Oil Prices Slide as Saudi King Gives U.S. President Token Output Increase

NYMEX crude oil futures for June delivery have retreated since hitting a new intraday record on Friday (16 May) of US$127.82/b. The benchmark then went on to close at US$126.29/b, up US$2.17 on the day. Brent crude June future in London meanwhile closed at US$124.99/b, up US$2.36 on the day. Key in pushing down prices has been Saudi Arabia's recent decision to increase output slightly.

Saudi Balancing

A visit by U.S. President George W. Bush to Saudi Arabia late last week, to celebrate 75 years of close U.S.-Saudi ties, failed to camouflage growing frustrations with each other and the increased fragility of their relationship. President Bush arrived in the kingdom with a clear brief to ask Saudi King Abdullah bin Abdel-Aziz al-Saud to increase his country's crude production in order to alleviate the impact of high oil prices on the world and U.S. economies, but was only given a face-saving increase of 300,000 b/d by the monarch, not even compensating for current temporary shut-ins elsewhere in the oil markets.

The Saudis were clearly uneasy about the request, currently being embroiled in a growing feud pitting factions that it supports in Lebanon against factions supported by regional arch-foe Iran and its ally Syria. It is against this context that the kingdom has been careful not to be seen as toeing the U.S. line too much, even as it has tried to rally for Arab unity around its regional policies. Whatever the case, the token increase in output—and the manner in which the news was delivered—did little to assuage domestic U.S. internally driven political tempers, and has done even less to improve the kingdom's standing in the eyes of the world's largest oil consumer.

Attempting to strike a careful balance, it appears that the Saudis might nevertheless have accepted the U.S. domestic public relations loss, while at least showing President Bush the courtesy of heeding his request partially and not snubbing it altogether, having been successful in securing a civil nuclear power co-operation agreement with the superpower in exchange. It will be fully understood, expected, and accepted in Saudi political circles—long used to operating along opaque and highly personalised levels—that the U.S. president later had to express disappointment over the miniscule increase and show himself unwilling to defend the visit's achievement vis-à-vis his home audience. Indeed, this was probably even appreciated by the Saudi rulers, given its current need to brandish its own Arab political credentials against a Syria that, through Iranian support, has been able to gather almost all radical Arab movements in Lebanon and the Israel-Palestine conflict around its camp lately.

Oil for Nuclear

Last week Saudi Arabia's Oil Minister Ali al-Nuaimi briefed President Bush and his entourage on Saudi Arabia's oil industry and its capacities. He was quoted by Reuters as saying that "on May 10, we raised supplies to customers by increasing 300,000 barrels per day of oil [output]. Therefore, production in June will be 9.450 million bpd...In the future if the need appears, Saudi Arabia has no objection to producing more". The extra supplies would go exclusively to some 50 U.S. clients that had asked for higher supplies, the oil minister revealed, adding that he saw supply and demand currently being balanced, with the high crude prices being the result of "international political tension, dollar weakness and the role of investors in the commodities market". Saudi Arabia claims it currently has a production capacity of 11.5 million b/d, although its ability to ramp up production to that level quickly has been questioned given, for instance, its need to build up reservoir pressures at mothballed fields. The kingdom is, however, investing heavily in adding production capacity to safeguard its role as OPEC's swing producer, aiming to attain a 12.5-million-b/d capacity before the end of next near.

Meanwhile, national gas shortages have forced the kingdom to look to nuclear energy for economically sustainable electricity production, with U.S. companies seen as the main possible suppliers of the necessary technological build-up. The U.S. president signed a memorandum of understanding (MoU) with Saudi Arabia over civil nuclear technology and non-proliferation co-operation, opening Saudi Arabia up as a future potential export market for U.S. nuclear technology companies, as the kingdom seeks to safeguard continued close long-term U.S. involvement in its security and economy, despite the current political trends. A memorandum on deepened security co-operation with the United States to guard oil and gas infrastructure was also signed.

Outlook and Implications

While Saudi Arabia essentially gave the U.S. president what he asked for—a rise in output—Bush has dismissed the modicum of added supply as quite unlikely to be effective in helping drive down prices over the longer term. Rather than focusing on OPEC's unwillingness to boost output further, however, the president has diverted his attention back towards home where he has roundly condemned political opposition as being responsible for failing to boost domestic oil exploration and production. Commenting on lawmaker resistance, the president neatly summed up the problem thus: "Our problem in America gets solved when we aggressively go for domestic exploration. Our problem in America gets solved if we expand our refining capacity, promote nuclear energy and continue our strategy for the advancing of alternative energies as well as conservation." The narrative is perhaps simplistic, but essentially follows the same line of thought the president has repeatedly expressed over the last year. While it is clear that the United States could stand to increase oil exploration and production from areas such as the federally protected Outer Continental Shelf (OCS), as well as other regions such as the Arctic, where large oil reserves are thought to be present, the likelihood of opening up these regions to development continues to be slim over the medium term.

With oil and refined products hitting repeated record highs since January, U.S. lawmakers have increasingly been keen to take action and to demonstrate that they still retain the power to affect prices, at least domestically. The unity behind that action, however, has been matched only by its ineffectiveness. Following on from recent legislative efforts in Congress, the U.S. Department of Energy is no longer accepting 70,000 b/d of royalty-in-kind crude for the country's strategic petroleum reserve (SPR). The measure to suspend SPR shipments received wide bipartisan support across both Houses, and despite the reminder by the president of just how small a component of the country's daily consumption that amount is, Bush has nevertheless said he would not veto the measure. It is perhaps a tragedy of recent American politics that unity has come only when solutions of marginal utility have been discussed and agreed upon.

With speculation growing that China is hoarding crude supplies in anticipation of greater demand during the Olympic Games in Beijing this August, and with the U.S. summer driving season officially due to begin a week from now, supply fundamentals continue to suggest tightness in oil markets over the coming months, with prices especially vulnerable to supply disruption such as those which recently took place in Scotland and Nigeria. Even though oil has slid somewhat from previous highs, the short-term outlook for prices remains bullish. At the time of writing, the NYMEX June futures contract was trading down at US$125.92/b.

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