CAPITAL: Riyadh

MONETARY UNIT: Riyal

REFINING CAPACITY: 1,685,000 b/d

OIL PRODUCTION: 8.08 million b/d

OIL RESERVES: 259 billion bbl

GAS RESERVES: 204 tcf

Disputes within the Organization of Petroleum Exporting Countries (OPEC) characterized the year of 1998, with Saudi Arabia in particular growing increasingly angry with quota violations at a time of plummeting oil prices.

In March Saudi Oil Minister Ali Al Naimi stated his country would never again play the role of swing producer in the oil market: "We have established long term, strong, and reliable relationships with many customers in all parts of the world which we cannot abandon at all.

"Therefore we do not want to reduce production to find out that other countries-especially those who do not adhere to their quotas-are flooding the market, undermining prices, and taking our valuable customers."

Shortly afterwards Saudi Arabia, along with Mexico and Venezuela, surprised the oil industry by pledging to cut output and asking for other OPEC and non-OPEC producers to join in.

An accord in Riyadh targeted total production cuts amounting to 1.725 million b/d, of which Saudi Arabia pledged the largest cutback of 300,000 b/d.

Upstream action

Major exploration and development steps in Saudi Arabia during 1998 included start-up of a giant field in the Empty Quarter and an oil and gas discovery in the partitioned neutral zone.

On July 2, Saudi Arabian Oil Co. (Saudi Aramco) began production from Shaybah oil field 800 km south of Dhahran following a $2.5 billion, 3 year development project. The field lies along the border with Abu Dhabi in a vast uninhabited desert area of salt flats and sand dunes.

Saudi Aramco estimated Shaybah reserves at 14 billion bbl of Arabian Extra Light crude and 25 tcf of natural gas. Production began flowing through a 635 km, 46 in. pipeline to a processing center at Abqaiq on July 2 at the rate of 200,000 b/d. It quickly climbed to 400,000 b/d from 60 horizontal wells and was to peak at 500,000 b/d.

The project eventually was to include 140 production and injection wells.

The field had been under evaluation for 25 years. Field facilities include three gas-oil separators. Facilities at Abqaiq handle crude spheroiding and stabilization, gas compression, and NGL stripping. Dry gas flows to Saudi Arabia`s master gas system, NGL to Ras Tanura for export. Crude goes to export terminals at Ras Tanura and Juaymah.

In October Saudi Arabian Texaco Inc. and Kuwait Oil Co. announced an oil and gas discovery on a jointly operated block in the partitioned neutral zone between Kuwait and Saudi Arabia.

The Humma-4 discovery well was drilled 16 miles southwest of the companies` Wafra field to a total depth of 10,180 ft and cut 726 ft of gross pay in five zones. Texaco said the well flowed 3,400 b/d equivalent of 32° gravity crude oil and sweet gas, at a flowing pressure of up to 1,649 psi.

The operators planned further seismic data acquisition and drilling in the prospect before a development decision due in 1999.

Petrochemicals, pipelines

Saudi Basic Industries Corp. (Sabic) signed a letter of intent in April with Parsons International Group for construction of a $400 million polypropylene plant in Jubail.

The plant was to have capacity to produce 320,000 metric tons/year of polypropylene, taking total capacity at the Jubail complex to 640,000 tons/year, and was scheduled to begin production in the second quarter of 2000.

At the same time Saudi Arabia`s National Manufacturing Co. announced it would build a $300 million plant in Jubail to produce 400,000 tons/year of propane and its derivatives. First production of propane was slated for 2001, with feedstock gas to be provided by Saudi Arabian Oil Co. (Saudi Aramco).

In May Sabic and Exxon Corp., joint owners of the Al-Jubail Petrochemical Co. (Kemya) complex, disclosed plans to expand operations at the main site, beginning later in the year.

The expansion plan included construction of a new steam cracker, debottlenecking of existing linear low density polyethylene (LLDPE) plants, and construction of a low density polyethylene (LDPE) plant.

The new cracker was scheduled for completion in late 2000 and was intended to have capacity to produce 700,000 metric tons/year of ethylene and 200,000 tons/year of propylene.

The site`s two LLDPE units were to be expanded by almost 40%, raising combined production capacity to 850,000 tons/year with construction due to start in late 1998 with a view to plant start-up in late 1999.

Construction of the 218,000 metric ton/year LDPE plant was also slated to begin in late 1998 but with start-up scheduled for the second quarter of 2000. The LDPE plant was to be based on Exxon`s high pressure tubular technology.

The Saudi daily newspaper Al Riyadh reported in September that Saudi Aramco planned to open in November a 750 km pipeline linking the oil-producing eastern area of the country with the center.

The first stretch of the pipeline, 70 km in length, was completed in May. The pipeline was designed to carry 285,000 b/d of crude oil from Dhahran on the Arabian Gulf coast to Al Qassim, north of Riyadh. Previously, oil had been carried from Dhahran to Al Qassim in tanker trucks.

Talks with majors

In October Saudi Arabia was reported to have approached seven large U.S. petroleum firms with a view to encouraging investment in Saudi upstream projects at a meeting outside Washington, D.C.

Saudi Crown Prince Abd Allah ibn Abd Al-Aziz Al Saud was reported to have asked executives of the companies to submit proposals for the investment relationships they would like to establish with the kingdom together with ideas for specific areas of activity.

The companies approached by the prince were listed as Exxon, Chevron, Mobil, Texaco, Conoco, ARCO, and Phillips. In the past Saudi Arabia had worked with Exxon, Mobil, Chevron, and Texaco, all of which once had interests in Arabian American Oil Co. (Aramco), which was later taken under state control.

The circle of long term contractors to the Saudis was expanded to include three other large international players-Conoco, ARCO, and Phillips. Middle East Economic Survey said, "It will be interesting to see whether the kingdom will now go on to extend its invitation for the submission of investment proposals to European oil majors as well."

While the prince did not rule out the possibility of investment by U.S. firms in Saudi oil exploration and production, he was apparently most keen to hear of projects to boost gas reserves and produce gas to feed new industrial projects within Saudi Arabia.

Yet in November the Gulf News regional newspaper reported that Saudi Arabia looked likely to remain largely off limits for foreign investors, despite the May launch of a privatization program at Saudi Telecommunications.

At the time London`s Centre for Global Energy Studies (CGES) predicted that Saudi Arabia would suffer huge revenue shortfalls in financial year 1998 after good years in 1996 and 1997 caused by unexpectedly high oil prices.

"The authorities," said CGES, "were suitably cautious in budgeting for 1998 an 8.5% increase in revenues over the 1997 planned amount, representing a 13% cut over 1997 actuals. However, little did they realize at the time that the oil price would collapse in 1998, putting this year`s Saudi budget in jeopardy."

CGES reckoned the Saudi budget deficit would be 43 billion riyals ($11.5 billion) in 1998, and then only if expenditures were on target. But the analyst noted that Saudi expenditures had exceeded forecasts "by very large margins" in the previous 2 years.

Having knocked at the door of the Saudis, in the hope of getting a slice of the country`s giant development and redevelopment projects, western petroleum companies were hoping that, with a need to cut operating costs and new development costs, Saudi Arabia might at long last be forced to court foreign partners.

Meanwhile, in December Saudi Arabia`s Saudi Consolidated Electricity Co. let an $835 million turnkey contract to Asea Brown Boveri Ltd., London, for construction of a 1,100 MW oil-fired power plant at Shoaiba, 120 km south of Jeddah on the Red Sea coast.

The plant was intended to comprise three 370 MW units, the first of which was slated for completion by mid-2001. The other two units were due in operation 8 and 14 months after the first. The contract included an option to build two more plants of the same size.

In December 1998 Saudi Arabia Oil Co. (Saudi Aramco) let contract for an undisclosed sum to the Technip Italy unit of Technip SA, Paris, and its TPL Arabia Ltd., affiliate, to build a sulfur recovery and utilities plant at Hawiyah gas field in Saudi Arabia.

Technip said the plant would be built 280 km south of Dhahran, and will comprise three recovery units with a capacity of 350 tons/day each, with sulfur loading facilities and related utilities.

Mechanical completion was slated for the end of November 2001 and the plant was due on stream in the first quarter of 2002. Aramco`s gas development in Hawiyah was expected to deliver 1.6 bcfd of gas to the Saudi master gas system.

Around year-end, with oil prices at their lowest ever in real terms, analysts began to see a new threat to markets from Arabian Gulf producers, and in particular they speculated about a new strategy for Saudi Arabia.

Crude oil markets had shown virtually no signs of improvement, despite OPEC production cutbacks, and the situation was expected to get worse before it got better.

The London branch of Commerzbank AG reckoned that Brent crude oil futures would average $11/bbl in 1999, a drop of $3/bbl from its previous quarterly forecast.

While the bank expected Brent futures to recover to an average of $13/bbl in 2000, it also feared that Gulf producers would attempt to keep oil prices at $10/bbl for a number of years to squeeze out higher cost producers.

The Petroleum Finance Co., Washington, had been thinking along the same lines, and said that with the collapse of oil prices the Saudi economy appeared to be on the brink of financial crisis.

Yet Petro Finance said that if the Saudi government decided to approach the problem by pursuing market share rather than higher oil prices, this could have a colossal impact on oil industry outside the gulf.

"Demand remains very weak," said Commerzbank, "OPEC compliance (with the June 1998 production cuts pledge) is slipping and further production cuts are unlikely before March, inventories are still at record highs and the hoped-for cold winter in the northern hemisphere has, as yet, failed to materialize."

The bank said hopes for an oil price recovery were then pinned on additional OPEC production cuts, and reckoned that further cuts of 1-1.5 million b/d were needed through 1999 to remove the global stock overhang of 400 million bbl of oil.

"Many of the smaller producers," said Commerzbank, "such as Kuwait, Algeria, and Libya, have called for further cuts. But the three largest producers, Saudi Arabia, Iran, and Venezuela, have been much less keen.

"Saudi Arabia, the single largest producer, has indicated it wants to see greater compliance with the existing agreements before it will reduce its own output below the 8 million b/d level."

The bank speculated that the supply/demand situation could soon go so far out of balance that oil prices would stay low long enough to encourage investment in low-cost producing regions, particularly in the Arabian Gulf states, in preference to relatively high-cost resources outside the region.

"The result," said Commerzbank, "could be a sustainable environment of very low oil prices. But why would the Gulf states, which have most of the world`s lowest cost reserves, want to tolerate such a situation?"

The bank reckoned that if the Gulf nations could afford to forego cash flow through lower prices in the short term, and also fund investment to boost production capacity, they could achieve a return on investment of 13%: "This is well above their cost of borrowing, so is potentially a highly attractive economic scenario."

Another possibility, said Commerzbank, would be for Saudi Arabia to pursue a low price strategy on its own: "If we assume that it picks up 60% of the extra production required from the Gulf, then the investment return ratio for the Saudis is even more attractive, at 15% real."

The bank believed that the balance sheets of the Gulf states would be able to withstand the cost of such a policy, despite the apparent pressure on domestic budgets.

"The low-cost, long reserve-life producers of the Gulf have a clear economic incentive to endure a period of very low prices," said Commerzbank.

"This has been a fact of life in the oil industry since John D. Rockefeller, founder of Standard Oil, first gave his competitors a `good sweating` back at the turn of the last century.

"Now, as we approach the new millennium, it is the big reserve holders of the Gulf that have the power to bring about such low prices. It is a risk that equity investors should bear in mind."

Petro Finance said that a price defense option would require Saudi Arabia to take the lead in restraining production and break the sanctity of the 8 million b/d production floor. It would also most likely need to cut proportionately more than other OPEC countries: 50% of a further 1.5 million b/d reduction.

"Such a cut," said Petro Finance, "which would bring Saudi production to about 7.25 million b/d, would purge high oil inventories, and push oil prices up to an estimated $17/bbl in 1999. The impact on Saudi finances would be immediate, providing the kingdom with a respite from its present troubles."

Yet the success of price boosting would be short-lived for the Saudis, said Petro Finance. Higher prices would encourage OPEC and non-OPEC companies to develop more projects, and prices would be undermined once more.

"Defense of market share," said Petro Finance, "is a longer-term strategy that entails a fundamental shift in Saudi oil and national economic policy.

"Under this option, the kingdom would seize the opportunity presented by the low oil price environment to recapture significant market share and marginalize high-cost producers.

"By allowing prices to remain at $11-12/bbl (WTI) for 2-3 years, Saudi production could grow from 8.3 million b/d in 1999 to 11 million b/d in 2003.

"This policy would increase the economic pain in the short term, but would secure a more viable production and revenue profile in the medium term.

"Oil prices would become structurally lower, and the impacts of developments in technology and cost-cutting would be undermined by removing all the areas where production costs average more than $8/bbl. The map of oil and gas exploration would be redrawn in favor of low costs producers in the Arabian Gulf."