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Home / Business

Unplugging Saudi Arabia's vast oil reserves is easier said than done

Daily Telegraph UK
10 Jul, 2018 06:12 AM5 mins to read

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The world's largest exporter claims to have 2 million barrels a day of spare production capacity ready to unleash. Photo / 123RF

The world's largest exporter claims to have 2 million barrels a day of spare production capacity ready to unleash. Photo / 123RF

COMMENT: Saudi Arabia is under intense pressure from US president Donald Trump to flood the oil market and cool prices.

The world's largest exporter claims to have 2 million barrels a day of spare production capacity ready to unleash at the behest of its ruler, King Salman bin Abdulaziz al-Saud.

Unplugging his kingdom's bountiful oil wells sounds easy, but in reality isn't so simple.

Firstly, Saudi Arabia has a deal with Opec to restrain its output, which it can't entirely ignore.

The kingdom's oil minister Khalid al-Falih agreed last month to a vaguely worded pledge with the 15-member cartel and its allies, including Russia, to continue managing supplies, while simultaneously releasing a combined 1m b/d of crude.

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If Saudi Arabia were to appease Trump's demands for more oil it could breach this contract.

The deal followed intense lobbying by America's increasingly oil-obsessed president for Saudi Arabia to ease the impact on prices caused by looming sanctions on Iran cutting off its supplies.

But if the Saudis were to appease Trump's demands for more oil, it would breach the contract.

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That could divide the group and potentially trigger an emergency meeting, something Riyadh would rather avoid.

Despite its status as Opec's largest producer, the kingdom may be reluctant to entirely turn its back on the Vienna-based organisation.

Combined, Opec still controls about a third of the world's supply and gives Saudi Arabia a genuinely powerful economic forum in which to exert its influence on a global stage.

Needless to say, Iran would also fiercely oppose any attempts to pump more Saudi crude.

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Tehran has already warned it will formally complain to Opec's president if Saudi Arabia breaks the terms of its deal.

Although Iran's options are limited, it could still make life very difficult in the Gulf region for its arch ideological rival.

President Hassan Rouhani, visiting Europe last week, even appeared to threaten cutting off its neighbour's shipments from the area if sanctions prevented the Islamic republic from exporting its own crude.

Those veiled threats were quickly backed up by the leader of Iran's ultra-hardline Islamic Revolutionary Guards Corp.

Although menacing a fifth of the world's oil shipped through the Strait of Hormuz is the oldest trick in the book for Tehran when it feels cornered, it adds to the already febrile geopolitical climate in the region.

Riyadh may be reluctant to add more fuel to the flames.

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Earlier this year, Iran-backed Houthi militants from Yemen attacked a supertanker carrying 2 million barrels of crude in the Red Sea and have repeatedly targeted Riyadh with missiles.

Of course, the region's most vital oil export route is heavily protected by an armada of US navy warships, but there is still a sense that Iran will do everything in its power to prevent Saudi Arabia exporting more crude if its own shipments are blocked by sanctions.

If Tehran's opposition isn't enough to prevent Saudi Arabia being given carte blanche in world oil markets, technical issues may present a bigger barrier to its crude.

During the long hot summer in the Gulf, the kingdom has to burn more of its oil in power stations to meet surging demand for electricity and desalinated water.

According to the Energy Information Administration, around 700,000 b/d of Saudi crude - almost equivalent to the entire output of Britain's North Sea - is used to produce electricity in the kingdom during the hottest months when temperatures reach their peak.

This erodes the kingdom's spare capacity - which is defined as production that can be brought on-stream within 30 days and sustained - to immediately increase exports when it needs to the most.

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Although Saudi officials claim the country's total production capacity exceeds 12 million barrels a day, many experts question its ability to reach this target in the near term.

S&P Global Analytics estimates production reaching a daily output of 11 million barrels would run its systems at stress-inducing levels.

In order to bring on significant additional volumes, the kingdom may first have to reactivate a strip of oil wells it shares with Kuwait in a region known as the neutral zone.

Plans are afoot to reactivate the mothballed Khafji and Wafra fields, which could yield 500,000 barrels a day of additional oil in total.

However, industry experts warn it could take many months before output from the region is restored fully after years of technical problems.

Of course, most of these concerns are dismissed by Saudi officials and output has already started to increase. Production hit almost 10.4 million b/d in June, an 18-month high, according to the latest survey of Opec members conducted by S&P Global Platts.

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Although the kingdom takes its leadership role within Opec seriously, the group's members are free to set their own production policies because the cartel has no executive powers to enforce decisions, which remain a sovereign right.

Riyadh may also see its future interests are better served building a closer relationship with Russia to co-ordinate oil policies.

With Moscow onside, the kingdom could arguably ditch Opec and capitalise fully on its ownership of vast proven reserves estimated to exceed 260 billion barrels.

Concerns of Iran closing off Hormuz are nothing new and despite repeated threats, the option would invite disaster.

Furthermore, Saudi Arabia is unlikely to do its biggest regional rival any economic favours while they fight a bitter ideological cold war for control of the Middle East.

The benefits of fulfilling Trump's request to pump more oil and appease its closest and most powerful international ally far outweigh the risks.

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Finally, analysts have historically questioned the kingdom's ability to increase production and consistently been proved wrong. Riyadh remains the world's capital of crude.

This story first appeared in the Daily Telegraph and was reproduced with their permission

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