Shifting sands for Saudi
The Kingdom’s attempt to float Saudi Aramco didn’t go fully to plan
“Energy is geography”, my boss Jan Nasmyth used to say: he meant that the business of energy is to connect the source with the point of consumption. From this axiom flow all the consequences: economic, commercial, legal, technical, diplomatic, environmental and occasionally military. Its central role in our lives means that the energy industry is intensely competitive, always evolving, and always subject to radical changes. And those changes drive a feedback loop which can radically affect the world order.
Here are some examples. Pre-industrial flour mills were sited by fast-running streams that turned the mill wheels that ground the corn. The discovery of electricity led to the development of a grid which could transmit the electricity from the point of generation to distant larger and more efficient mills. Until the late 19th century, whaling ships spent months or years at sea harvesting whale oil to light lamps in the industrialising world; the discovery of petroleum ended the need for whale oil and, together with other technical advances, created huge new markets for petrol, jet fuel and heating oil, to name but three.
The upstream oil industry was based on large resource concentrations, which tended to be distant from potential markets: initially places like northwest Pennsylvania and southern Russia, later Texas, the Middle East and Siberia. They relied first on railways, and later on new transport systems to bring the oil to market. The industry’s economics combined the cost of production, transport and processing, all in competition with other sources like coal. Inevitably, economies of scale led to the discovery of larger oil provinces and the development of ever-larger tankers and pipelines.
Four American companies combined to develop the colossal oil wealth of Saudi Arabia
From the start of the 20th century, the Middle East was increasingly key to this conception. In 1900, the British Empire had no oil of its own, and the Royal Navy on which the empire depended was coal-fired. Recognising the greater efficiency of oil to coal, the British explored for oil in Iran and discovered huge reserves which they claimed for their own. The navy switched to oil fuel, and the company now known as BP was born. The French were active in Iraq and Syria, giving birth to what’s now called Total. Between the world wars the British also developed Kuwait, and four American companies combined to discover and develop the colossal oil wealth of the Kingdom of Saudi Arabia. The company they formed was the Arabian American Oil Company, or Aramco: long ago nationalised, it is today known as Saudi Aramco.
After WW2 rapid economic growth led to vast increases in demand for oil, which was largely satisfied by ever-rising supplies from the Gulf, particularly from Saudi Arabia. Later, through the institution of OPEC, the big oil producers took control of their resources away from the western majors, while the development of a competitive global market took control of pricing away from both sides. But the Middle East remained the focus of big power rivalry throughout the late 20th and early 21st century, with the Americans in the driving seat. Until now.
Fast forward to 2019, and all is in flux. Climate change has convinced policy-makers, especially in Europe, to turn away from fossil fuels in favour of renewables. The shale boom has turned the US into an oil and gas exporter. Each of these very different developments illustrates the Nasmyth axiom: renewable energy sources, especially wind and power, are essentially local. Even large offshore windfarms generate power within a hundred miles of the centres of consumption. Shale oil and gas have transformed the US economy in the past decade, providing vast new sources of energy to be consumed within the country at significantly lower cost than imported fuel. Thanks to fracking for shale, US crude oil output has more than doubled from 6.8 million barrels a day in 2008 to15.3 million b/d in 2018.
The USA now buys relatively little oil from Saudi Arabia, most of whose exports go east, to India, Japan, Korea, above all to China. Saudi Arabia remains a key American ally in the region, but its status is no longer unquestioned. Under a new and ambitious young leader, Saudi Arabia is trying to diversify its economy. President Trump has walked away from the Iran nuclear deal negotiated by his predecessor and is using sanctions to force Iran (a) to give up its nuclear ambitions and (b) to cease exporting its brand of terror across much of the region. His chief personal interest in Saudi Arabia is to get the kingdom to recognise Israel.
Of course, Saudi Arabia remains a lucrative market for American exporters, particularly armaments manufacturers and oilfield service companies. And the Saudis, together with their Arab neighbours UAE, Qatar, Kuwait and Iraq, rely on the US to underwrite their defence against Iran, and to keep oil and liquefied natural gas (LNG) flowing through the Gulf and on to world markets.
The attack causes longer term fear and confusion to the Saudis’ attempt to float their oil company
Thus the oil market – and the wider global economy – was shocked on 14th September by the airborne attacks on Saudi Arabia’s enormous crude oil processing centre at Abqaiq, as well as the nearby Khurais oil field. Abqaiq handles 5.7 million barrels a day of Saudi crude production: nearly half of the Kingdom’s capacity and more than 5% of global demand. The Saudis and the Americans blamed Iran and its proxies, and although Iran denied the charge, it is hard to see who else might have been responsible.
Neither it is hard to see why the Iranians chose this moment to start throwing their weight around. President Trump’s sanctions are causing severe pain to the Iranian economy. Iranian crude oil exports are down to perhaps 200,000 barrels a day, less than 10% of the pre-sanctions level. If we suffer, so must our bitter enemies the Saudis, goes the reasoning. And while physical damage can be repaired, the attack causes longer term fear and confusion to the Saudis’ much vaunted but problematic attempt to float part of their giant oil company Saudi Aramco.
Saudi Aramco runs the Saudi oil industry, and boasts the 2nd largest oil reserves and 2nd largest oil production in the world. Saudi Aramco’s cost of producing a barrel of oil averaged $2.80 in 2018, a minuscule figure by global standards. The average price of the Brent crude oil benchmark in 2018 was $71.31. In other words this is an astonishingly profitable oil company. But it is vulnerable on a number of fronts. The IPO (initial public offering) is the brainchild of Crown Prince Mohammad bin Salman (MbS), who needs the revenues for ambitious development plans which will not be sustained with oil prices at their present level.
The Saudis announced on 11th September they would shortly launch the IPO. The attack on Abqaiq came three days later. From that point there was no chance of Saudi Aramco shares listing on the New York Stock Exchange, as had been hoped. Some of the investment banks invited to help prepare the IPO valued Saudi Aramco at $2 trillion or more. This pleased MBS who hoped to earn $100 billion from selling 5% of the equity. But on 15th November the banks revealed their real valuations, which were $1-1.5 trillion. The infuriated Saudis have scaled their ambitions back, and now hope to raise only $25 billion from domestic and local investors.
The banks and major investors had genuine concerns, in addition to the danger from Iran. Purchasing a small part of a very large company based in a dictatorship with less firm property rights than obtain in the US or Britain is always going to be a gamble: it is unclear what one really owns, or what redress one has against expropriation or a radical change of regime. The sense of instability had been heightened by senior management changes ordered recently by MbS. The Crown Prince began by replacing the respected Energy Minister and Saudi Aramco chairman Khalid al-Falih with his own brother Prince Abdulaziz bin Salman. This change violated one of the key tenets of Saudi governance since the 1950’s, that the Energy Ministry should be run by a technocratic commoner rather than a member of the royal family.
The Saudis have, to be fair, reacted swiftly and effectively to the Abqaiq attack. The facility has been partly brought back into production, and the release of oil from storage has met most if not all of the demand for Saudi oil. Much work remains, but no one doubts that the Saudi oil export machine will return to smooth running by early next year – as long as it suffers no further violence.
There’s the rub. Abqaiq was a shrewd blow and also an unusual one, targeting strategic onshore infrastructure. Over the last thirty or forty years there have been occasional attacks on tankers in the Persian Gulf (especially in the Iran-Iraq war from 1980-88) but damage to onshore production has been rare. Tankers loaded with crude oil do not burn or explode – when punctured by a missile they merely leak, usually slowly – and are relatively easily repaired or replaced. But sophisticated processing complexes like Abqaiq are not.
The attack on Abqaiq illustrated another vulnerability, the inefficiency or incompetence of Saudi defences
Saddam Hussein’s parting shot in the first Gulf War was to set fire to 700 Kuwaiti oil wells – something never done before in the Middle East, and an economic and environmental disaster which took many months to bring under control. It is estimated that one billion barrels of oil was destroyed: a loss of $20 billion at the 1991 market rate. Like the presumed Iranian attack on the Saudis, there was a strong personal element to Saddam’s sabotage: he believed that Kuwait’s ruling al-Sabah family had deliberately stolen “his” oil by horizontal drilling into Iraqi fields.
The attack on Abqaiq illustrated another vulnerability, the inefficiency or incompetence of Saudi defences. The weapons that did the damage seem to have been a combination of drones, perhaps launched from Yemen, and cruise missiles fired from the area of southern Iraq that is effectively under Iranian control. Wherever they came from, they easily evaded the expensive anti-missile systems the Saudis had purchased from the US. And there is evidence that the Saudi personnel responsible for monitoring possible attacks were, literally, asleep at the controls.
As the industrialised world turns more to renewables, and particularly if electric vehicles start to edge out the internal combustion engine, the balance of power – diplomatic as well as economic – will shift in the Middle East. The world will still want its oil for several decades, but the big external influences will come from Asia rather than Europe and North America. Donald Trump’s decision to abandon America’s Kurdish allies and his unwillingness to expend more blood and treasure defending countries he thinks fail to take responsibility for their own safety will expose the real fault lines in the Middle East.
The Saudi population is about 33 million, compared to 82 million in Iran. Qatar, the world’s largest exporter of LNG, has a native Arab population of only 300,000. Its gas exports are drawn from the world’s largest gas field, which extends across the median line into Iranian waters. Hampered by sanctions and the corruption and inefficiency of its own government, Iran has been unable to exploit its share of this bonanza, and must watch in envy as the Qataris earn $130 billion a year from their LNG exports. A large country prepared to attack one neighbour’s oil facilities will surely be aware of the much smaller neighbour’s vulnerability.
The geography of energy led to the development of Middle Eastern oil and the enrichment of what were for the most part traditional desert societies. It also turned the region into a global flashpoint kept under control by its largest customer. Profound changes in that geography threaten to reduce its wealth and to increase the danger of regional conflict.
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