A FORMER senior energy official of the United States has revealed that a critical battle for domination of oil market is currently raging between Saudi Arabia and Russia as an important offshoot of September 11.
And this battle will have fundamental consequences for the world’s economy, America’s energy security, Russia’s global role and, most importantly, the future relevance of Saudi Arabia.
Edward L. Morse, who served as deputy assistant secretary of state for international energy policy from 1979 to 1981 has, in an article appearing in March-April 2002 issue of the prestigious “Foreign Affairs” magazine, also indirectly suggested that Washington’s blessings in this strife are with Moscow confirming fears that America is now determined to reduce its dependence on Saudi oil. He observes :”The time has come to recognize that September 11 has opened new vistas for Russia, the United States and OPEC... If both Washington and Moscow encouraged what their (oil) companies and publics already do - increasing production in both countries while restraining demand in the US - the stage could be set for a very new petroleum world.” The write-up is co-authored by James Richard, an investment expert.
The article — a comprehensive but a biased narrative of the oil sector developments — reflects loud-thinking of America’s policy-makers in the wake of post-9/11 tensions between Washington and Riyadh: the latter seeking decrease in US military presence in the Kingdom and the former determined to extend its “war on terrorism” into the Arab world.
The problem is that the conflict the America is currently involved in has its roots in the Middle East but it is not willing to recognize and remove the causes of the conflict. An easier option is to re-examine its relationship with Saudi Arabia — increasing distance with the royal family and exploring new, more secure sources of energy supplies. But it is a long-term process and could be overtaken by events that none can foresee yet. It goes without saying that the US has historically viewed oil as a national security concern and organized its foreign and military policy around the protection of oil. That gets America involved in local situations which sometimes get violent.
The contest for oil market supremacy between Riyadh and Moscow is two-years old but had emerged suddenly and unexpectedly. It was seen to have been resolved by the end of 2001 but has aggravated again. For each of the past two years, Russia has been quietly increasing its annual oil output at a rate of nearly half a million barrels a day (mbd) — the largest single increment of increased output of any country in the world. With the world oil demand stagnating, Saudi Arabia and its OPEC partners had opted to reduce their output by 3.5 mbd. Then, on January 1, 2002, OPEC cut output by another 1.5 mbd to prevent a price collapse. Even though Moscow made a symbolic cut in output as well, OPEC has not welcomed Russia’s gain at the cartel’s expense.
Not surprisingly, Moscow’s motivations are being questioned and are often seen as an attempt to grab power in the global arena. But Russia’s petroleum revival has also coincided with the terrorist attacks of September 11, which have provided Moscow a chance to displace OPEC as the key energy supplier to the West. Moscow’s political leaders, as well as its corporate leaders in oil and gas, are portraying Russia’s oil firms as stable sources of supply, willing to add output to the market to keep prices reasonable and thus revive the global economy. According to Edward L.Morse, “Moscow is poised to assume a far more significant position in the world petroleum sector than ever before”.
In the eyes of Russian leaders, the new geopolitics of energy can help Moscow gain both economically and politically. In economic terms, energy production lets Russia integrate itself into the industrialized West. In political terms, energy resources can help Moscow become a key partner of the United States.
The U.S. Department of Energy and the International Energy Agency say that global oil demand could grow from the current 77 mbd to 120 mbd in 20 years. The agencies assume that most of the supply required to meet this demand must come from OPEC, whose production is expected to jump from 28 mbd in 1998 to 60 mbd in 2020. Virtually all of this increase would come from the Middle East, especially Saudi Arabia. A simple fact explains this conclusion: 63 percent of the world’s proven oil reserves are in the Middle East, 25 percent (or 261 billion barrels) in Saudi Arabia alone.
Given the size of the Saudi oil sector, the kingdom has a unique role in setting world oil prices. The critical balancing act of Saudi foreign policy is to maintain oil prices within a reasonable price band. Stopping oil prices from falling below the minimum level and preventing them from rising too high requires keeping enough spare production capacity to use in an emergency. In today’s soft market, in which Saudi Arabia produces around 7.4 mbd, the kingdom has close to 3 mbd of spare capacity.
Edward Morse describes Saudi spare capacity as “the energy equivalent of nuclear weapons”, as it is a powerful deterrent against those who try to challenge Saudi leadership and Saudi goals. It has also been the centrepiece of the U.S.-Saudi relationship. The United States relies on that capacity as the cornerstone of its oil policy. That arrangement was fine as long as U.S. protection meant “Riyadh would not blackmail Washington” — an assumption which, Morse thinks, is more difficult to accept after September 11. He is also convinced that Saudi Arabia could use this weapon if Moscow ignores Riyadh’s requests for cooperation.
The hard fact is that Riyadh’s relations with Washington are much more complex than they appear on the surface, because they involve unspoken understandings. September 11 has complicated these understandings, because elites in both countries are suspicious of the cooperation between the two governments. Today, Saudi Arabia supplies around 1.7 mbd of the roughly 10 mbd imported into the United States — a market share higher than that of any competitor.
The Kingdom maintains this share to show how important Saudi supplies are to the United States. The Saudi leadership can thus expect that Washington will help defend Saudi Arabia, its oil fields and territorial integrity.
Saudi Arabia pays a price for this. Saudi Aramco, the state oil company, earns about $1 a barrel less on sales to the United States than on sales to the countries of Europe and East Asia. That discount translates into a subsidy to U.S. consumers of $620 billion per year. In return, the United States deploys military forces in the Persian Gulf. To the degree that Washington decides to reduce the U.S. economy’s dependence on oil, the Russian challenge to Saudi Arabia can become a reality.
Russian oil exports began to rise in 2000 for the first time since the Soviet era. By the time Vladimir Putin was elected president in March 2000, Russian firms were ready to capitalize on the internal reforms that they had begun years earlier. The CIS oil sector is now expected to increase exports by at least 2 mbd between 2002 and 2006. Until September 11, the United States pursued two often conflicting goals: encouraging Russia to better protect U.S. corporate investments in the Russian energy sector, and assisting the Caspian countries in developing and exporting their own hydrocarbons, thereby avoiding pipeline routes through Russia. Events are now squaring the circle.
The emerging battle for market dominance between Russia and Saudi Arabia is a clash between two extremely different cultures and involves radically different agents.
The Russian government has extremely limited powers over how Russian firms allocate their sales or investments. Moscow can encourage or limit access to pipelines under government control, but it cannot control what companies do. In contrast, Saudi Arabia is governed by a royal family that sees its interests as part and parcel of the state it rules.
When Saudi Arabia and other OPEC members sought Russian cooperation last year in managing the international oil market, they were seen having a wrong view of Moscow’s position. The Saudis did not understand the new Russia whose government was too weak to actively limit the country’s oil exports. Nor was Moscow so dependent on oil revenue that it had to cooperate with the Saudis. Thus Riyadh made a tactical error: it threatened Moscow with a price war. Moscow’s reaction was calculated. Some Moscow officials therefore welcomed a price war.
However, both sides decided to declare a truce by the end of 2001. Russia thought that cooperating with OPEC and other independent oil producers was in its best interest — for now. Despite the truce, however, the battle is not over.
When it comes to compliance in preventing overproduction, Moscow and Riyadh remain suspicious of each other. It seems that the policies pursued by Moscow and by Washington will restructure the battlefield.
Russian oil is not as large in its reserve base or as cheap to produce as Saudi crude, but market forces are, at the moment, on Moscow’s side and will enable it challenge OPEC and Saudi Arabia. In a free market economy, Russian companies are, hence, poised to capture the lion’s share of growth in demand, thanks to Washington’s long-term strategic interests. And for Saudi Arabia, in such a situation, to afford a sustained price war to block Russian and CIS oil development may be a risky proposition.
