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Page added on November 13, 2017
What the Saudi Arrests Mean for the Kingdom’s Oil Policy
We may never fully know what lies behind Crown Prince Mohammed bin Salman’s decision to arrest more than 200 Saudi citizens, including 11 princes and four government ministers, on corruption charges, just as tensions with Iran are escalating.
What we do know is that his move simultaneously boosted the oil price and undermined the attractiveness of Aramco to potential foreign investors. But it would be a mistake to conclude that this political decision also heralds a shift in Saudi oil policy, or permanently damages the prospects of the state oil company’s IPO.
Crude prices always rise in response to unrest in the Middle East, even when the countries involved produce little or no oil. That it has done so now, in the wake of the arrests in the region’s biggest producer and the threats against Lebanon and Iran in response to a missile launched from Yemen, should come as no surprise.
The jump, which took oil prices to their highest level in more than two years immediately after the arrests, might be expected to boost support for a pause before OPEC and its friends decide whether to extend their current deal on production cuts until the end of 2018. There are some, including Russian President Vladimir Putin, who have said that it is too early to decide what should be done beyond the deal’s current expiry in March.
But dissenting voices are likely to fade into the background when the groups meet in Vienna on Nov. 30. The output cuts do not target a specific oil price — as Saudi oil minister Khalid Al-Falih said in June, the aim is to reduce excess inventories. That problem has not yet been resolved.
MbS, as the crown prince is widely known, is already setting the kingdom’s oil policy. He turned on its head Saudi Arabia’s earlier stance of boosting oil supply in an attempt to drive out higher-cost producers, and he has placed his country at the forefront of output cuts aimed at draining excess inventories, cutting production by more than required under the agreement. He has already expressed support for extending the production deal. Only by returning global oil inventories to more normal levels can Saudi Arabia, and OPEC, hope to return to a world where their actions influence the market.
The Saudi anti-corruption purge should change nothing for the kingdom’s oil policy. MbS is surely mindful that an extension of the current output deal has already been priced into the market, and failure to deliver it at the end of the month would kill the recent rally in prices, despite the elevated tensions in the Middle East.
Assessing the impact of the detentions on the Saudi Aramco IPO is less straightforward. Ninety-five percent of the shares will remain the property of what is now clearly an unpredictable government. If the arrests turn out to be no more than a purge of opponents to the crown prince’s accession to the throne, potential investors will run for cover.
But perhaps the anti-corruption purge is the first step towards creating a more open and dynamic business environment in Saudi Arabia. If it truly marks the beginning of the end of the of the rentier state that has crippled the country’s development then it could even improve the prospects for inward investment, and boost the attractiveness of the shares.
Foreign investors’ appetite for a piece of a partially-privatized Saudi Aramco will not depend on whether the price of oil at the time of listing is $50, $60, or $70 a barrel. A decision to invest in the company will depend much more on the dividend and taxation policies of the major shareholder — the Saudi government — and the investor’s view of the long-term future for oil.
Indeed, it could be argued that over the longer term Aramco would benefit from a lower oil price, which simultaneously boosts demand for crude and makes alternative energy sources less attractive while undermining other, higher-cost oil supplies. That ought to give the best outlook for production as Aramco still extracts some of the lowest cost oil on the planet. If Saudi Arabia’s “Vision 2030” plan to wean the kingdom off its dependence on oil revenues is even partly realized, Aramco will be relieved of much of its burden of supporting government expenditure. That should serve to burnish the appeal of the shares.
To realize his dream of privatizing Aramco — and the planned 5 percent offering may be only the beginning — the young crown prince will need to show hoped-for investors that his recent purge of the kingdom’s elite really is a first step on the road to a brave new Saudi Arabia.
Julian Lee is an oil strategist for Bloomberg First Word. Previously he worked as a senior analyst at the Centre for Global Energy Studies.
8 Comments on "What the Saudi Arrests Mean for the Kingdom’s Oil Policy"
Anonymous on Mon, 13th Nov 2017 11:16 pm
It’s hard to know what the eventual result will be. A single monarch might or might not be better for the country and the world. Hard to tell.
In terms of oil price, my assumption is that the Saudis will follow a practice of further cutting to prop up price. This will be done quietly. The rationale is not even monetary per se but that higher prices are seen as a win publicly within the Kingdom. And the Crown Prince and King need this for now. So they will follow this policy even if it is not the right one because the near term is more important than the long term when consolidating power. (They may also believe the policy and it may be a sound policy even…but that is not the point.)
malahmadi on Tue, 14th Nov 2017 5:38 am
Saudi Arabia looks mainly to long term aspects of oil demand. Saudi suggested in late 2014 to cut oil production but every country almost refused,so Saudi and its allies in the Arabian Gulf went on to flood the market.In 2016 all producers started crying and accepted to reduce production.The primary aim of Saudi is to bring up prices to level that stimulate investment otherwise oil prices will overshoot and encourage oil alternatives which harms Saudi in the long run.
The problem now is that process is slower due to tight oil and we may witness runaway prices next decade.
Cloggie on Tue, 14th Nov 2017 5:54 am
Return to $100-150 oil price would be best for the planet, enforce price-induced peak oil demand and cause a global rush into renewable energy.
Apart from storage, everything is now mature enough and production facilities in place to push through renewable energy. Offshore wind technology from Europe and solar technology from Asia.
Antius on Tue, 14th Nov 2017 7:29 am
Energy storage will always be expensive, inefficient and impractical. It will have niche applications but the reality is, adapting to an intermittent power supply will mean using energy when it’s there and curtailing use when it isn’t. Kris De Decker’s website has produced an excellent article on this topic: http://www.lowtechmagazine.com/2017/09/how-to-run-the-economy-on-the-weather.html
It isn’t impossible – our recent ancestors lived in exactly this way. But needless to say, life will be very different to what we have gotten used to if we adapt to living this way.
On the plus side, the EROI of renewable electricity sources (I am talking about electricity and mechanical power, not heat) is much better if we stop wasting large amounts of exergy by trying to store it.
Davy on Tue, 14th Nov 2017 8:05 am
Antius, thanks for the link. Micro grids with a population educated to demand management is the key. Strategies of conservation, seasonality, and localism can thrive in these situations. The problem is scale and cost. Incorporating modernism with its travel and consumption lifestyle do not fit. That is where the money is. This means subsidies are needed. Subsidies are not affordable in a scale needed to be a solution for civilization. That said elements are affordable for individuals and enlightened communities.
Cloggie on Tue, 14th Nov 2017 8:45 am
@Antius – Kris de Decker believes in a 100% renewable energy society, but not in plug-and-play. I am not so pessimistic, my comments on de Decker here:
https://deepresource.wordpress.com/2017/09/16/can-society-run-on-renewable-energy-alone/
Energy storage will always be expensive, inefficient and impractical.
It is too early day to arrive at that conclusion. Hydro storage delivers 80%, which is fine. Power-to-gas is currently at 50%, but potentially 70-80%:
https://deepresource.wordpress.com/2017/03/07/power-to-gas/
Antius on Tue, 14th Nov 2017 11:35 am
Davy wrote: “Antius, thanks for the link. Micro grids with a population educated to demand management is the key. Strategies of conservation, seasonality, and localism can thrive in these situations. The problem is scale and cost. Incorporating modernism with its travel and consumption lifestyle do not fit. That is where the money is. This means subsidies are needed. Subsidies are not affordable in a scale needed to be a solution for civilization. That said elements are affordable for individuals and enlightened communities.”
Agreed. The problem is that the systems that we have built up over the past 150 years are based upon a just in time philosophy that only works with abundant stored energy that can be released whenever we need it. A factory that only makes widgets when the wind is blowing or the sun is shining and whose delivery times depend upon weather patterns, will face a severe penalty in terms of capital cost repayments, labour productivity and future orders. In some cases there may be workarounds, but they always add complexity and difficulty and are situation specific, requiring innovation at the design stage. It is easily forgotten that wind and water power (in addition to human and animal power) provided nearly all mechanical power during the early decades of the industrial revolution. Steam power was not practical or widely deployed until well into the 19th century. But back then land was cheap and so was human labour. Transportation was much slower and intermittent. It was easier to accept the limitations of an intermittent energy supply under those conditions.
Most contractors today simply cannot be bothered considering anything that is remotely non-standard. I know that from personal experience when I tried to get a contractor to consider installing an air source heat pump instead of a gas boiler in a facility that I was trying to commission. The device could have used the same plumbing and with sufficient thermal inertia added to the building, could have worked using intermittent electricity. The difference in cost would have been minimal – over the life of the building it would have been substantially cheaper. The contractor simply wasn’t interested in exploring it and was impatient with me for daring to raise it. What’s more, newer buildings are thin walled structures made from sheet cladding and mineral insulation with no thermal mass whatever. They are designed to be built rapidly at minimal labour cost. No one involved is really that interested in how much they cost to operate over a period of decades or even if they will survive decades. They require an air tight envelope and constant air conditioning to maintain a comfortable internal temperature.
Take a new job now and almost without exception you are expected to drive and be able to visit remote clients at short notice. In the era of the car, public transport systems that could work efficiently on direct electric power but require just a little more time and patience, have suffered and would not have survived in Europe without subsidy.
Thanks to Amazon, delivery of goods is becoming more rapid and would not be possible without combustion driven vehicles able to reach remote locations rapidly using stored energy.
In many significant ways, society is moving backwards from a sustainability viewpoint. For all the talk of sustainability and the hype about renewable energy, the actual systems that we have are becoming less flexible and less adapted to the sort of constraints that renewable energy would impose upon us. It suggests to me that any retreat to intermittent energy will be extremely difficult.
Antius on Tue, 14th Nov 2017 12:40 pm
Cloggie wrote: ” @Antius – Kris de Decker believes in a 100% renewable energy society, but not in plug-and-play. I am not so pessimistic, my comments on de Decker here:
https://deepresource.wordpress.com/2017/09/16/can-society-run-on-renewable-energy-alone/
Energy storage will always be expensive, inefficient and impractical.
It is too early day to arrive at that conclusion. Hydro storage delivers 80%, which is fine. Power-to-gas is currently at 50%, but potentially 70-80%:
https://deepresource.wordpress.com/2017/03/07/power-to-gas/
.”
I have always been sceptical about claims that renewable energy and storage can produce cheap baseload power. It just doesn’t ring true to me. I no longer have the same amount of time to go into the sort of detailed numerical analyses that I used to. But from a qualitative point of view, here is why I do not believe it will ever be cheap.
Firstly, none of these systems are new. We have had the capability of building pumped storage systems practically since mediaeval times. Thermal energy storage systems could have been built 130 years ago: all it requires is sticking heating elements into an insulated lump of rock or concrete and then recovering the electric power using a steam plant, with pipes passing through the hot mass. This is very easy to do in principle . Battery electric storage has been available since the late Victorian era. Power-to-gas could have been done at about the same time – electrolysis cells making hydrogen, gasometers to store it, spark ignition engines to recover the power. We have had all of these things for as long as we have had electricity. In many ways we were better placed to do these things years ago – coal mining was labour intensive back then, electricity prices were much higher, hydrogen storage, distribution and end-use technologies were commercially available thanks to coal gas and society as a whole was less regulated and more flexible, making it easier to integrate things like district heating systems and thermal stores.
In all that time, none of these systems has found anything more than niche applications. We talk about improving technology making renewable energy more affordable. Yet these systems are technologically simpler than the ones we are trying use them to replace. Technology in this context is about incremental improvements gradually reducing costs. But it comes at the expense of greater complexity. The problem with these schemes is not that they cannot be made to work in principle and that we need some new method to make them workable. In many ways, it is easier to build and operate a wind power + thermal storage system than it is to make a gas turbine, coal power plant or nuclear reactor work.
The problem is that renewable energy sources are fundamentally less power dense making them capital intensive. Storage makes this problem a lot worse – it wastes a lot of the exergy being stored and in effect requires an entirely new power plant just to buffer the effects of intermittency. The energy store is often bulky requiring substantial invested energy. So to get the same amount of baseload power – you must build 2.5 power plants instead of one and one of those power plants (the store) is a monster. Increasing the efficiency of storage with ‘better technology’ sounds straightforward, but requires more complex and more expensive systems and ultimately, more invested energy. This is why in the real world wind power plants are backed up by combined cycle gas turbines. The invested energy in a CCGT is low enough and the fuel is dear enough that its operators can afford to take the capacity hit from load following the wind plant. It is still more expensive than running the CCGT flat out, but it provides baseload without having to waste a substantial part of the exergy in the wind electricity.