OPEC: Saudi Arabia Gets Tough

By John T. Haldane

King Fahd's dismissal of Sheikh Ahmad Zaki Yamani as Saudi Arabian Minister of Oil marks a turning point in Saudi oil policy and the role that nation will play in the Organization of Petroleum Exporting Countries (OPEC).

It is no secret that Saudi efforts over recent years to stabilize world oil production have cost Riyadh dearly in lost oil revenues and have forced sharp cutbacks in the development of its economic infrastructure.

A combination of internal financial problems and external political and military pressures from Iran made King Fahd decide it was time for Saudi Arabia to relinquish its role as the moderate leader within OPEC. Saudi Arabian-Iranian cooperation in enforcing production controls will mean higher prices for oil in the future as Western inventories are consumed during the coming winter.

The Saudi ruler moved quickly to implement his new tougher policy. Less than 24 hours after Sheikh Yamani was removed, and with oil at about $13 a barrel, the new Oil Minister, Hisham Nazer, called for an emergency meeting of the 13 OPEC members "to raise the price to at least $18 a barrel."

When Saudi Arabia, Iran, Iraq, Kuwait, and Venezuela founded OPEC in 1960, their purpose was a defensive one. They were expressing concern that their one non-replenishable natural resource was being drained away by foreign oil firms at a fraction of the price paid for oil pumped in Texas and elsewhere.

Saudis Moderated OPEC Pricing Policy

From the beginning, Saudi Arabia played the role of moderate leader in OPEC councils. However, the OPEC "hawks"—Iran, Algeria, and Libya—succeeded in driving the official price for the best quality crude oil up from about $2.50 a barrel to $41 a barrel. Saudi warnings that over-charging would be self-defeating in the long-run were ignored. Later, Saudi Arabia tried but failed to secure British and Norwegian cooperation in ensuring that all of the world's oil producers would have an equitable share in international oil markets. Finally, the Saudis agreed in 1983 to act as a "swing producer" in order to relieve pressures on other OPEC members. This meant that Saudi Arabia would adjust the volume of its oil exports downward to maintain market equilibrium. In exchange, the other OPEC nations agreed to lower prices by $5 a barrel (to $29) and to follow production quotas set in 1982. Riyadh suffered badly from this decision because lower prices failed to stimulate demand and many OPEC members quietly cheated on their quotas.

By the summer of 1985, Saudi sales had plummeted to about 1.5 million barrels per day (b/d), causing the Saudi government to abandon its defense of OPEC prices and to raise production to its OPEC quota of 4.35 million b/d.

Despite all of these efforts to maintain some order in OPEC policies, Saudi Arabia never was given credit, in OPEC or in the West, for its sensible and moderate strategy. The Western press, disregarding non-Arab OPEC members—Venezuela, Ecuador, Indonesia, ]ran, Nigeria, and Gabon—generally presented OPEC decisions as an Arab strategy against western oil users. In fact it was the non-Arab states that generally supported efforts by the radical "hawks" to keep oil prices climbing.

The Impact on Saudi Arabia's Economy

Since 1983, Saudi Arabia has incurred large deficits to keep its economy from losing momentum. Gross Domestic Product (GDP) fell 8.6 percent in the 1984-85 fiscal year, from $107 billion to $96 billion. Experts estimate that it probably has declined by even more than 8 percent during the fiscal year just completed. Saudi imports in 1985 fell by 28 percent. The Kingdom's foreign assets reportedly have declined by more than $50 billion over the past three years because of budget deficits and the private demand for dollars.

The Saudi budget for the current fiscal year was based on expectations of a $28 a barrel oil price and production of more than 3.8 million b/d. Revenues and expenditures were to be matched at about $55 billion. When the Ministry of Finance realized that revenues probably would amount to no more than $40 billion, a five-month postponement of the kingdom's balance sheet was announced. Government spending was cut back, a number of capital projects postponed, and costly subsidies on wheat production, water, and electricity were sharply reduced.

For the remainder of 1986, it is expected that Riyadh will attempt to hold spending to about $45 billion. Total government revenues, given an average transaction price for Saudi petroleum of about $15 a barrel, are unlikely to be more than $30 billion. Thus, based on current trends, Saudi Arabia is likely to face a deficit of more than $10 billion in FY 1986/87, which will have to be financed largely by a draw-down on foreign reserves.

In order to appreciate the seriousness of the current Saudi financial crisis, one must look back to the golden decade of 1970-1980, when the Kingdom's GDP rose from an estimated $6 billion to $16 billion, at an annual compounded rate of 10.5 percent. This growth rate compared favorably with those of West Germany and Japan during the 1950's and 1960's, and considerably exceeded that of the United States. The Saudi Ministry of Planning stated that Saudi Arabia spent more than $570.5 billion on development programs during the 1970-1985 period. This spending literally changed the nation from one with a modest agricultural economy to one with a modern industrial base.

Cutting a Deal With Iran

The current dark financial picture comes at a time when Saudi Arabia feels increasingly endangered in foreign affairs. The Iran-Iraq war has dragged on for over six years, with Iranian troops in southern Iraq on the Kuwaiti border. Ships of Saudi Arabia and its Gulf friends have been attacked. The Ayatollah Ruhollah Khomeini is feared throughout the Gulf area because of his potential for fomenting Shiite fundamentalist subversion against local Sunni Muslim leaders. The possibility that an Iranian military victory over Iraq would be followed by Iranian backing for uprisings against the conservative Arab leaders in the Gulf is of overriding concern to Saudi Arabia and Kuwait, as well as the small and practically defenseless Gulf states.

The watershed in Saudi oil policy came at the August OPEC meeting, when a reported 11 of the 13 members approved an Iranian proposal to reduce the cartel's production by nearly 4 million b/d. Viewed as a major political victory for Iran and a defeat for the Saudi price-war policy, it led to an intensive Saudi review of its role in OPEC as well as the state of its own finances.

Under the August agreement, all OPEC members except Iraq will return to a combined ceiling of 14.8 million b/d, on the basis of a 1984 OPEC quota system. Saudi Arabia will be allotted 4.3 million b/d, Kuwait 900,000 b/d, and Iran will produce 2.3 million b/d. Iraq will be free to keep production at its current output level of approximately 2 million b/d.

Ministerial sources reported at the time that "extremely sensitive" political contacts took place between Iran and Saudi Arabia. Senior Arab diplomatic sources confirmed that the level of "political confrontation" between the two countries over the financial aid extended by Saudi Arabia to Iraq would be diminished and that Iranian officials had pledged that Iran would refrain from threatening Saudi security, including attacks on Saudi tankers in the Gulf.

The October 22 OPEC meeting resulted in an agreement to continue restraints on production, indicating that the Saudi-Iranian understanding was being kept. Saudi Arabia now is guaranteed a substantial share of OPEC sales, a point crucial to Riyadh since it lost much of its market share in 1984 and 1985.

There is no doubt that the new Saudi Oil Minister will follow King Fahd's desire to pursue Saudi interests within OPEC. A Department of State official said recently: "It's not hard to argue that Saudi oil policy will be more nationalistic than in the past. A lot of Saudi officials argue that they held the 'swing producer' role too long"

Mixed Impact in America

If OPEC is able to insure an $18 a barrel price, the United States will again be facing higher oil import bills. Last year, US consumption was 4.9 million b/d of imported oil and in 1986 it increased to almost 6 million b/d. Experts predict that American consumption of imported oil will rise further to 6.1 million b/d next year. If this trend continues as expected, most oil company analysts predict imports to comprise more than one-third of US oil consumption.

Unfortunately for American oil producers, a rise to $18 a barrel won't lessen the decline in US domestic oil production. Most American oil experts agree that world oil prices will have to reach $23 to $25 a barrel, with some expectation that it will hold there, before the production slide halts. More conservative experts state that prices will have to rise to last year's level of $28 a barrel before wildcatting for new oil reserves revives.

If the new Saudi-Iranian cooperation in OPEC serves to relieve political pressure in the Gulf area, it will likely be welcomed in Washington. American international oil policy long has been concerned with the assurance of uninterrupted transportation of oil through the Straits of Hormuz, not only to the United States but to its Japanese and West European allies. Thus, any move to reduce tensions between Iran and Saudi Arabia, even at the cost of higher oil prices, will be welcomed.

Except for the current Iranian threat, the major determinants of Saudi policymaking are domestic in nature. Saudi leaders are aware that the stability of their regime depends upon its ability to satisfy the rising expectations of its people. The primary aim of Saudi internal policy traditionally has been to promote the material well-being of the nation while at the same time preserving the Islamic religious and social structure. Seen in this light, King Fahd's decision to work with Iran in seeking higher oil prices was a sensible one designed to further his country's well-being.

John T. Haldane is a specialist in Middle East affairs who has served as a Foreign Service Officer in Baghdad, Cairo, and Beirut, and as an international economist in the Departments of Treasury and Commerce.