Saudi Arabia’s Oil Productive Capacity – The Trade-Offs
In a series of recent speeches and interviews, a consistent message coming from Saudi Aramco is that ‘future profit growth will be more from diversification into integrated oil refining and petrochemicals, besides natural gas production and supply for both the domestic and international markets’. But what about opportunities in the upstream oil sector and the potential expansion of oil productive capacity? How does upstream oil fit within the future portfolio of Aramco and the Kingdom’s role as the ‘central bank of oil’ as some describe it? These are key questions, which don’t only have implications for Saudi Aramco’s capex budget and how the budget is allocated across the various business segments and the company’s future sources of profitability growth, but also on oil market dynamics and the future of the Kingdom’s revenue paths.
Much of the recent discourse has focused on the upside potential of Saudi Arabia’s oil productive capacity and every time Saudi Aramco announces plans to expand an existing field or develop a new field, there is much speculation whether this would represent a net capacity addition. Also, at times when expectations about global oil demand peaking soon are rife, many have argued that this would induce a shift in the output strategies of large resource owners. Those who recommend a fast monetization strategy however fail to appreciate the constraints that Saudi Arabia faces in pursuing such a strategy given the heavy reliance of the government’s income on oil revenues. For Saudi Arabia to pursue a strategy of fast monetization, it needs to diversify its sources of income away from oil exports, for instance by heavily taxing its businesses and individuals, without jeopardizing political and social stability. This requires deep economic and political structural transformations, which will take a long time to implement with no guarantee of success.
Rather than pursing an aggressive monetization strategy, the question perhaps should be posed differently. In the current context of wide uncertainties about global oil demand and the speed of the energy transition and the limited diversification of government’s income, is there a case for Saudi Arabia to reduce its capacity to lower levels and/or let its spare capacity erode? It is argued that the strategy to manage a reduction of its output capacity could maximise revenues over the medium-term especially given that the capital costs are low in implementing such a strategy. However, there are adverse consequences for the Kingdom as a result of this strategy. For instance, Saudi Arabia would become a price taker; it would end up with a lower market share; it would undermine the Kingdom’s geopolitical status; and it would lose an important discipline mechanism. These are all significant costs. It may also require coordination with other low cost producers that would be eager to increase capacity. Such coordination is extremely difficult if not impossible. But it is important to make a few points. The alternative strategy of fast monetization of reserves is also associated with a high cost in terms of lower revenues. Also, Saudi Arabia cannot afford to be reactive in the event that the impacts of energy transition fully materialize, as the costs of absorbing such a shock are too high, not only in absolute terms, but also relative to other options.