Saudi Arabia's Market-Control Means Higher Oil Prices

THE billion-dollar question for a grateful world, now that the Gulf war has ended, is once more what will be the price of oil. Oil prices have collapsed from their crisis peak of $40 per barrel. Currently the Gulf price is some $17 a barrel, close to historical lows. But talk of a ``glut'' and falling prices is exaggerated, much like the rumors of Mark Twain's death. Instead, political forces now militate for higher oil prices.

The Organization of Petroleum Exporting Countries (OPEC) meets next week in Geneva. The key player is Saudi Arabia, because it now exercises full control of near-term oil pricing. The Saudis are expected to reverse their prior strategy aimed at maintaining market share. Instead of capping oil at $18 a barrel, they will use their production muscle to push for a price in the low twenties.

The Gulf war has radically changed the rules of the OPEC game, shifting pricing power completely to Saudi Arabia. Kuwait, once a spoiler with over-quota production, will be hard put to export any oil for many months. The United Arab Emirates (UAE), another former spoiler, is already producing at full capacity.

The recession has cut oil demand growth. But the much touted oil glut is in fact mostly a Saudi ``glut,'' resulting from production they added to offset the United Nations embargo of Iraq and Kuwait. Saudi Arabia now produces some 8.7 million barrels per day - 3.5 million b.p.d. more than last summer.

Cutting oil production could be all but costless for the Saudis. The market is tight, so a cutback would raise prices and offset any losses due to lower output - a strategic pricing mechanism the Saudis have predatorily used before. In the short run, a 1.5 million b.p.d. reduction by Saudi Arabia might push prices up by as much as $3 to $4 a barrel.

Saudi market-power rests on several factors.

First, there is no shut-in, surplus production capacity anywhere in the world except in Iraq and Kuwait, and most of that is theoretical. There is no parallel to the sag in oil prices early last summer. Then, just before Iraq's invasion of Kuwait, there were 4 million to 5 million b.p.d. of shut-in capacity and Kuwait was producing well above its OPEC quota.

Second, while demand is weakened by the recession, so is non-Gulf oil supply. Competing oil production outside the Gulf is now either stagnant (the North Sea) or actually falling (the Soviet Union and the United States).

Third, neither Kuwait nor Iraqi exports pose any immediate threat. Six to 24 months will be necessary to repair the extensive damage to their field facilities and export terminals and clear the mines in the upper Gulf waters. Also, the Saudis control Iraq's two major export pipelines, which were built through Saudi Arabia during the Iran-Iraq war to avoid Iranian interdiction.

Fourth, Saudi government cash needs do not dictate production levels. Judicious cuts in oil output leave revenues essentially unaffected. Liquidity is a constraint, forcing the Saudis to do some short-term borrowing. But the Saudis foreign assets of $60 billion to $100 billion provide 100 percent collateral for such short-term bridge loans, which thus do not signify real financial stringency.

Fifth, the old ceiling price of $18 a barrel is economically obsolete. Allowing for inflation and the eroding value of the US dollar, it should be $21 to $24 in today's dollars. If $18 sufficed to deter competing energy sources in 1985-6, then $21 to $24 would be equally effective today - an argument raised repeatedly by other OPEC producers.

Sixth, low prices are politically dangerous - Saudi Arabia is already under fire across the Arab world for having acquiesced to perceived US-Israeli pressures to destroy Iraq. Any policy of keeping oil prices low reinforces the charges.

Thus the cost-benefit calculus is clear. Cutting production to raise prices can preserve revenue so nothing is lost economically; higher prices mend fences within OPEC and, especially important, forestall charges of selling out to the US.

Prices thus must be expected to rise: the open question is only how Saudi Arabia will prevail upon Venezuela and the UAE to absorb at least some part of whatever modest production reduction is needed to achieve the $21-plus price already nominally approved last July. The outcome is foregone, but the detailed mechanism is yet to be revealed.

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