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Crisis, crunch or crumble: after Yukos, it's time we started fearing for the future of Saudi oil

Sixty per cent of Saudi production comes from the 'King of Kings' field. If this starts to decline, production has peaked.

A threatened halt of oil supplies from Yukos, the largest Russian oil company, sent the oil price to a 14-year high last week. The reason was a row between the company and Russian authorities and it now seems that supplies will continue. But Yukos pumps 2 per cent of the world's crude, and the threat underlined the fragile state of the global energy market.

So how bad are things? The clearest analysis I have seen comes from Nariman Behravesh at World Markets Research Centre, who thinks oil markets are in the most precarious situation since the early 1980s and are the biggest single threat to the global recovery over the next couple of years. The market is tight; Saudi Arabia is the only country with any spare capacity and its oil facilities are under terrorist threat; and other big producers, such as Iraq, Venezuela and Nigeria, for differing reasons all face possible disruption of supply.

Mr Behravesh sketches three scenarios: the crisis one, the crunch one and the crumble one.

Crisis is oil at $65 a barrel. That could be triggered by a combination of a terrorist attack in Saudi Arabia, disruption in Iraq and strikes in Venezuela. The effect would be most serious in continental Europe and the Asia/Pacific region, with Germany and Italy both pushed back into recession, and South Korea and China facing much slower growth. The US would suffer but not as gravely as continental Europe, while Russia would do well out of it all. (The UK's position, I imagine, would be broadly neutral as we are still, just, net exporters of oil but would suffer from slow growth in export markets.)

Crunch is oil staying more or less where it has been for the past couple of months, between $35 and $40 a barrel. Growth will be slow, particularly on the continent, as present forecasts are based on oil going down in price, not up.

And lastly, the crumble - the oil price crumbling back down to the $20-$30 a barrel region. Under those circumstances the present growth phase will continue, even speed up.

So what will it be? The joy of scenario planning is that it makes people think through the consequences of different events so that they are prepared. Obviously, we as individuals can't do much, except perhaps make the next new car a fuel-efficient one, although businesses can and should think about the implications of big swings in energy costs. But by its very nature, the exercise does not tell you which scenario is the one to go for.

What one can say is that the risks of a spike in the oil price must be quite high. The principal reason is the fragility of the Middle East.

The two graphs above, from BP's annual energy statistics, [note: graphs were not present at original -ed] show how the region dominates the world's proven reserves and also has the highest ratio of reserves to production. The obvious moral is that as the world's oil is gradually depleted, the Middle East will become more important, not less. But at least there is nearly 90 years of supply in the Middle East, at current rates of production, and more than 40 years of supply for the world as a whole. Given that technology is always advancing and more oil will almost certainly be discovered, that sounds all right.

But is it? I have been looking at an intriguing report by Mathew Simmons of Simmons & Company International, presented to the Hudson Institute in Washington last month. The theme is that Saudi Arabia has had an exceptional track record as the world's oil steward, with 70 years of outstanding performance as a producer and an advocate of "fair pricing". But serious technical concerns have arisen about its ability to continue producing at its present rate, a problem made worse by a lack of verified data.

The nub of Mr Simmons' argument is that all but two main fields are old and that intense exploration has failed to find much more oil. Some 60 per cent of Saudi production comes from the "King of Kings" field, Ghawar, discovered in 1948, which produces five million barrels a day. It is 174 miles long and a maximum of 16 miles wide and is the world's largest oil field, producing about 7 per cent of the world's supply.

It has been a reliable supply and a huge amount of oil is clearly left. But its pressure has been maintained by water injection, which is perfectly normal, but which might mask depletion. Mr Simmons feels Ghawar is vulnerable and that if its pressure drops, its production will decline and a lot of oil will be "left behind". He has concerns about other Saudi fields too, but the main point is that if Ghawar started to decline it would mean Saudi production had peaked.

The Saudi response is that estimates of "original oil in place" have grown by 20 per cent in the past 20 years and that the country can safely produce 10-15 million barrels a day for the next 50 years. That may be right - the experts seem to disagree, and as outsiders we cannot hope to judge. But it is worth noting these concerns. If a large amount of technical expertise is needed just to maintain Saudi production, any exodus of foreign experts would have consequences for future output.

There is no particular reason to expect, even if these concerns are justified, that Saudi production will start to fall in the next couple of years. You would expect any problem to be a medium-term matter, not an immediate one. The trouble is that bad news has a nasty habit of coming in batches. We should not assume that the continued steady supply of Saudi Arabian oil is simply a political matter; it may also be a technical one.

This need not be cause for panic. We are not going to run out of oil next week, nor next year, nor next decade. But oil supplies are likely to remain quite tight and may become tighter. Tight markets increase the likelihood of price spikes. In real terms, oil is still only half the price it was in 1980 but that led to a global recession.

We also have to accept a shift in power towards Russia and other producers. (Not much of a shift to the UK, though, where production is starting to decline.) And we have to accept that energy-poor regions, such as western Europe and Japan, will have to butt into a headwind of higher prices. This is not a disaster; probably, in environmental terms, it is a good thing to make us use energy more carefully. But it is a concern.

© 2004 Independent Digital (UK) Ltd

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