has enabled the Kingdom to demonstrate to the US its credentials as a stable supplier at a time of heightened strain on US-Saudi relations. Since the May 2003 Riyadh bombings, the government has been especially anxious to prove it is business as usual on the oil export front.

What may spur Riyadh into implementing a possible price collapse is a more worrying prospect: signs of rampant Russian crude export growth to US markets.Russian producers appear to be increasingly targeting the USA as a destination for their crude exports. These reached 424,000 bpd in June, a three-fold increase on May's 142,000 bpd and the highest volume so far recorded, according to the US Energy Information Administration (EIA).
In contrast, US imports of Saudi crude slipped to 1.92 mm bpd in June, down from 2.23 mm bpd in May, the EIA says. Intra-OPEC politics will also come to the fore in Q4. During the Iraq invasion, Saudi Arabia boosted market share in European, US and Far East markets at the expense of other cartel players. But a revival of Iraqi exports later in 2003 could force Riyadh to cede quota, undermining Saudi efforts to maintain market share.

So far, these scenarios remain only distant possibilities. With prices well above the $ 25 a barrel level and volumes high, Riyadh can afford to be relaxed about the likes of Russia for the moment. But the probability of high non-OPEC supply growth in 2004 amid relatively stagnant global demand growth will test the Saudis' mettle.
A price crash, though bad for the exchequer in the short-term, could once again make the Kingdom the market kingpin that Saudi policy-makers deem its divine right.