Saudi's Cutbacks Raise Oil Concerns

By MICHAEL E. KANELL
The Atlanta Journal-Constitution
Published on: 02/20/07

Drivers who remember those $3-a-gallon days of the past two years, be warned.

Oil prices are up and the world's biggest producer has been cutting back — a recipe for those prices to keep on climbing.

But whether they are still arching skyward by the time summer driving starts depends largely on just why Saudi Arabia has been pumping less crude.

No one outside the kingdom really knows for sure, but some oil experts think the Saudis' oil reserves may not support increased production.

Official Saudi explanations for production cuts cite the recent dips in global prices, arguing that a little shrinkage in supply will help stabilize the market. So when demand accelerates this summer, a little boost to Saudi production would keep prices from soaring.

But what if the Saudis cut back because they had no choice?

"It's going to be a different world if Saudi Arabian production is going into decline," said economist James Hamilton of the University of California, San Diego. "If that is the world we are in, we really need to be making plans."

The price of a regular gasoline averaged $2.10 a gallon in metro Atlanta on Monday, up a dime in a month, according to GasBuddy.com. During that same period, the global price of oil has risen about 14 percent.

Meanwhile, Saudi production is reportedly down about 1 million barrels a day from an average of about 9.5 million barrels a day through much of 2005.

It is not just the decline that is troubling, Hamilton said. "I don't know for sure what the answer is, but I find the facts disturbing."

• Cutbacks started when prices were high.

• The Saudis have been nearly frantic in their recent drilling for more oil.

• Some reports show the Saudis increasingly relying on lower-quality, less valuable oil.

The questions about Saudi Arabia tap into an ongoing controversy.

Nearly all geologists agree that sooner or later the world will reach the midway point in the era of oil, the moment when half the Earth's crude has been pumped. But there is a small, vocal contingent who have been warning that the world is approaching peak oil very soon.

Or is already there.

From the moment "peak oil" arrives, the search will be on for cost-efficient alternative fuels. Meanwhile, producers will have an incentive to hunt for and pump lower-quality or hard-to-find crude.

Relentless economic pressures will send oil — now selling for just under $60 a barrel — steadily toward the stratosphere, Hamilton said. "If Saudi Arabia is in decline, then oil is way too cheap."

Saudi Arabia has long claimed a massive oil reserve and — since the decline of U.S. production and the breakup of the Soviet Union — it has been the global production leader.

But many of Saudi Arabia's fields are more than a half-century old.

In the early 1970s, the Saudis led the Organization of Petroleum Exporting Counties in aggressive action. Some of the goals were political, some strictly about boosting revenue.

But a tripling of oil prices spurred recession among the world's largest economies, who were also OPEC customers. For the next several decades, the Saudis pursued a careful strategy: Keep prices high enough to fill the country's coffers, but not so high that customers get serious about conservation and alternative forms of energy.

The Saudis are not always successful, but hardly anyone else could even make the attempt. Saudi Arabia has been virtually the only producer with enough extra capacity — and discipline — to move the market.

Saudi skeptics, like oil investor turned critic Matthew Simmons, say the Saudis cannot admit that their market power is dribbling away. But the scramble to find more oil, Simmons says, is evidence of desperation.

For their part, the Saudis dismiss the concerns — and many experts back them up.

Amy Myers Jaffe, associate director of the energy program at Rice University in Houston, said that the Saudis are spending enormous amounts of money finding more oil, and they are likely to make up for fields that have peaked — and then some. "They are like people on a treadmill who have to run a little faster," she said.

The Saudis aim to expand capacity by 3 million barrels a day so they can maintain their role, she said. "The Saudis have been explicit. They need more capacity so they can continue to balance the market."

Yet there are other short-term issues, like Iran.

Concern about Iran's ambitions — and a possible confrontation with the United States — only makes it harder to read the Saudis.

Iran is a Shiite state and the world's fourth-largest oil producer. Saudi Arabia is dominated by a Sunni sect that has often been at odds with the Shiites. The two nations are seen as supporters of opposing sides in Iraq, even as they vie for a larger leadership role in the region.

Yet experts say Saudi Arabia, where oil production is relatively cheap, can handle low oil prices better than Iran — whose government has used oil revenue to smooth over recent economic trouble.

So why would the Saudis lower production and raise prices when it serves their Iranian rivals?

It may be, Jaffe argues, that the Saudis do not want to push Iran into a corner yet. It may also be that they want to have lots of extra pumping capacity ready if there is a crisis.

Now, the market is mostly balanced, she argues.

"I'd be surprised to see the price go to $75 a barrel again," Jaffe said. "But if they get into a war and start blowing up each other's oil facilities, the price is going to go way past $75."