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Saudi Arabia was worried about a danger much bigger than shale when it blindsided oil markets

saudi1While the new Saudi stance that has shaved 50% off oil since June has been trumpeted as a war on U.S. shale, the puppet master of global oil Ali Al-Naimi has been pushing prices lower because of a much deeper fear. Muzammil Pasha/Bloomberg News

Last fall, as oil prices crashed, Ali al-Naimi, Saudi Arabia’s petroleum minister and the world’s de facto energy czar, went mum. He still popped up, as is his habit, at industry conferences on three continents. Yet from mid-September to the middle of November, while benchmark crude prices plunged 21 per cent to a four-year low, Naimi didn’t utter a word in public.

For 20 years, Bloomberg Markets reports in its May 2015 issue, the world’s US$2 trillion oil market has parsed Naimi’s every syllable for signs of where supply and prices are heading. Twice during previous routs—amid the Asian financial crisis in 1998 and again when the global economy melted down 10 years later — Naimi reversed oil’s free fall by orchestrating production cutbacks among members of OPEC. This time, he went to ground.

At the cartel’s semiannual meeting on Nov. 27 in Vienna, Naimi shot down proposed output reductions supported by a majority of the 12 members in favor of a more daring strategy: keep pumping and wait for lower prices to force high-cost suppliers out of the market. Oil prices fell a further 10 per cent by the end of the next day and kept going. Having averaged US$110 a barrel from 2011 through the middle of 2014, Brent crude, the global benchmark, dipped below US$50 in January.

“What they did was historic,” Daniel Yergin, the pre-eminent historian of the oil industry, told Bloomberg in February. “They said: ‘We resign. We quit. We’re no longer going to be the manager of the market. Let the market manage the market.’ That’s when you got this sort of shocked reaction that took prices down to those levels we saw.”

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Naimi, 79, dominated the debate at the November meeting, according to officials briefed on the closed-door proceedings. He told his OPEC counterparts they should maintain output to protect market share from rising supplies of U.S. shale oil, which costs more to get out of the ground and thus becomes less viable as prices fall. In December, he said much the same thing in a press interview, arguing that it was “crooked logic” for low-cost producers such as Saudi Arabia to pump less to balance the market.

Supply was only half the calculus, though. While the new Saudi stance was being trumpeted as a war on shale, Naimi’s not- so-invisible hand pushing prices lower also addressed an even deeper Saudi fear: flagging long-term demand.

Naimi and other Saudi leaders have worried for years that climate change and high crude prices will boost energy efficiency, encourage renewables, and accelerate a switch to alternative fuels such as natural gas, especially in the emerging markets that they count on for growth. They see how demand for the commodity that’s created the kingdom’s enormous wealth—and is still abundant beneath the desert sands—may be nearing its peak. This isn’t something the petroleum minister discusses in depth in public, given global concern about carbon emissions and efforts to reduce reliance on fossil fuels. But Naimi acknowledges the trend. “Demand will peak way ahead of supply,” he told reporters in Qatar three years ago. If growth in oil consumption flattens out too soon, the transition could be wrenching for Saudi Arabia, which gets almost half its gross domestic product from oil exports.
Last week, in a speech in Riyadh, Naimi said Saudi Arabia would stand “firmly and resolutely” with others who oppose any attempt to marginalize oil consumption. “There are those who are trying to reach international agreements to limit the use of fossil fuel, and that will damage the interests of oil producers in the long-term,” he said.

U.S. State Department cables released by WikiLeaks show that the Saudis’ interest in prolonging the world’s dependence on oil dates back at least a decade. In conversations with colleagues and U.S. diplomats, Naimi responded to the American fixation on “security of supply” with the Saudi need for “security of demand,” according to a 2006 embassy dispatch. “Saudi officials are very concerned that a climate change treaty would significantly reduce their income,” James Smith, the U.S. ambassador to Riyadh, wrote in a 2010 memo to U.S. Energy Secretary Steven Chu. “Effectively, peak oil arguments have been replaced by peak demand.”

The Saudis, to be sure, never thought much of peak oil. That’s the theory that global crude supplies, on an upward trajectory for a century and a half, were about to stop rising and could no longer keep up with demand. A faction of geologists and environmentalists made this argument part of the policy debate in the early years of this century. In 2005, when a book by oil analyst Matthew Simmons predicted a drop-off in Saudi output would signal that global supplies were beginning an irreversible decline, Naimi belittled the claims and promised higher production capacity. He won the argument. The Saudis pump more today than a decade ago. Saudi oil fields boast state-of- the-art technology, and at least two of them, in the middle of the desert, have gourmet restaurants. U.S. output has had a stunning rise as well, to more than 9 million barrels a day at the end of 2014 from less than 6 million five years ago. The peak that has the Saudis more worried is peak demand.

Before oil prices tanked last year, Saudi officials were bracing for global demand to level off as soon as 2025, says Mohammed al-Sabban, a senior economic adviser to the Saudi petroleum minister from 1988 to 2013. By letting prices fall, they may have bought themselves some time. At US$60 to US$70 a barrel, peak demand gets pushed back at least five more years, according to Bank of America Merrill Lynch commodities researchers. Such a delay would be bad news for renewable energy companies and for anyone hoping to bend the demand curve lower—slowing or stopping the relentless rise of global oil consumption that has transformed the planet since the first commercial deposit was developed in Pennsylvania in the early 1860s.

Crude prices above US$100 a barrel had been bringing a demand peak closer. “The past four years were a disaster for oil producers in terms of energy market share,” says Sabban, who was also Saudi Arabia’s chief international climate negotiator. “Emerging economies are getting more efficient and diversifying their energy sources. That has definitely impacted oil consumption.”

Saudi officials were in a state of “near panic” last summer, when they recognized how quickly demand growth in China was leveling off, in part because of persistently high crude prices, says Ed Morse, Citigroup’s head of commodities research. “Naimi saw the era of frantic fixed-asset investments in China was over,” says Morse, a former deputy assistant secretary of state for international energy policy, who still communicates regularly with Gulf Arab officials. “That translates to the end of rapid urbanization, the end of doing things in unbelievably energy-intensive ways.”

Substitution of lower-cost fuels is also taking a toll. Chinese diesel demand, after rising an average of 8 per cent a year for a decade, actually fell in 2013 and 2014. The International Energy Agency attributes this partly to the country’s rapidly expanding fleet of natural gas vehicles. Chinese demand for oil this year is expected to rise to 10.6 million barrels a day, an increase of 2.6 per cent, or half the average annual growth of the past decade and one-sixth the rate in 2004. China’s oil use is still climbing twice as fast as global consumption, but the IEA has in the past year shaved 500,000 barrels from its 2019 China demand forecast. More efficient autos and factories reduced the overall oil intensity of China’s economy—oil burned per unit of GDP—by 18 per cent from 2008 to 2014. “If I were in Naimi’s shoes, I’d do exactly what he’s doing,” Morse says.

Naimi, who for the past five years has been telling friends he’s ready to retire, faces big risks as he sees through one more dramatic market realignment. His refusal to put Saudi Arabia and OPEC once again in the swing producer role, cutting supply to balance the market, hurts economically troubled member states that most need a price rebound. In Venezuela, where the economy is teetering and foreign-exchange reserves are depleted, oil’s collapse blows a bigger hole in the government budget and deepens the crisis. Iran, which needs high prices to help offset the effect of sanctions that have choked off its exports, has had harsh words for the Saudi-led policy. Persian Gulf producers should try to halt the decline in prices, a deputy foreign minister said on state-run television in January, and Foreign Minister Mohammad Javad Zarif delayed a meeting with his Saudi counterpart due to the discord. Regional tensions were highlighted in late March, when Saudi Arabia led airstrikes against Yemen’s Houthi rebels, seeking to counter Iranian influence there.

Even Saudi Arabia, with more than US$700 billion in reserves, could suffer financial strain if oil prices stay low for several years. The kingdom, with a population of about 30 million, spends lavishly on domestic programs and foreign aid. When King Salman ascended to the throne in January, after the death of King Abdullah, he promised in his first speech to improve education and expand health care. The Saudi budget was in deficit in 2014, despite strong oil prices for most of the year. The government forecasts a 2015 budget gap of 145 billion riyals (US$39 billion), and it will be wider if oil prices don’t rebound.

Still, Naimi has said several times since the November meeting that he doesn’t know how low prices might go or when they will recover—and that the Saudis are willing to wait and see. Naimi’s concerns for Saudi Arabia are further in the future.

“Our ultimate aim is to diversify away from our overreliance on oil revenues,” the petroleum minister said at a 2013 seminar in Washington. The centerpiece of that effort is the establishment of the King Abdullah University of Science and Technology on the Red Sea, north of Jeddah. Naimi, who was CEO of state oil producer Saudi Aramco before becoming petroleum minister, recounted how, at a council of ministers meeting in 2006, the monarch took his hand and asked if he could build a university. “I said: ‘Your Majesty, we have­ built—I mean, Saudi Aramco has built—a lot of refineries, gas plants, pipelines, some housing. But universities? No. But we can, if you want.’ And we did.”

‘Our ultimate aim is to diversify away from our overreliance on oil revenues,’ Naimi said in 2013. ‘It will not happen overnight. But it is happening.’

The school’s mission, as Naimi articulates it, is nothing less than to lead Saudi Arabia into the post-hydrocarbon age. The campus, built for 220 professors and 2,000 graduate students, is a bastion of tolerance and religious liberty in a country often criticized for having neither. Heavily armed guards on land and at sea protect the facility, where unveiled women study and work side by side with men, undisturbed by the religious police who patrol Saudi cities. Research there is aimed at scientific and commercial breakthroughs using those things Saudi Arabia has in abundance, such as sun, sand, and saltwater. When he discusses retirement, Naimi says it’s to devote more time to the institution.

While the university is key to Saudi Arabia’s diversification effort, there are other initiatives for the nearer term. The kingdom already is exploiting its huge deposits of phosphates to export fertilizer and is mining bauxite to smelt and roll aluminum. Eventually, Naimi says, Saudi Arabia wants to manufacture finished goods such as car parts. “We are generating job opportunities for our young people, encouraging enterprise, and providing the right environment for innovation and progress,” Naimi said at the Washington seminar. “It’s not easy, and it will not happen overnight. But it is happening.”

How much time Saudi Arabia has to prepare for the eventual decline of the oil era may depend, in part, on how alternatives fare during this period of cheap oil. Will sales of wind turbines and solar panels stay strong? Or will they enter a tailspin like they did during the Great Recession, when project financing dried up? And will sales of electric vehicles continue to climb even as gasoline prices slump?

Adam Sieminski, head of the U.S. Energy Information Administration, said at a Washington forum in late January that lower crude prices wouldn’t slow development of wind and solar power because there’s little direct competition with oil in electricity generation. Electric vehicles, he said, are helped by tax incentives and government policies and perhaps also by the cachet of green technology.

‘Our ultimate aim is to diversify away from our overreliance on oil revenues,’ Naimi said in 2013. ‘It will not happen overnight. But it is happening.’

“The Saudis may be once again trying to prolong the age of oil,” says Bill McKibben, the author and environmental activist who has helped lead the campaign to block the Keystone XL pipeline, which would bring oil from Canada’s tar sands to the U.S. market. “But it feels like the steady, relentless fall in costs for renewables may make this different from other cycles.”

Naimi, who carefully manages his public comments the way a central banker or top diplomat might, hasn’t said how close he thinks the world may be to a peak in oil demand. He didn’t respond to requests to be interviewed for this story. But he has articulated his view that the crude market can no longer be understood without considering the effects alternative energy sources are having. “One has to be realistic,” Naimi told the Middle East Economic Survey in an interview published in December. “There are many things in the energy market—not the oil market—that will determine prices in the future. A lot of effort is being exerted worldwide, whether in research or boosting efficiency or using nonfossil fuels.”

Ali bin Ibrahim al-Naimi has lived the post-World War II history of oil—and done much to shape it. Born in 1935 in Saudi Arabia’s oil-rich Eastern Province, he spent his early childhood as a desert nomad, moving from spring to spring with his extended family and their livestock. When Naimi was 8, his Bedouin mother sent him to live with his father in the provincial capital of Dammam. He attended a school operated by Arabian American Oil Co., known as Aramco. The petroleum producer was founded by Standard Oil of California in the 1930s and became Saudi Aramco after its nationalization in the 1970s.

At 12, Naimi became a mail boy at Aramco, taking over for his brother after his sudden death, and he quickly shined as a star typist. One day at the Aramco offices, the American CEO stopped Naimi in the hallway and asked the teenager what he wanted to do with his life, says Peter van de Kamp, who became friends with Naimi at Lehigh University, recounting a story Naimi told their classmates in the early 1960s. “Well, sir, someday I would like to have your job,” Naimi answered. “If that’s the case,” the American said, “you’ll need an education.”

Aramco sent Naimi to school in Beirut and then to Lehigh in Pennsylvania and Stanford University in California, where he earned a master’s degree in geology. At Lehigh, the chair of the geology department assigned the 6-foot-5-inch Van de Kamp to watch out for Naimi, who’s around 5 feet tall. The transfer student from a Mideast country few students had heard of was a good companion, Van de Kamp says, respectful of Christians and Jews, comfortable socializing with women. He was eager to chop firewood and “get his hands dirty” doing chores at the Van de Kamps’ New Jersey home on holidays, he says. Proud of his Bedouin roots, Naimi told stories about tending sheep and goats in a forbidding desert with scarce food or water. He did his senior research project in 1962 on the commercial mining potential of New Jersey’s beach sand. “Ali was a comer­; we all could see it,” says Van de Kamp, who’s now a geologist in Oregon.

After returning to Saudi Arabia, Naimi zoomed through a series of oil production and executive positions at Aramco, culminating in his 1984 appointment as the company’s first Saudi president and, four years later, its CEO. At the time, U.S. and European consumption was in decline, due in part to sluggish economic growth and conservation measures adopted after the oil shocks of the 1970s. In response, Petroleum Minister Ahmed Zaki Yamani slashed Saudi oil output from 10 million barrels a day in 1981 to just 3.5 million in 1986. Prices kept falling, briefly getting to around US$10 a barrel, as non-OPEC producers and cartel members cheating on their quotas filled the gap. In 1986, King Fahd fired Yamani, and the Saudis flooded the world with cheap oil to seize back market share—and induce Americans to resume their gas-guzzling habits. (The era of big SUVs was just beginning.)

Aramco’s new president saw firsthand what happened when the Saudis cut output and others didn’t, a lesson he cites today. “We will not make the same mistake again,” he said in Berlin in March.

Promoted to petroleum minister in 1995, Naimi spends weekdays working in Riyadh and weekends at his family’s villa or at a small farm near Dharan. He arrives early each day at the ministry, a set of nine-story stone and black-glass blocks. His seventh-floor offices aren’t grand, the decor little changed in 20 years. He leaves in a black Mercedes by 2 p.m., Saudi government quitting time, and works the rest of the day at home.

Naimi’s tenure got off to a rough start. With demand rising in China, he persuaded OPEC to expand production in November 1997, just as the Asian financial crisis was deepening. During the next two years, oil prices fell 50 per cent.

He also mishandled Saudi Arabia’s overture to Western energy companies to help develop the kingdom’s natural gas reserves. By 1998, then-Crown Prince Abdullah was trying to lure back foreign firms to tap Saudi gas for industrial projects such as electricity generation, water desalinization, and petrochemical manufacturing. Naimi, however, kept the best gas fields for Aramco while offering Exxon Mobil and dozens of other companies blocks that some Saudi geologists doubted contained much commercial gas, according to Sadad al-Husseini, who led Aramco’s exploration and production operations from 1985 to 2003.

The Exxon Mobil negotiations blew up in 2003, at the home of Saudi Foreign Minister Saud al-Faisal in Beverly Hills, California, according to journalist Steve Coll’s book Private Empire: ExxonMobil and American Power, published in 2012. Exxon Mobil’s then-CEO Lee Raymond informed Faisal and Naimi that the Saudi field on offer didn’t have enough gas to warrant his investment, Coll wrote. Naimi responded that Exxon Mobil’s experts were playing down the block’s potential to get a better deal. At that point, Raymond exploded at Naimi for questioning his people’s integrity, and the deal soon fell apart, Coll wrote. “I was very unhappy,” Raymond says in an interview. “The reality was that there was never access to the potential reserves you would need to support the project.”


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