Saudi Arabia and oil
Terrorists are now targeting Saudi Arabia's oil infrastructure. How bad could things get?
NOT SO long ago, a certain well-known international figure penned a heart-felt speech he called his “Letter to the American People”. In it, he said: “You steal our wealth and oil at paltry prices because of your international influence and military threats. This theft is indeed the biggest theft ever witnessed by mankind in the history of the world.” The author was Osama bin Laden.
The impact of those chilling words is still being felt in today's chaotic energy markets. Oil prices have recently been above $40 a barrel. Politicians in oil-consuming economies are up in arms. Saudi Arabia, the head of the Organisation of Petroleum Exporting Countries (OPEC), has promised relief. It is trying to persuade reluctant cartel members to increase production when they meet on June 3rd in Beirut.
Typically, a decision by OPEC to increase quotas cools prices. This time may be different. A soaring world economy has sucked global inventories dry. Nearly every OPEC producer, save Saudi Arabia, is already producing about as much oil as it can. That means that any new OPEC promise of oil will have to come chiefly from the Saudis themselves—and that is not good news.
The main reason for worry is the so-called “terror premium”. Oil traders report that fears of terrorist attacks that might disrupt Middle-Eastern oil exports may account for as much as $8 of the current per-barrel price. That may be because what was once unthinkable now seems possible, perhaps even inevitable: a major terrorist attack, or series of attacks, on oil facilities within Saudi Arabia.
But how well-founded are these fears? For the terror premium to be justified, one needs to consider three questions: Is Saudi Arabia really so important? Would it in fact be easy to pull off a serious attack inside the desert kingdom? And even if such an attack were to take place, would the oil markets suffer so badly?
First, is Saudi Arabia so important? Until the recent rise in prices, most headlines had trumpeted the growing importance of other oil producers. The revival of Russia , overtaking even Saudi output, was supposed to undermine OPEC. Oil from Alaska would give America “energy independence”. The quest for oil in the Caspian Sea was called the “Great Game”. Striking oil in the waters off Brazil and west Africa was even likened to hunting elephants.
Surely all this investment and discovery prove that the Saudis are ever less important to the oil market these days? Nonsense. Ignore the headlines and look instead at geological and market realities, and it quickly becomes clear that Saudi Arabia remains the indispensable nation of oil. The Saudis not only export more oil than anyone else, but they also have more reserves than anyone else—by a long shot. Fully one-quarter of the world's proven reserves lie in Saudi Arabia. Four neighbours—Iran, Iraq, the United Arab Emirates and Kuwait—each have about one-tenth. Russia, Nigeria and Alaska put together do not match Saudi reserves.
Even more important is Saudi Arabia's role as swing producer. Unlike other countries, the Saudis keep several million barrels per day (bpd) of idle capacity on hand for emergencies. Today Saudi Arabia is the only country with much spare capacity available (see chart 1), though the precise amount is a matter of intense debate. Nansen Saleri, an official at Saudi Aramco, the country's state-owned oil company, will say only that Saudi output will rise in June to about 9m bpd, and that the country can raise its output above 10m bpd “rapidly”.
This spare capacity allows the Saudis to moderate oil-price spikes. They have done precisely this at various times: during the Iran-Iraq war, when output from both countries was disrupted; during and after the first Gulf war, when output from Iraq and Kuwait was lost; and last year, when civil strife in Venezuela and Nigeria curbed output from both countries on the eve of last year's invasion of Iraq (which itself disrupted Iraqi output).
Produce the juice
The Saudis remain keen to moderate prices by using their buffer capacity. Last week, when some OPEC ministers rebuffed a Saudi proposal to raise output quotas at the Beirut meeting, they offered to lift production unilaterally. That might cool prices a bit, but would also leave the Saudis with less spare capacity to prevent a further oil shock.
That points to the second question: how vulnerable is Saudi Arabia's oil industry to terrorist attack? Not long ago, this desert kingdom was seen as a reliable and supremely safe source of oil. Indeed, some called it the central bank of oil.
After the September 11th attacks, such assessments seem too rosy. Terrorism is now clearly a serious problem. Not only were most of the 9/11 suicide attackers Saudi (15 out of 19), but reports suggest some Saudis are fighting against American-led coalition forces in southern Iraq. And increasingly, Saudi terrorists are striking targets at home—including oil infrastructure. On May 1st, one group killed several foreigners working at a petrochemical complex in Yanbu, the biggest oil-export terminal on the country's Red Sea coast (see map, above).
Not everyone is worried. Nawaf Obaid, an adviser to the Saudi royal family, argues in the latest issue of Jane's Intelligence Review that the risk of a successful attack on oil facilities remains “very low”. He explains: “At any one time, there are up to 30,000 guards protecting the Kingdom's oil infrastructure, while high-technology surveillance and aircraft patrols are common at the most important facilities and anti-aircraft installations defend key locations.” Mr Obaid claims that the Saudi government has added $750m over the past two years to its security budget (which totalled $5.5 billion last year, according to him) specifically to fortify the oil sector.
A sitting duck?
Kevin Rosser of Control Risks Group, a business-risk consultancy, agrees. He observes that there is plenty of redundancy built into the Saudi network—through multiple ports, pipelines and excess capacity—that should ease the blow from any attack. Besides, he insists, to do any real damage terrorists would have to hit bottlenecks, not just blow up random bits of pipeline. Mr Rosser quips that, “the golden goose is not a sitting duck.”
Maybe so, but other security experts think that goose may yet be cooked. James Woolsey, a former head of America's Central Intelligence Agency, is unimpressed by talk of improved security: “Guards and fences are easy to put up, but they don't defend against the real threats.” Trucks have to come in and out of facilities, he observes, and Aramco employees and security guards have to move about. He thinks that several attacks, if co-ordinated by terrorists who have infiltrated Aramco, could cripple the Saudi system.
How, exactly? Robert Baer, an intelligence expert, offers some suggestions in his disturbing recent book, “Sleeping with the Devil”. He reckons that Ras Tanura, a port on the Gulf, is a vulnerable terrorist target. With an output of perhaps 4.5m bpd, this is the biggest oil-exporting port in the world. Mr Baer thinks a small submarine or a boat laden with explosives (as happened in October 2000 with the attack on the USS Cole off the coast of Yemen) could knock out much of Ras Tanura's output for weeks, or even longer.
An even scarier possibility raised by Mr Baer is the crashing of a hijacked aeroplane into Abqaiq, the world's largest oil-processing complex. If done with the help of insiders, he speculates that the facility's throughput (nearly 7m bpd, on his estimate) would be choked off to as little as 1m bpd for two months—and might remain as low as 3m bpd for seven months.
Mr Woolsey adds that an attack using weapons of mass destruction (especially “dirty bombs”) would be even more devastating than one that used mere aeroplanes. All told, the pessimists reckon that well-co-ordinated attacks could take as much as 6m-7m bpd of Saudi output off the market for weeks, and perhaps longer.
How would the world oil market react to such a blow? The world is clearly better equipped to handle a supply shock than it was during the turbulent 1970s. For a start, the rich world is much less energy intensive. Unlike three decades ago, OECD countries now maintain large “strategic reserves” of petroleum, and co-ordinate the release of these during emergencies through the International Energy Agency (IEA). The rise of energy futures markets over the past two decades also offers some scope for the world to deal better with short-term price shocks.
Even so, there is good reason to worry. The unprecedented prospect of Saudi Arabia under attack from within exposes the vulnerabilities of the world's two chief forms of insurance against oil shocks: IEA stocks and Saudi swing capacity.
As chart 2 reveals, strategic petroleum stocks (which are stored in such places as salt domes in Louisiana) cannot be drawn down all at once. If a loss of Saudi output is anything like as long-lived as Mr Baer fears, or if other Middle Eastern output is also lost at the same time, then strategic stocks may prove inadequate. Prices will soar, and the market will return to equilibrium only through painful cuts in consumption and accompanying losses in economic output and welfare.
The more troubling revelation surrounds Saudi swing capacity. There is the obvious point, of course, that this particular insurance policy will not be worth very much if there is a serious supply crisis inside the kingdom. However, even if the horror scenarios never happen, the global spare-capacity crunch is still alarming.
Amy Jaffe of the Baker Institute, at America's Rice University in Texas, observes that in 1985 OPEC maintained about 15m bpd of spare capacity—about one-quarter of world demand at that time. In 1990, when Iraq invaded Kuwait, OPEC still had about 5.5m bpd of spare capacity (about 8% of world demand). That, argues Ms Jaffe, meant that the cartel could easily and quickly expand output to absorb several disruptions at once.
That is simply no longer true. Today's fast-shrinking spare capacity of about 2m bpd is less than 3% of demand—and it is entirely in Saudi hands. And yet, “normal” threats to supply that fall far short of doomsday terrorist scenarios remain. Venezuela and Nigeria both face political tests in coming weeks that could cripple oil exports. The coalition in Iraq is due to hand over power to local authorities at the end of June, and terrorist attacks are possible. Whether the Saudis can handle the consequences of all this is entirely unclear.
And yet somehow they must. There is little chance that the Saudis will be dislodged as swing producer anytime soon, even by a resurgent Iraq. One reason is cost: the Saudis sit atop the cheapest reserves in the world. Another is the fact that Saudi oil remains in state hands. Aramco does not have to justify to shareholders the billions it wastes on idle fields—a luxury that privatised Russian firms and western oil majors do not enjoy. Even if Iraqi oil remains in state hands, as appears likely, a cash-starved independent Iraqi government could not justify developing fields that will remain idle.
A witch's brew
Of course, disaster might not happen. The Middle East may cool down, Osama bin Laden may be nabbed and al-Qaeda disrupted, and a speculative bubble in American gasoline may burst. Oil prices could yet moderate. If they do, however, it would be wise to remember just how precariously the world's oil markets are balanced now—and may again be in future, if things take a wrong turn in Saudi Arabia.
A witch's brew of soaring oil demand, private-sector destocking and lack of investment in new production capacity by OPEC has left the world with an extraordinarily tight oil market today. There is less spare capacity than at almost any point in the past 30 years. As Edward Morse, an energy expert at HETCO, an oil-trading firm, puts it: “The world has been living off surplus capacity built a generation ago, and thought it could get by. It turns out not to be the case.” Building a new surplus will inevitably take a long time. Until then, the potential instability of Saudi Arabia's oil supply will remain a strategic weakness for the world economy.