Saudi oil diplomacy and Egypt crisis

SAUDI ARABIA’S OIL CLOUT AND EGYPT’S FATE

Andrew McKillop

OIL SHOCK FOR SOME – FOOD SHOCK FOR EGYPTIANS

Since the army-led overthrow of Mohamed Morsi, July 3, the Arab Gulf states rushed to supply aid to Egypt. World media announced from July 18 that the United Arab Emirates was first in line, transferring $3 billion to Egypt’s central bank shortly before another $2 billion came in from Saudi Arabia and Kuwait promised $4 billion. In total Gulf Arab oil producers promised aid packages worth $12 billion after President Mohamed Morsi’s ouster, throwing a lifeline to Egypt struggling to maintain food imports for the Arab world’s most populous nation, and world’s No 1 importer of wheat.

Mohamed Abu Shadi, a 62-year-old former police general with a doctorate in economics who became Egypt’s minister of supplies following the army coup said in a VOA interview, July 17, that: “The biggest mistake the deposed President Mohamed Morsi made was stopping wheat imports”. He said that Egypt’s stocks of wheat were enough to last until November 25, but due to the gifts from Gulf Arab states another 480 000 tonnes had been purchased immediately after Morsi was deposed, stretching Egypt’s wheat stocks to last “until the end of the year”.

Although it grows its own wheat, Egypt still needs huge quantities of foreign wheat with higher gluten content to make flour suitable for subsidized bread, and for years has been the world’s biggest importer.

Bread, as much as politics has long been a sensitive issue in Egypt. Mubarak faced unrest in 2008 when the rising price of wheat caused shortages. Similar problems in the 1970s provoked riots against former President Anwar Sadat and helped make way for his October 1981 assassination, the responsibility for which is either claimed or denied by the military, Sadat’s rivals, the Muslim Bortherhood – and others.

Helping seal the fate of Morsi, he had bet on Egypt’s national harvest of wheat coming in big this year, and in anticipation froze international purchase for months, from February onward. Bread price rises therefore led food inflation until his overthrow. Immediately after, bread prices dropped alongside diesel fuel and gasoline prices, and other key consumer items. The Gulf Arabs had purchased street sympathy for their own-version Islamist cause, opposed to the Muslim Brotherhood of Egypt.

COORDINATED ACTION – OIL SHORTAGE

One of Wikileaks’ most celebrated revelations, in 2011, was a confidential mail from a US diplomat in KSA (Kingdom of Saudi Arabia) stating that he had been convinced by a Saudi oil expert named Sadad al-Husseini using data from as far back as 2005 that the nation’s oil reserves are overstated by nearly 40%. The diplomat was certain that KSA could not “keep a lid on oil prices”.

To be sure, there was no need to consult Wikileaks or the State Dept to hear that – for at least a decade Matthew Simmons, author of books including Twilight in the Desert: The Coming Saudi Oil Shock published in 2005 has worked the theme of Saudi exaggeration or lying about its oil reserves. Simmons main argument was that over and above the political uncertainty of reliance on Middle Eastern oil, the reserve decline rates for conventional or first-generation oil in the region should raise our awareness of the physical unreliability of Middle East oil.

Due to the huge dominance of KSA in Middle East oil and Arab world politics, KSA’s decisions on how and when it uses its Oil Weapon concerns the rest of the region – and the world. . KSA’s recoverable oil reserves, depending on what date, as well as what source inside the Kingdom provides the data, could range from 250 – 350 billion barrels (250-350 Gb). More bizarre, the reserve number never declines – it only grows despite KSA producing roughly 3.65 Gb-a-year, about 10 million barrels-a-day (Mbd). The Financial Times reported June 11 that KSA is presently producing “nearly 9.7 Mbd”.

One single chart shows the large range and potential for KSA “opening and closing the oil tap” (Source: Gregor Macdonald)

UNABLE TO PREVENT PRICE RISES – OR UNWILLING?

Despite the US shale oil and gas revolution, Canadian tarsand oil, extensive new oil finds in Africa and rising output from Iraq, the spectre of oil shortage can be, and is used to work oil markets upwards, with inevitable political reaction in major consumer nations to higher oil prices. Currying favour with the Gulf Arab states, especially KSA is a long-running State Department theme, as well as the foreign ministries of other major importer countries. Whatever the merits of the Saudi oil decline “analysis”, from Wikileaks or Matt Simmons before his death in 2010, the same can be applied almost word-for-word to joint-No 1 or close No 2 world oil producer Russia.

This only underlines that anything concerning world oil and oil prices concerns the Dominant Pair, producing a combined total of about 25% of world total oil output.

In Russia’s case, even more than KSA, the role of conventional oil reserves versus “assisted recovery” tapping secondary or tertiary reserves utilising steam-assist, water flood, chemicals, compressed gases

(Source: Gregor Macdonald).

and other means to enhance and increase recovery from “tight” source rocks or declining conventional reserves is a constantly moving frontier. This makes the definition of Russia’s recoverable oil reserves at least as variable as for KSA but in both cases, and anywhere else in the world – notably US, Canadian and Venezuelan shale oil extraction – higher oil prices expand the recoverable reserves, and lower prices do the opposite. The main difference between Russia and KSA is that Russia has very little “discretionary output” power or capability for a range of reasons, from the technical to political.

All we need to note is the 2011-vintage Wikileaks revelation has resurfaced as the oil price has soared in recent weeks to well above $100 a barrel, with the mass media-friendly explanations being a very slight recovery of global oil demand and above all tensions in the Middle East and Arab North Africa focused on Egypt. With totally predictable timing, KSA has announced it will either maintain highest-possible production, or increase it.

For as long as this does not prevent oil prices rising, KSA will “almost regrettably” enjoy especially large windfall revenue gains. Russia ditto.

MANAGED OIL OUTPUT – MANAGED POLITICAL ACTION

As the charts show, Saudi production is “managed” but Russian production is far less compressible, explaining the meaning of the key price setting term: “reserve or spare capacity”. The key major difference between KSA and Russia is therefore simple – KSA can “open the tap” provided it has previously cutback output – making its Swing Producer role one of the most basic, fundamental oil price-setting factors.

Consequently, given that the Kingdom’s powerful but hidden role in the Egyptian crisis needs constant bolstering, the news and views or opinions and spin on the subject of KSA’s oil production intentions and policies are likely going to get huge airtime – as the Egyptian crisis deepens. The role of KSA oil politics will return in force, this time given an extra layer of intrigue on its intentions and policies due to Saudi security minister, the prince Alwaleed bin Talal, a nephew of King Abdullah warning on July 28 that global demand for the kingdom’s oil is constantly and clearly dropping, urging revenue diversification and investment in nuclear and solar energy to cover domestic and local energy consumption. See also my article: /energy/2013/07/saudi-royal-sounds-alarm-on-fracking-2450748.html.

In the current global context, despite very weak oil demand, Saudi action to not increase output or to cut back would give a home run for oil bulls working major markets. As the oil price rose, Western leaders will act predictably to comfort and bolster Saudi policy on Egypt. Russia, to be sure, is also watching the action KSA will take, as well as Iran, Iraq and Venezuela – the other leading OPEC producers. Any Saudi action to cut back on production – for example with the pretext of oilfield maintenance or equipment breakdowns – will almost certainly result in raised production from the other main producers and cause the worst outcome for Saudi’s oil diplomacy: falling prices.

KSA’s discretionary or spare capacity has proven crucial in meeting recent supply shortages. It raised output during the 2011 civil war in Libya, and in 2012 raised production to a 30-year high slightly above 10 Mbd as US-led sanctions reduced exports from Iran. Saudi action, and posturing in Egypt today can however have unintended political consequences and the crisis-atmosphere has already led to further tightening by Saudi Aramco on the sale of its crude, ensuring only end-users obtain it to restrict their ability to resell barrels.

Overall and due to the total opacity of oil market trading – shown by increasing action by regulators in Europe and the US to rein in abuses – oil prices effectively tell us little or nothing about fundamentals and everything about speculation. Middle East supply risk is however rising, and KSA will exploit this to its own ends – political leverage and windfall revenue gains – for as long oil prices can be kept high. Leaving the last word to KSA’s oil minister al-Naimi, his “preferred market equilibrium price” which has disappeared from all speeches, interviews and comments he has given for more than 9 months, was $75 a barrel. At that price level Prince Alwaleed’s so-called pessimism is likely unfounded but above it, KSA will go on losing demand volume if not revenues.