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Posted by on Jul 3, 2008 in At TMV | 6 comments

The Price Isn’t Right

Over at the Wall Street Journal, reporter Neil King Jr details the internal debates in Saudi Arabia over oil production. With the price now skyrocketing past $140 dollars a barrel, some Saudi officials are starting to sweat.

Intuitively, you’d think it would be the opposite. Higher prices lead to greater revenue, right? Yet historically, Saudi Arabia has been the leader of the OPEC block pushing for mid-range oil prices. They have resisted driving the price through the roof, much to the irritation of oil-producers like Iran. There are a few reasons for this. Back in the 1970s, during the Arab oil embargo, the Saudis began to notice that the effects of high oil prices – much celebrated amongst OPEC states – were not entirely positive. Exploration by non-OPEC countries began to occur in places like the North Sea, a development that would soon cut into the Saudis’ market share; moreover, investment in alternative fuels rose.

Just as it occurred in the mid-1970s, the same thing is happening today. Oil companies are looking wildly for new reserves to tap into (think ANWR) and research into alternative energy sources has apparently jumped some 60% in the past year alone. In oil-importing states, there is also more talk about conserving energy and switching to fuel-efficient technologies. None of this is in the Saudis’ long-term interest. If prices were to remain steadier, they figure, many of these outcomes could be delayed for years to come. Moreover, Riyadh worries that high prices will undercut the United States’ economy – and, by extension, their own. The country’s foreign holdings, totaling billions of dollars, would also be hit hard.

Then there’s Iran. Higher prices give their regional rival a huge boost. During the Iran-Iraq war, the Saudis (allied with Saddam) worked to keep Iran low on cash by ensuring that OPEC’s production remained high. The same fear holds now; with an expansionist and rising Shiite neighbor, the Saudis are quietly trying to keep the lid on the region’s shifting power balance. With a stumbling President Ahmadinejad, tightening the screw on oil prices would lead to domestic troubles for Tehran, and would also undercut the country’s aggressive foreign policy agenda.

Their problem, however, is that there’s only so many extra barrels that they can put onto the market. Over the last few weeks, the Saudis have agreed to increase production by about 500k barrels. Yet a lot of the new supply consists of heavier oils, for which there is less demand. For now, at least, the Saudis may be stuck with skyrocketing prices like the rest of us. Whether they like it or not.

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