The End of the Saudi Oil Reserve Margin

Riyadh is less and less able to cushion supply shocks as it consumes more and more of its own oil.

By JIM KRANE

Doha, Qatar

President Obama’s sanctions plan on Iran follows an old Mideast policy playbook. Western moves against an oil-exporting country take place with the cooperation of Saudi Arabia. U.S. strategy requires the Saudis to ramp up production and replace Iranian exports in hope of avoiding a damaging spike in prices.

It’s a familiar scenario: At one time or another, the Saudis have been called upon to replace exports from Iran, Iraq, Kuwait and, most recently, Libya. The idea is to have your cake and eat it—to meet U.S. foreign policy goals without disrupting oil markets and antagonizing the American motorist.

But the old playbook may have to be torn up. This time Saudi Arabia is struggling to assume its usual role as the oil market’s swing supplier. This can be seen in current market tightness and in U.S. gasoline prices, which are edging toward $4, a dangerous prospect at election time.

The Obama administration’s sanctions plan acknowledges Saudi weakness. Rather than try to impose a blanket ban, it has introduced piecemeal measures, such as encouraging China and South Korea to demand discounts for continued imports of Iranian crude. For the first time, Saudi Arabia’s vaunted spare capacity appears insufficient to cover the loss of a major exporter.

When revolution last year took Libya’s 1.5 million barrels a day off the market, the Saudis and other producers were able to fill the gap. A slack oil market helped. But Iran has been exporting roughly 2.2 million barrels a day. And now something else is afoot.

Saudi Arabia isn’t the same depopulated petro-state that the West found itself so dependent on in the 1970s. The kingdom and its oil-rich neighbors have seen their populations and industrial bases swell. They have become huge consumers of their own energy. The ruling sheikhs have cemented themselves in power by erecting energy-driven welfare states which provide some of the world’s cheapest electricity, natural gas and gasoline.

With domestic electricity demand rising 10% per year in Saudi Arabia, the kingdom now devours more than a quarter of its oil production—nearly three million barrels per day. International Energy Agency figures show that Saudi Arabia now consumes more oil than Germany, an industrialized country with triple the population and an economy nearly five times as large.

In the medium-term, Saudi Arabia is in danger of losing its all-important “reserve margin” of oil production that so often calms market volatility. Loss of this spare capacity would remove a crucial safety mechanism from the global economy, to say nothing of tying America’s hands when it comes to future moves against oil states.

Longer-term, the kingdom’s very exports are at risk. A projection by Jadwa Investment of Riyadh shows that, at current rates of consumption growth, the Saudi reserve margin will dwindle until it disappears sometime before 2020. At that point, the Saudis would begin diverting oil destined for export into the domestic market.

Following the trend further, Jadwa finds that Saudi Arabia will consume its entire production capacity of 12.5 million barrels per day at home by 2043. London’s Chatham House finds that the kingdom will become a net oil importer even earlier, by 2038.

These projections don’t take into account the possibility that Saudi Arabia’s production could rise above an expected plateau of 13 million barrels a day, or that ruling sheikhs might stop encouraging their citizens to waste energy by dropping some of the world’s deepest fossil-fuel subsidies.

As U.S. drivers are now learning, however, the Gulf countries have limited ability to increase production beyond current capacity, and they show even less ability to curb their domestic demand. When it comes to competition for supply, they will retain a natural advantage. They own the supply.

America’s Middle East confrontations have long depended on Saudi spare capacity. Without it, as the faceoff with Iran already shows, Washington—and the world—will be less free to intervene in the region without raising gasoline prices at home. And unless the Gulf Arab monarchies can gain control of their own consumption, their role in global energy markets will dwindle, as prices grow even more volatile.

Mr. Krane is the author of “City of Gold: Dubai and the Dream of Capitalism” (St. Martin’s Press, 2009). He researches Gulf energy policy at Cambridge University’s Judge Business School.


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