[A-List] Saudi Arabia: "in chaos"

["Michael Keaney" <michael.keaney@xxxxxx>]

Oil kingdom 'in chaos' unnerves markets and threatens health of global
economy
High prices and terrorist threat in Saudi Arabia prompt fears about
disruption to supplies
By Saeed Shah and Philip Thornton
The Independent, 11 May 2004

The rupture in US-Saudi oil relations over the last three years has left the
markets wondering: what if production from the Kingdom was disrupted or
taken out altogether?

Although the Saudis provided a helpful statement yesterday, saying they
would push Opec to raise production, the fact is that the country's regime
has been willing to tolerate much higher oil prices in recent times ­ even
in a US election year. That has been a major breach with past policy and it
has left Opec's official target range of the oil price ­ of $22 to $28 a
barrel ­ looking irrelevant.

Saudi Arabia is the leader of Opec, it is the world's biggest producer and
it is sitting on a quarter of the globe's oil reserves. It is no
exaggeration to say that, given the importance of oil, the health of the
global economy rests on the maintenance of supplies from this despotic
Middle Eastern kingdom.

Leaving aside Saudi Arabia's shift in policy, more worrying still for the
West is the prospect that terrorist attacks on Saudi soil ­ which we have
seen directly target oil facilities ­ or a change of government could
seriously dent the country's output.

Mai Yamani, an expert on Saudi Arabia at the Royal Institute of
International Affairs, says that political tension, rising violence and
division among the princes of the ruling House of Saud, means that the
country is in "chaos".

"Certainly the violence is going to increase.... It is the beginning of the
end [for the regime]," Dr Yamani says.

There is little in the way of a liberal opposition to the authoritarian Saud
regime, leaving the extremists the likely successors if the government did
fall. However, analysts are united in believing that any regime in Saudi
Arabia would need to export oil.

Valerie Marcel, also of the Royal Institute of International Affairs, says:
"There is very little chance of a new regime that would not sell the oil.
What else would it survive on? Ninety per cent of government revenues come
from oil exports."

Although Dr Marcel gives a much higher chance of survival to the House of
Saud, she says the Government must overcome major obstacles. "Saudi Arabia
is facing some very serious challenges in the next 10 years. The population
will double by 2020. Many more jobs have to be created, the economy must be
diversified," she said.

With Iraq in turmoil, and big political troubles in Nigeria and Venezuela,
two other major producers, the markets have been spooked by the
possibility ­ however remote ­ of a further destabilisation of Saudi Arabia.

Analysts point out that markets are driven by perception, as well as
reality. So an avowedly anti-Western regime in Saudi Arabia, even if it
continued to export similar levels of oil, would be likely to add a risk
premium to the price of oil. And there may be relatively small changes in
the supply of oil from Saudi Arabia that can often cause huge swings in the
price.

Jamal Qureshi, of PFC Energy, a US consultancy, points out: "So much of the
[oil] market trades at the margin. It's the amount of cushion that makes an
impact."
A Saudi government unsympathetic to US and other Western interests, could,
for instance, stop the current practice of supplying the US at a discounted
rate or not take on the current role of Saudi Arabia as the "swing producer"
that maintains spare production capacity to plug any shortage in supply.

There has been a break in US-Saudi relations, particularly since the 9/11
terrorist attacks led Americans to question how close it should be to the
Kingdom ­ some even see this as the real reason for the American invasion of
Iraq.

For its part, the Kingdom has seen that serving US interests threatens its
position at home with its own population and its anti-Western clerical
establishment. Furthermore, unlike in the past, the Saudi Government needs
oil cash to shore up its strained finances.

Compared with the 1970s, which produced two "oil shocks", the amount of
world oil that Opec produces has reduced from more than 50 per cent to less
than 40 per cent now, as production from countries outside the cartel has
risen. And we should remember that, in real terms, $40 oil today means a
much lower price than it did in the 1970s.

However, the enduring power of Opec has been shown in the last three years
by its ability to successfully keep the price of oil high. Although Opec is
currently producing some 28 million barrels a day, of total world output of
some 80 million barrels, only the cartel has spare capacity.

Opec could pump out another 3 million barrels a day ­ of which Saudi Arabia
could provide 2 million extra barrels. As well as the geopolitical fears, a
tight fundamental supply-demand situation has seen a high price maintained
in recent times ­ culminating with the oil price hitting a 13-year high of
$40 a barrel last week.

So if increased output is required to moderate the high price of oil, it is
Opec and, most importantly, Saudi Arabia, that must provide it.

Saudi Arabia's intervention yesterday, calling for Opec to raise output by
1.5 million barrels a day, shows that even it has become concerned about the
threat to global growth from high oil prices ­ lower growth would mean lower
oil demand.

Rising oil prices have a triple-barrelled impact on the economy. Their
immediate impact is to cut consumers' disposable income, as rising petrol
and energy costs leave them less cash in their pockets to spend on goods and
services. At the same time, many of those businesses that are hit by a fall
in demand are also pummelled by a surge in their raw material costs.

Lastly, rising oil prices push up inflation as businesses raise their prices
and workers demand higher wages to offset their sagging incomes, forcing
central banks to raise interest rates.

Andrew Oswald, a professor of economics at the University of Warwick, said
the West had become too complacent about the role of oil prices in booms and
busts. He believes he was proved correct when the collapse in oil prices
coincided with an economic boom in the US in the 1990s that ­ mysteriously ­
came to a halt as oil prices tripled within the space of three years.

He dismisses arguments that oil no longer matters because of the fall in the
amount of economic wealth now spent on oil. "That's not a sensible
argument," he says. "You should remember that the modern world runs by
moving things and people and that 95 per cent of everything that moves,
moves because of petroleum."

He said the arrival of China as a global economic powerhouse would force
analysts to revise their forecasts. Professor Oswald said a country four
times the size of the US was using just a quarter of the amount of oil. "As
China becomes as industrialised as the US, none of the oil arithmetic will
add up any more," he said.

Raghuram Rajan, an economic counsellor at the IMF, said last month that
every extra $5 on a barrel of oil would cut world growth by about 0.3 per
cent. "It is worrisome that supply conditions are not slack enough,
especially if one major producer is withdrawn perhaps because of
geopolitical conditions," he said.

Oil prices have jumped from $30 to £40 a barrel in just five months, almost
perfectly tracking the build-up of armed resistance to the American presence
in Iraq. "Oil prices at $50 would tip us into a world recession ­ not a
1970s style recession which was the worst for 100 years ­ but certainly
serious," warns Professor Oswald.

The oil arithmetic, and with it the success of the global economy, rests on
Saudi Arabia. That is an awful lot to rest on the continuation of a brutal
regime that is under increasing threat from its own people and that has lost
its key alliance with the United States.