Saudis Adjust Long-Term Oil Strategy

WASHINGTON Jan 10, 2007 (Dow Jones Newswires)

Saudi Arabia's growing fear of Iranian hegemony in the Middle East may be driving the world's largest crude oil exporter to prepare a more aggressive long-term political oil strategy that could subvert an Iranian ascendancy, insiders and analysts say.

Under a new, accelerated production program, the kingdom could increase its spare oil drilling capacity to at least 3 million barrels a day by 2011, up from around 2 million now. Intelligence experts estimate Iran might have the capability to develop nuclear weapons by then. Additional spare capacity could give the Saudis greater leverage as a political tool.

Iran's alleged aim to develop nuclear weapons and its interference in Iraqi and Lebanese politics and conflicts are feeding fears among the Sunni states in the region, particularly Saudi Arabia, that Iranian ascendancy might tip the balance of power towards a Shi'ite domination of the Middle East.

"Fear of an emerging Shi'a crescent has been reflected in speeches by Egypt's President (Hosni) Mubarak, Saudi princes and clergy, and other Sunni Arab heads of states," says Mordechai Abir, a senior Middle East analyst for Burnham Securities.

That anxiety, along with concerns for domestic security, has spurred Saudi Arabia to boost its defense spending to between $50 billion and $60 billion in the next several years for a major upgrade of its entire military.

Beyond A Military Revamp

Saudi Arabia has repeatedly said it won't use oil as a political tool and most experts agree that the kingdom's power to influence oil prices is currently limited by a tight global market and subsequently thin spare capacity. But recent developments in Saudi Arabia's plans to boost production, and briefings by a former consultant to the Saudi ambassador to the U.S. have raised questions about whether the country is considering new strategic oil options to counter Iranian influence in the region.

Some analysts say Saudi Arabia is preparing its massive crude oil reserves as its own "nuclear" weapon to undercut Iranian power.

In an opinion piece published in the Washington Post in late November, Nawaf Obaid, previously an advisor to the Saudi government, said the Saudis may consider not only officially funding the anti-Shi'te militias in Iraq, it also might consider strangling Iranian funding of the militias through oil policy. Obaid was fired by the Saudi government for airing his frank insights in the op-ed piece.

In the weeks prior to the op-ed, Obaid had briefed the U.S. State Department, the National Security Council and the Department of Energy on "New Strategic Initiatives" emerging in Saudi Arabia in his position as the head of the Saudi National Security Assessment Project.

If the Saudis were to flood the market with increased oil production, it could halve the price of oil, Obaid wrote, in the op-ed. Although the kingdom would be able to continue spending at current levels, with tens of billions of dollars in cash reserves, "it would devastate Iran, which is facing economic difficulties even with today's high prices," Obaid wrote.

The Saudi government vehemently denied statements Obaid made in his opinion article. Most analysts believe the Saudis are highly unlikely to use such a measure except as a last resort, nor would they currently be able to flood the market with crude oil given the tight margin between demand and supply. Still, analysts say Obaid's article reveals what some people in Saudi Arabia's policy ranks are thinking about longer-term oil strategy.

Accelerating Production

Saudi Arabia is already accelerating its near and long-term production expansion plans. The country's previous plans called for maintaining its spare production capacity - the prime metric that drives crude price levels - at around 2 million barrels a day. After visiting the country, Guy Caruso, head of the U.S. Energy Information Administration, said last month he believes Saudi Arabia is about six months ahead of schedule and its spare capacity could hit 3 million barrels a day by 2011.

The first phase, increasing production to 12.5 million barrels a day from current capacity of 11.3 million barrels a day, has been placed on an accelerated timeline. The second phase - to grow capacity as high as 13.5 million barrels a day by 2011 - is in the planning stage.

With that kind of capacity, the country could be in a better position to influence prices.

In December, the board of Saudi Arabian Oil Co., or Aramco, approved an "aggressive" operating plan for 2007, including the largest spending program in the company's history. The plan includes a goal of 121 drilling rigs, up from the country's previous target of 110.

Saad Rahim, a top energy analyst and Country Strategies Manager at PFC Energy, said "there's certainly a risk" of the Saudis using oil politically because of growing fears of Iranian power.

Especially if U.S. President George Bush moves ahead with proposals to withdraw most U.S. troops by 2008, which the Saudis appear to adamantly oppose, he said.

"They feel that a withdrawal would leave the job unfinished, and leave not only a collapsing country to their north, but would embolden Iran even further," Rahim said. He added that although worries about a "Shi'ite crescent are overblown to a degree...the Saudis are very wary of what might be coming down the pike next year."

Holding Off

Rahim believes the Saudis will hold off on using the oil card and aren't likely to leverage their power as the de facto leader of the Organization of Petroleum Exporting Countries.

"In fact, the longer they wait, the better positioned they are to undertake such a move," said. "They will have built up the capacity to really flood the market and they will have built up enough foreign reserves to feel comfortable doing so for an extended period of time."

"However, we basically refer to this move as 'the nuclear option' for Saudi, and really only to be undertaken as a last resort," Rahim added.

The Saudi National Security Assessment Project said the increased capacity would also give the kingdom the ability to offset Iranian exports should they enact an oil embargo, which some Iranian officials have threatened should the U.S. try to destroy its nuclear program.

By the middle of the year, Rahim said, Saudis' spare capacity will be able to compensate for a complete loss of Iranian exports of around 2.5 million barrels a day. "But that essentially soaks up global excess capacity," he said. "So any other disruptions (such as from Nigeria or Venezuela) would really stretch the system."

Shibley Telhami, a senior fellow with Washington think tank the Brookings Institute, said the Saudis are unlikely to use their capacity as a weapon unless they have ruled out all other diplomatic means.

"The Saudis want Iran contained, there's no doubt," said Telhami, "But they're also very worried about war with Iran," not least because it might prompt an uprising from their own Shi'a population.

Political use of oil would be seen as a declaration of war against Iran, Telhami said, even if it were an economic attack. Instead, the Saudis are plying a more careful approach, he suggested.

"When you play for the long term, you want to be cautious, you want to have containment policy, you want to weaken," said Telhami, "But you don't want to go into an all-out confrontation that becomes a historical struggle."

Nevertheless, Telhami said, the Saudis remain pivotal for the global oil market.

"Obviously, the more excess capacity they have, they more influence they have," he said.

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