Tuesday, May 17, 2005

CSIS Oil Conference

There was quite a big conference at CSIS in Washington today. Speeches were given by Saudi Arabian Oil Minister Ali al-Naimi, the new US Energy Secretary, Samuel Bodman, and Senator Jeff Bingham. Apparently Jeff Bingham (D, NM) was the minority member on the Senate Energy and Natural Resources Committee in 2003 - presumably he still is, I haven't come across him before.

Naimi's speech (pdf) contains quite a bit of useful information, though his allusions are a little opaque if you're not familiar with the oil market.

He begins by pointing out that while oil producers are committed to being environmentally friendly, environmental regulations in OECD countries have made it difficult for oil producers. Local opposition to the construction of oil infrastructure, combined with the lack of investment in the sector during the era of USD$10-$15 oil, has "tended to reduce flexibility in the system creating situations where isolated supply/demand imbalances become magnified, affecting world price levels."

This is a pretty explicit description of what has become the Saudi position on the state of the oil market, and I have to say I agree with it. The period of cheap oil coincided with the progressive introduction of fairly stringent environmental regulations on oil products, not least in the imposition of sulphur limits. Since there was ample supply of sweet (low sulphur) oil in the market during that period and oil was cheap, few companies thought fit to invest in refineries which can process sour oil. The last two years, however, saw Indian and particularly Chinese demand increase significantly, and refiners suddenly found that the price of light sweet oil was rocketing. Because few had the capacity to process sour oil, sour oil started trading at quite an increasingly large discount to sweet oil, and those refiners that could process sour made a killing running their refineries at full capacity and taking advantage of the high petrol prices.

The differentials between sweet and sour seem to be easing slightly at the moment, but the Saudi government has taken the issue very seriously - at a previous appearance at CSIS, Naimi offered to build two refineries in the US (presumably ones that could deal with sour crude). He was told that he'd be lucky to get them past environmental regulations. So Saudi Aramco is now spending US$5bn building a refinery in Yanbu. It is also investing in refineries in India and China. I'm under the impression that it's more cost effective to ship crude than refined products, hence the Saudi interest in building refineries at the target markets rather than refining at home and shipping the products, so I imagine that the Chinese and Indian refineries will be able to deal with sour crude as well.

Next Naimi moves onto concrete policy directions. I'll go through them one by one.

a) Increase global crude production capacity.

There isn't much spare capacity left in the world, because most countries with oil produce at full capacity because they're desperate for the cash. Only Saudi Arabia and UAE have room to expand, and they're both investing to do just that. KSA is already running at full capacity, though they don't like to advertise the fact, and they're investing in an additional 2.2m bpd to take their capacity up to 12m bpd.

b) Address downstream bottlenecks

That's pretty much the refining issue which I mentioned above. There is also the question of tankers, which are in scarce supply just at the moment. In October 2004 KSA put an order in to Hyundai for 6 tankers worth US$380m.

c) Upgrade Saudi energy infrastructure

This is interesting. They're investing to increase capacity to produce oil derivatives, which are going to be useful if Saudi industry ever takes off in a meaningful way. Whether there's scope for export I'm not sure, but it'll be interesting to check that out.

d) Improve efficiency and conservation

This is quite an important policy. Oil is Saudi's legacy, its great gift and curse. They need to focus on how to make the most of it. Greater efficiency, whether on the production or the consumption side is going to make the oil last longer; conservation may well mean that KSA will be less willing to push its fields hard for the sake of bringing prices down. There are already suggestions that some damage may have been done to some of the reservoirs by pushing them too hard (a problem Iraq is currently facing rather acutely).

e) Improve transparency. Naimi mentions that they put up a building so that the International Energy Forum Secretariat in Riyadh, though to be honest I'm not entirely sure what the forum achieves - it's an elite talking shop, not a negotiating arena (according to the RIIA), and it has been slated for not producing much of any real use. Though there's something to be said with increasing communication between producers and consumers, which would help to filter out some of the speculative froth that has been making oil prices particularly volatile. To that end, the Joint Oil Data Initiative would be a particularly useful step. It has been talked about for rather a while, though, and as of yet the database is still in development, you can't use any of the information in it, and you need a password to get at it. All of which means that it is having precisely no effect on the market, which is precisely where the information is needed. Pricing is just coded information signals, after all.

f) Expand human capital in the industry

This is pretty standard, actually - Saudisation and so on.

g) Innovate technologically

Also fairly standard, but also rather crucial. Minimising oil left behind (that is, the oil they can't get out of the reservoirs at an economic price) means investing in more advanced technologies. Finding more oil and making existing unextractable oil (at current economic conditions) extractable also means investing more in technology.

The first thing that strikes me about Bodman's speech is that it's printed in huge type with a large white space at the bottom for him to hold it. Good thinking, I always seem to end up squinting at the page when I'm giving a presentation.

More seriously, his speech is more diplomatic (I don't mean 'soft', I mean instrumental). He basically says that the US appreciates Saudi efforts but that it's going to invest large amounts of money in alternative energy because a) pricing is too volatile and b) it's a finite resource. I'd read that not only as a statement of intent but as a veiled threat to KSA - as in, 'improve your game or we'll have no choice but to stop playing'. In the nicest possible way, of course, but why else talk about alternative energy sources at length to an ally whose only real strategic value is its energy resources and attendant financial clout? KSA needs to start being a lot more open with its data, first and foremost - that is the single thing that would take a lot of froth out of the markets. At the moment speculators are able to feed quite nicely off the oil depletion trope, which although not inaccurate is more than slightly overegged - a 40-year window is still rather a long time, given the rate of technological advancement in this day and age.

I'm leaving Bingham's speech, he seems just to say that he's glad KSA is taking the US' issues seriously and so on.


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