On gasoline prices, President Obama is starting to learn the lesson of his predecessors. The quickest way to lower gasoline prices is by calling on Saudi Arabia.
For three decades, US presidents have called on Saudi Arabia to get them out of an oil price bind. Saudi Arabia helped President Ronald Reagan get a leg up in the Cold War by dumping oil prices in the mid-1980s, thereby putting the finishing touches on an ailing Soviet economy. The Saudis similarly ramped up supplies to assist President Bush Sr.in driving Iraq out of Kuwait with little cost at the US gasoline pump.
Now the Obama administration is also trying its hand at Saudi oil diplomacy. Deputy Secretary of Energy Daniel Ponemon at the sidelines of the International Energy Forum called for increased oil production to relieve tight global oil markets.
The Ponemon public diplomacy is an acknowledgement by the US administration that crude oil prices are the single largest determinant of the fate of US retail gasoline prices, and that talk of alternative energy is not a here-and-now solution to the negative impact rising gasoline prices can have on the US economy.
Saudi Arabia has responded to calls for calmer markets by vocally advertising that it is increasing oil production and building a large stockpile of oil outside the precarious Strait of Hormuz bottleneck. Oil traders have generally failed to recognize this very significant shift in Saudi oil policy, but they need to take it on board. Saudi Oil Minister Ali al-Naimi was quoted in early March as saying Saudi Arabia was storing “additional quantities of crude oil” in strategic stockpiles in Europe, Japan and Egypt. The stored oil will allow the kingdom “to better meet any additional call on its production.”
This policy of strategic storage is reminiscent of past decades when the US-Saudi alliance was better coordinated and more effective and reflects new changes in the Saudi royal hierarchy, as well as improved bilateral diplomacy and stronger confluence of foreign policy interests. Floating stocks were a pivotal tool in the Saudi oil price war in the 1980s and again in preventing oil price rises after Iraq invaded Kuwait.
Perhaps one reason why the buildup of Saudi strategic and floating stockpiles has not done more to lower oil prices is that oil markets do not understand the large size of the oil being put aside outside of the Strait of Hormuz for a rainy day. The kingdom is going to have to be less vague if it is going to be effective.
Saudi Arabia’s promise to replace lost oil production from Libya, whose internal turmoil cut its exports, did not fully materialize. State oil firm Saudi Aramco used the excuse that the market demand was already being “addressed by others,” with the Saudi oil industry claiming customers were not making requests for additional oil. But clearly, Saudi non-competitive pricing of those barrels negatively impacted their desirability to refiners. A later release of strategic stocks by the US and the International Energy Agency was oversubscribed in the market, calling into question the concept that there was no demand for extra oil.
More recently, the kingdom appears to be making more serious efforts to push its oil into the market in an effort to dampen escalating prices. Last year, more Saudi oil, sold from Asian storage, appeared to be showing up in oil markets, including three cargoes arriving to the west coast of the US.
Saudi Aramco has been steadily increasing its production. In speaking to reporters during a trip to India in late February, Saudi Deputy Oil Minister Prince Abdul-Aziz bin Salman suggested that February’s level of Saudi production was in line with January’s output, with the Saudi oil official telling reporters that his country is producing 9.8 million b/d and has 2.5 million b/d of spare capacity. The Saudi government has suggested that its output has remained at 9.8 million b/d or above since this past November, when Saudi production reached a near-record 10.047 million b/d. According to Prince Abdul-Aziz, “we have demonstrated to our friends here how much excess capacity there is today and how much capacity will be there in the future.” Industry estimates put exports in the week ending February 24 at just over 9 million b/d, implying production levels of more than 11 million b/d, factoring in domestic consumption.
Oil Minister al-Naimi announced in mid-January that Saudi Arabia could increase oil output by around 2.5 million b/d within roughly 90 days from just below 10 million b/d. In an interview, the Saudi oil official commented that, “we can easily get up to 11.4, 11.8 [million b/d] almost immediately in a few days …. All we need is to turn valves.” Al-Naimi went on to say that the kingdom could pump a further 700,000 b/d to reach full capacity of 12.5 million b/d within 90 days.
Thanks to a three-year contract signed between Tokyo and Riyadh in December 2010, Saudi Arabia has leased storage tanks in Okinawa from Japan Oil, Gas and Metals National Corp. Diplomatic correspondence as revealed on the Wikileaks website also indicates that Saudi Arabia made an explicit pledge to offset any losses of Iranian crude imports China might experience with Saudi barrels, and it is believed that the kingdom has utilized other storage in Asia to ensure its Asian customers have adequate supplies if Iran temporarily closes the Strait of Hormuz or if Iranian exports get cut off.
The kingdom also has underground storage of oil for military purposes. The Saudi government in the mid-1980s began looking at the idea of building underground strategic petroleum reserves in the kingdom to protect against supply disruptions in the event of a future attack on key oil installations or the need to tap into additional supplies in an emergency. The result was the $2.9 billion Saudi Strategic Storage Program, involving the construction of five underground storage facilities at Riyadh, Jeddah, Abha, Medina and Qasim, with total capacity of 12 million barrels. The first facility at Riyadh was completed in 1999, and the final site at Qasim was officially handed over to Saudi Aramco in 2009. The sites were designed as cavern tanks located at depths of up to 190 meters below ground. The program also involved the construction of 700 kilometers of pipelines, some of which link to the Red Sea port of Yanbu, which is outside any risk to the Strait of Hormuz. The domestically stored oil is yet another avenue for Saudi Arabia to supply more oil to the market in the event of a major disruption in supply.
There are also indications that Saudi Arabia has oil stored on tankers outside the Strait of Hormuz that could be rapidly deployed in a market emergency. Thus, oil speculator assumptions that a Saudi response in the event of war or other disruptions is limited solely by its “at home” oil production capability of around 11.5 million b/d are miscounting barrels. The best Saudi policy to calm markets is transparency. And for the Obama administration, diplomatic coordination with Saudi Arabia on managing oil market expectations needs to come up a notch.