Regime Change for OPEC?

From The Economist
May, 2003

The fall of Saddam Hussein is already spelling trouble for OPEC and its leader, Ali Naimi. Will the defeat of Saddam Hussein bring about regime change in the world's oil market? Ever since the inflationary oil shock of the early 1970s, overseen by Zaki Yamani, a Saudi Arabian sheikh, gas-guzzling Americans have dreamed of smashing the OPEC cartel.

Some of the oil men close to George Bush privately fantasise about how a pro-American and privatised Iraqi oil sector might, within a decade or so, crank out so much oil that Saudi Arabia, which in effect runs OPEC, would lose its market power. The world would be awash in cheap oil, priced by the forces of supply and demand, not by the anti-western price-fixers now led by Ali Naimi, the Saudi oil minister and de facto boss of Saudi Aramco, a state-owned firm with more than 20 times the oil reserves of Exxon Mobil.

Such fantasies may not be far-fetched, judging by the ructions in the oil market since the end of war in Iraq. For a start, OPEC called an emergency meeting in Vienna on April 24th to deal with the fact that the Iraqi war went so swiftly. In anticipation of huge supply disruptions, members of the cartel had flooded the market with oil-which now threatens a price collapse. Two days earlier, Yukos, a big Russian oil firm, said it would buy a local rival, creating an oil giant bigger than France's TotalFinaElf. So it is not just Iraq that may threaten the Saudis; Russia is also becoming a contender. A final blow seemed to come from within Saudi Arabia: well-sourced rumours this week suggested that Mr Naimi is about to be forced out of office.

If this week's OPEC meeting is Mr Naimi's last, the oil world will lose its biggest hitter since Mr Yamani. Mr Naimi's influence has derived not from royal blood-the Saudis prefer a non-royal as oil minister-but from his technical expertise and his canny management of the oil market. When a price plunge in the late 1990s shocked and (relatively) impoverished OPEC, Mr Naimi worked with Venezuela's then-new leader, Hugo Chavez, to revive the cartel with concerted production cuts. That lifted prices from around $10 a barrel in 1998 to nearly $30 a year later, saving Saudi Arabia from financial disaster. The kingdom earned over $80 billion from oil in 2000, its second-highest amount ever, estimates Nawaf Obaid, an expert on Saudi oil.

If Mr Naimi is now on the way out, it is unlikely to be as punishment for the short-term miscalculations that have produced the present glut of oil in world markets. Indeed, reducing that glut will require just the sort of political skills of which he is a master. The trick is not merely to win agreement among OPEC members in Vienna to cut production, but to get them to make the cuts when they go home. Saudi Arabia is the only country that can usually enforce cartel discipline. If the oil market tightens in the next few weeks, it will be because Mr Naimi-or a successor-has cajoled or bullied smaller cartel members into meeting their quotas. However, in this instance, ensuring that cuts happen should be even easier, as most of the recent increase in output is the responsibility of the Saudis themselves. As Michael Lynch of Strategic Energy & Economic Research, a consultancy, puts it: "The market is in the hands of the Saudis, who are over-producing like crazy and should have no problem cutting back to 'normal' at the first sign of weakness." As if to prove the point, Mr Naimi ensured that Saudi Aramco started to reduce its output even before this week's meeting in Vienna.

It is this ability and willingness to turn supply on and off quickly that may enable Saudi Arabia to continue to be the dominant price-setter in the global oil market, whatever American fantasists hope. As Mr Naimi has pointed out, Saudi Arabia maintains an expensive cushion of excess capacity so that it can manage the market. It was this buffer, rather than any non-OPEC production, that came to the rescue when supply was disrupted by events such as the Iranian revolution, the Iran-Iraq war and the first Gulf war. And, as recent weeks made clear, Mr Naimi has used his buffer once again. Neither Iraq-nor, for that matter, Russia-seems likely to develop a similar buffer, despite the market power it brings. To do so would require the investment of many billions of dollars to develop wells that must then be kept largely idle. Russia's mostly private oil firms seem unlikely to waste capital in this way, and Iraq will not be able to do so for many years. Saudi Arabia has the world's largest reserves, and production costs well below Russia's-wags joke that you need only stick a straw in the ground to strike oil. So it could outlast any rival, albeit not painlessly, in a prolonged price war.

Sheikh out

So, why might the Saudis even think of firing Mr Naimi, who has been their oil minister since 1995? The most plausible explanation is that he has lost a power struggle over the role of foreign investment. For years, a faction led by the foreign minister has been pushing to open up the country's natural gas and power sectors to foreign money. Even though this would certainly not involve the full privatisation of Saudi oil into foreign hands, Mr Naimi saw this proposal as an attack on his beloved Aramco and fought it tooth and nail.

He may have lost this battle soon after Saddam lost his. It seems that Exxon Mobil's formidable boss, Lee Raymond, who has long had a testy relationship with Mr Naimi, recently complained via back-door channels to the powers in the House of Saud about the oil minister's obstructionism on the gas deals-suggesting that investment dollars might flow instead to newly liberated Iraq. If the rumours are indeed true, this prospect appears to have worried the Saudi royals enough for them to move against Mr Naimi. Although letting in foreign capital would surely benefit Saudi Arabia-keeping it out never made much sense-it would also be evidence of growing nervousness in the kingdom. That hardly amounts to the end of OPEC. But President Bush's oily friends would be delighted.

Courtesy: The Economist
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