I would like first to thank the Royal Institute of International Affairs for giving me this unique opportunity to speak before your distinguished gathering about Saudi Arabia’s Energy Industry.
In earlier days, in particular prior to the 1970s our energy industry was comprised of a single energy source, Oil. Although gas associated with crude oil was abundant, it was mostly disposed of by flaring as a useless and indeed worthless by-product of oil production. With the change of circumstances that pervaded the world energy industry in mid 1970s and the subsequent rise in energy prices, the Saudi Government implemented a super project for gathering, treating, and fractionating the gas associated with crude oil production.
This super project, dubbed the “Master Gas System,” cost 13 billion dollars, and conferred great economic value on our gas as fuel and petrochemical feedstock, enabling it to join oil as the second most important source of primary energy in Saudi Arabia.
As supplies of oil and gas became more accessible for local use as a result of rising crude production in the late 1970s, our young power industry was developing at an impressive rate, thanks to the input feeds of crude oil, derivatives and gas, and in time emerged as a major secondary energy source.
Our oil industry is one of the biggest in the world. It is primarily based upon the existence in Saudi Arabia of the largest single-owned crude oil reserve in the world. Officially this reserve stands today conservatively at 263 billion barrels, or about 26 percent of total world reserves.
Over the past few years we have discovered new reserves in volumes that compensated for the oil we have produced, with the end result that we have maintained our total reserves intact. Additionally all indication suggest Saudi Arabia has significant quantities of the world oil to be discovered.
Our recent exploration activities and updated geological studies corroborate that prediction.
Saudi Arabia’s current oil production level of about 8.2 million barrels per day is the highest in the world. It reached even higher levels during the 1979-81 period, after which it declined to very low levels particularly during the 1984-87 period, as a result of a sharp decline in world demand. Production began climbing steadily thereafter in tandem with rising world demand until it reached the current levels.
Over the last 25 years we have maintained an excess production capacity ranging between 2 to 4 million barrels per day as a contingency measure that may be activated if necessary during periods of world supply shortfall.
In periods of low demand, excess production capacity is mothballed but is always capable of being reactivated when the need arises. Over the last 22 years this arrangement has twice proven its effectiveness to the world. The first occasion took place in the aftermath of the Iranian revolution of 1978; the second in 1991 in the wake of Iraqi and Kuwaiti supply interruptions that resulted from Iraq’s occupation of Kuwait.
In the process of determining our production and capacity levels, five factors are instrumental. They are:
1 - World oil demand
2 - The size of our oil reserves
3 - The Government’s policy of ensuring continuity and smooth flow of world supply to consumers
4 - The Government’s objective of stabilizing world oil prices to eliminate harmful and unnecessary fluctuations in those prices.
5 - Our production quota under the OPEC production scheme.
As it applies these factors in its deliberations, Saudi Arabia is guided by three objectives: The first is realization of the highest revenue from oil over the long run. The second is maintenance of oil’s share in world energy consumption. The third is the evolution of a robust integrated and highly efficient petroleum industry capable of making significant contributions to a growing Saudi economy, and laying the foundation for diversified sources of income for the country.
In terms of efficiency, Saudi Arabia’s oil industry is endowed with a distinct comparative advantage. For example, the cost of adding new reserves in the country is about 10 cents per barrel, compared to 4 dollars per barrel in some other areas. Our cost of production is currently less than 1 dollar and 50 cents per barrel compared to a global average of about 5 dollars per barrel. Our National Oil Company, Saudi Aramco, has achieved major strides towards full integration. In the refining sector, Saudi Aramco owns or operates a capacity of 2.2 million barrels per day or about 25 percent of its crude oil production.
Saudi Arabia has an area of two million 220 thousand square kilometers, 90 percent of which is desert. The Saudi Government is keen to overcome this drawback by utilizing its hydrocarbon wealth in a manner that will help create other sources of income and change the quality of life by improving the standard of living of its citizens and creating more jobs for them.
In pursuing the objective of diversifying sources of income, the Saudi Government has been remarkably successful. By implementing a programme of massive investment in infrastructure and utilities throughout the Kingdom including creation of two major industrial cities in Jubail and Yanbu, coupled with discreet fiscal and monetary policies.
As a result a sizeable private sector has emerged. The contribution of this sector to our GDP increased from 13 percent in 1974 to 38 percent in 1999, whereas the contribution of the oil sector declined from about 80 percent to 34 percent in the same period.
While oil revenue was used by the Government to help finance the process of diversification in the Saudi economy, natural gas in addition to oil products, has provided the raw material base for this transformation. Gas is our twin source of primary energy. As I mentioned earlier, gas was mostly flared or re-injected in oil fields for pressure maintenance prior to 1975. Following the rise in world oil prices, the economics of utilizing our gas became clearly favourable.
Consequently the government instructed Aramco to implement the Master Gas System, which was designed to extract Methane and Ethane from raw gas for domestic use, and natural gas liquids for export. That system began functioning in 1981 with production of about 1 billion standard cubic feet per day of associated gas. With the discovery of new non-associated gas reserves, production of non-associated gas started to flow in adequate volumes in 1984 to supplement the gas requirements of water desalination and power utilities as well as our new petrochemical industry. As a result of enhanced supply availability and competitive prices, demand for gas was stimulated in all its uses and grew at a brisk rate of 11 percent annually for the period 1984-2000. In 2000, sales gas production reached a level of more than 3 billion cubic feet per day. In addition, ethane production reached 400 Million cubic feet per day.
As demand is expected to continue growing at high rates in the medium to long term, reaching almost 7 billion cubic feet per day in 2005 and 8 billion cubic feet per day in 2012, a supply strategy was laid down by the Government to cope with those increases. Since gas supplies associated with oil production have peaked, we recognize that supply increments will have to be met from non-associated gas fields.
Consequently a long-term strategy was laid down by the Government for identifying the ultimate economically recoverable gas reserves of Saudi Arabia, including a detailed plan for meeting domestic demand for gas and optimizing ethane and NGL utilization. The plan provides for comprehensive exploration and development activities to assure sufficient gas supply to meet demand to the year 2025 and beyond.
The ultimate objective of the strategy is developing a self-sufficient fully integrated gas industry capable of providing gas to the Saudi economy at competitive prices that will help support a thriving industry enabling it to generate value added and provide adequate supplies of water and electricity to Saudi society.
An example of the Kingdom’s impressive achievements in exploiting its hydrocarbon resources for attaining value added and improving the quality of life is the staggering growth of our power industry. Domestic sales of power increased from 4 million gigawatt/hours in 1974 to 97 million gig watt/hours in 1999, an expansion of 2,300 percent. This growth was facilitated by the availability of domestic hydrocarbon supplies at competitive prices. In 1999, our power industry consumed an average of 903 million cubic feet per day of sales gas, constituting about 32 percent of total gas sales. Power plants also consumed other petroleum liquids to supplement rising requirements for electricity generation.
The water desalination industry provided various cities in Saudi Arabia with 775 million cubic meters of fresh water from 27 desalination plants located on the Arabian Gulf and the Red Sea in 1999. These plants consumed an average of 646 million cubic feet per day of sales gas and additional amounts of petroleum liquids in the process of producing that volume of water in 1999.
The petrochemical industry in 1999 used an average of 877 million cubic feet per day of sales gas, 398 million cubic feet per day of ethane, and supplemental amounts of NGL’s as feedstock to produce about 18 million metric tons of petrochemical materials and polymers and 4 million tons of fertilizers. These are only examples of the current and projected levels of demand for gas in various sectors of the Saudi economy. Total gas demand for all these sectors, together with demand from the oil industry and other industries, is expected to grow more than four-fold in the coming 25 years, from 3 billion cubic feet per day in 1999 to more than 12 billion cubic feet per day in 2025.
To cope with these increases in future gas demand, the Government has laid down a strategy for a robust gas exploration and development programme that provides sufficient gas supply to meet demand to the year 2025, and which optimizes ethane and NGL utilization. This programme takes into account the currently known gas reserves of about 219 trillion cubic feet and the Kingdom’s undiscovered gas potential of sizeable amounts. The plan will use an integrated approach to assess the Kingdom’s gas potential and optimize gas supply development and required capital expenditures. We have determined that the benefits to be derived from using our gas for domestic purposes far outweigh the benefits of exporting it in the form of liquefied natural gas or LNG. Consequently the LNG export option has been ruled out for the time being. This decision does not apply, of course, to the export of NGL’s.
In line with the Government’s objective, and as a result of the invitation extended to multinational oil companies to submit investment ideas of mutual benefit in the gas value chain, the oil companies submitted proposals for exploration and development of gas resources across the Kingdom, including relevant mid- and downstream investments.
The Kingdom has converted these preliminary proposals into identifiable investment opportunities for companies to pursue and bid upon.
These opportunities encompass the full gas value chain from upstream non-associated gas exploration and development, to gas processing and transportation, to ethane and NGL extraction and fractionation facilities, to downstream petrochemical, power and water desalination projects.
The Kingdom has identified and is offering mega projects. The exploration acreage offered within these projects covers vast areas of the Kingdom from the Red Sea in the west to the Rub‘ al-Khali in the southeast of the Kingdom. The offered acreage is very promising. These vast prospective areas will be made available for outside investors to conduct exploration and development activities. In addition, some undeveloped fields are also being offered for development.
The Kingdom is currently working diligently in establishing favorable environment to attract these investments to provide a win-win situation to both the investors and the Kingdom.
In the process of implementing its oil and gas policies, Saudi Arabia responds positively to market indicators. Of prime importance for the Kingdom is the level of oil demand and the factors that influence its movements. Bearing in mind its supply and price policy, which aims at satisfying its need for revenue and development, Saudi Arabia has a commitment to ensure supply availability and continuity for world consumers. As reserves are abundant, Saudi Arabia’s levels of production capacity and actual production are guided by its perception of the levels of current and future world demand. Transparency of demand is therefore very important for policy implementation.
One area of demand ambiguity stems from the world power industry. A quarter of a century ago, the international power industry largely depended on oil as an energy input for electricity generation. This dependence started to decline in the early 1980’s as a result of a decision taken in 1979 by the member countries of the International Energy Agency to freeze the use of oil in new power generation plants and to reduce oil utilization rates in existing ones.
Those countries have withheld authorization of new oil-fired power plants from that year to the present as a matter of government policy. That decision resulted in the decline of oil use in power generation in those countries by about 110 million tons of oil equivalent in the period 1973-98, or about 43 percent over the last 25 years.
Furthermore, opportunities for increased oil use in power generation were also denied in favour of coal, gas and nuclear power, despite the fact that oil is competitive with some of these sources for new generation plants at prices prevailing since 1986.
The use of coal in power generation in IEA countries increased by 404 million tons of oil equivalent or 90 percent over the same period despite the fact that coal emits 20 percent more CO2 into the atmosphere than oil per unit burned. Other major consuming countries in the developing world have also been influenced by IEA policies in this regard and switched their power generators away from oil, towards coal, and nuclear power.
These trends have unjustifiably created a bias against oil for use in a major component of growing world energy demand. The dismissal of oil as an effective and major input in power generation has reduced competition by restricting the number of viable energy sources suitable for the purpose. It has further deprived consumers of the advantages of an input feed whose supplies are readily available in times of power shortages anywhere in the world, with the ultimate effect of raising the costs of power generation to consumers.
The question now arises as to whether the ban on oil use in power generation will be removed in favour of allowing free market forces to determine demand for oil use in that important sector over the next few years in light of world globalization.
Another factor that helped to distort perceptions of demand movements for oil is the staggering rise in excise taxes imposed on oil consumption in consuming countries. The conventional wisdom has it, particularly in major industrialized countries, that crude oil prices of about 25 dollars per barrel are high.
In fact, deciding whether 25 dollars is high or low is a relative matter and should be judged in terms of other costs. For example, over the period 1980-2000, excise taxes on oil products in the European Union increased from 21 dollars per composite barrel to 60 dollars per barrel, an increase of 186 percent.
In OECD countries they increased from 11 dollars per composite barrel in 1980 to almost 35 dollars, a rise of 218 percent. Meanwhile the crude oil price, to take Brent as an example, fell from 36 dollars per barrel in 1980 to less than 29 dollars in 2000, a decline of 24 percent. In fact the oil price over the period 1986-2000 averaged less than 19 dollars per barrel, whereas the excise taxes imposed in the European Union averaged almost 54 dollars per barrel, and those in the OECD averaged almost 30 dollars per barrel, during the same period. When these taxes were added to the CIF price of imported crude oil and to the refining and distribution costs, they resulted in very high levels indeed, which reached almost 104 dollars per barrel in the EU and more than 82 dollars in the OECD in 2000.
OPEC has abandoned the price-fixing policies implemented prior to 1986, considering them to be counterproductive measures that constrain free market forces, and it now lets prices seek their own levels as determined by the forces of supply and demand.
Paradoxically the tax fixing measures adopted by industrialized countries may be likened to a coordinated effort at price fixing, which will negatively impact demand levels and frustrate market signals. Rather than blame OPEC for oil price increases, one can objectively note that higher prices, as we have indicated, are in fact more attributable to the taxing policies of industrialized countries than to the production policies of OPEC countries.
The drivers’ crises that erupted last fall in certain industrialized countries, including those endowed with high oil production, cleared OPEC of the monopolistic charges usually directed against it. It is widely known that the effect of the crude oil price on GDP performance and other macro-economic indicators is now minimized due to the drastic fall in GDP/energy elasticities in world economies over the last 20 years.
Between 1979 and 1999, the energy elasticity of GDP in industrialized countries declined by 29 percent and in developing countries by 35 percent. A closer look at the performance of industrialized countries’ economies, as well as those of non-OPEC developing countries, over the period 1979-1999, reveals that the GDP grew remarkably well and at a greater pace than that of OPEC countries, including Saudi Arabia, despite the oil price fluctuations in the world oil market during that period.
Saudi Arabian oil policies are well known to consuming countries. We are firm believers in the importance of a continued dialogue between oil producers and oil consumers as a means of providing acceptable solutions to market problems.
High on our agenda for dialogue are the subjects of market stability, security and transparency of supply and demand for oil, the relationship between energy and sustainable development, and environment concerns. We were active in initiating the first North/South dialogue held in Paris in 1975-1977. We also attended the seven other energy forums directed at such a dialogue, held between 1991 and 2000 with high-powered delegations.
During the most recent Forum, held in Riyadh in November last year, His Royal Highness Crown Prince Abdullah Bin Abdul Aziz proposed institutionalizing this energy dialogue by establishing a permanent Secretariat to be headquartered in Riyadh. We hope that this initiative will further facilitate the ongoing dialogue between producers and consumers aimed at reaching more effective solutions to market volatility and imperfections.