Iran's Reshadat oil field

Saudi Arabia and extra oil output; challenges & restrictions

SHANA – The US withdrawal from Iran’s 2015 nuclear deal with six world powers and Washington’s attempts to cut Iran’s oil exports to zero have raised serious questions about the future of energy market and possible fluctuations and shocks in the oil market.

Well mindful of the consequences of this policy, the US government recently announced it would tap its Strategic Petroleum Reserves (SPR) to compensate for shortages in the market once sanctions against Iran’s petroleum sector have snapped back into place.

The Trump administration has left no stones unturned and ratcheted up the pressure on OPEC member states in a bid to win them over in its anti-Iran oil policy. Traditionally close ally of the US, Saudi Arabia is counted on by President Trump for maintaining oil market balance.

Due to political hostilities, Saudi Arabia has every reason to be on the US side in its anti-Iran campaign; however, Saudi is faced with numerous restrictions and challenges for oil production and exports.

Challenges & Restrictions

In case the US manages to reduce Iran’s oil exports to zero, other oil producers will have to supply 2.7 mb/d of oil on a sustainable basis. Saudi Arabia has welcomed the US decision, but the fact is that Riyadh is facing a variety of restrictions and challenges in that regard.

Since Saudi energy policies have always appeased the US and Western governments, most energy centers have been widely covering Saudi Arabia’s claims in a bid to introduce it as OPEC’s kingpin and world oil market leader.  That is why the International Energy Agency (IEA) has released unrealistic and exaggerated predictions about Saudi oil output on many occasions. Saudi Arabia has for years ranked the first in the world in terms of crude oil reserves and production capacity; however, realistic forecasts call into question data presented about the Arab nation’s crude oil reserves. In its Changing Wealth of Nations 2018 report, the World Bank has said that Saudi Arabia would have oil for 80 more years, which is far less than the survival rate given for Iran, Venezuela, Libya, Canada, Iraq, Kuwait and the United Arab Emirates (UAE).

Saudi officials are undoubtedly well aware of their genuine data about oil reserves. They cannot simply jump into the fray and supply more oil to reduce their own reserves. In fact, the Saudis’ long-term policy of political and economic exploitation of oil would pose a serious obstacle to their unbridled use of oil resources.

Over recent years Saudi Arabia has sought to apply cutting edge technology in order to develop its newly discovered oil fields and maintain its production levels. But in practice, despite the large number of oil fields, such challenges as production falloff and large quantities of oil water are threatening the country’s future crude oil production.

Currently, rarely can a Saudi oil field be found to have been exposed to vertical drilling. Furthermore, oil fields that have been developed since the 2000s onward, have managed only to make up for part of production falloff in aging oil fields to relieve pressure on such fields.

Oil production hike by Saudi Arabia for politically motivated reasons under different circumstances has seriously harmed oil output in this country, causing a slump in oil production rate while increasing oil water. Therefore, any future attempt by Saudi Arabia to enhance output would be costly for Riyadh, which would even inflict more harm on its petroleum industry. Saudi Arabia has only 200,000 b/d of extra capacity.

Influencing Prices

Saudi Arabia is also facing restrictions when it comes to dipping into its strategic oil reserves to keep the market under control. It must be always kept in mind that any increase or decrease in strategic petroleum reserves would significantly change the price of this product. As soon as there is talk of supply of strategic oil reserves on the market, prices go into fluctuation. In other words, the psychological impacts of the supply of such reserves on the market are more significant than its real impacts. The higher the level of strategic oil reserves the lower oil prices will be. Therefore, once the volume of strategic oil reserves declines, oil prices would go up. It means that in countries like Saudi Arabia, where strategic oil reserves largely contribute to energy pricing, any decline in the strategic reserves would give rise to a negative atmosphere which would finally boost prices. Releasing the strategic reserves into the market may boost oil supply; however, the impact of rainy day reserves may be negative and drive prices up significantly. Therefore, tapping strategic oil reserves to supply more is intertwined with its special complications and therefore these reserves may not be simply used for regulating oil markets.

Aside from the aforesaid challenges, even if the idea of increased output works properly and oil prices decline Saudi Arabia would then face a big challenge because it would see its petrodollars, which make up more than 70% of its economy, fall to very low levels. That would definitely threaten attempts by Crown Prince Mohammad bin Salman who has embarked on reforms to boost his popularity prior to ascension to the throne.

Therefore, the Saudi regime is not much willing to see oil prices fall in the status quo. In the meantime, another important point is that any increase in oil production and exports by Saudi Arabia would be in contradiction with agreements reached within the Organization of the Petroleum Exporting Countries (OPEC).

Saudi Arabia was among leading OPEC members to bring up the idea of oil freeze in a bid to help boost prices following the 2014 crash. Therefore, any attempt by Saudi Arabia to release oil from its strategic reserves would draw negative reaction from fellow OPEC members and even non-OPEC countries participating in the “Declaration of Cooperation” in favor of prices.

Saudi Arabia is facing a sensitive choice; either it will cooperate with fellow OPEC members and non-OPEC producers or it will join US unilateral sanctions on Iran. In the latter case, oil production by Riyadh will face tough restrictions.