DUBAI (Reuters) – Top oil exporter Saudi Arabia may cut output more as it seeks to put a floor under oil prices, in spite of the challenges that would pose to domestic energy supply and to its budget.
The kingdom plans to pump in February below its OPEC target of 8.05 million barrels per day (bpd), undershooting what was already a record OPEC supply cut agreed in December.
“The Saudis know that extraordinary times require extraordinary measures,” said David Kirsch of Washington-based PFC Energy.
“If measures are needed to stabilize the oil price and market at lower production levels, they’ll be prepared to take them. They are ready for a year of deficit and they can finance that for longer than other producers.”
As the oil exporters’ group races to match supply with falling demand, Saudi Oil Minister Ali al-Naimi has said he would do whatever it takes to balance the market.
Saudi oil infrastructure is in better shape than that in most of its OPEC peers to pump less without damaging fields, analysts and industry observers say.
It has shown in the recent past it has the capacity to both accelerate and slow production, Kirsch said. It raised output to 9.6-9.7 million bpd last summer, after paring it to 8.6 million bpd in early 2007.
“You don’t get that kind of performance out of a sector that is in plateau or decline,” Kirsch said.
Saudi Aramco’s hi-tech approach allows it to monitor reservoirs and limit the potential for damage as output slows, said Sadad al-Husseini, a former top executive at the state oil firm.
“Saudi Aramco is well ahead on all of this,” Husseini said. “It’s been done enough times that they can do it without damaging systems and reservoirs.”
Industry sources say the kingdom will cut output to 7.7 million bpd in February, already the lowest level in more than six years and around 2.0 million bpd below July.
As the biggest producer in the Organization of the Petroleum Exporting Countries (OPEC), Saudi Arabia shoulders most of the producer group’s cuts and has the largest impact on the market.
DOMESTIC GAS SUPPLY
But cutting output further could exacerbate a domestic shortage of gas. Like its Gulf neighbors, Saudi has seen gas demand for power generation and heavy industry grow rapidly with a petrodollar-fueled economic boom.
Most Saudi gas is produced as a by-product of oil output, so volumes fluctuate with oil production.
“I don’t think they really wanted to go below 8 million bpd,” said an industry source in the kingdom.
“They certainly won’t want to go much below 7.7 million bpd for long. They need the associated gas for power generation and for petrochemicals. Much lower may mean they may have to ration gas.”
Power plants would be the first to see gas supplies halted and would swap to fuel oil or diesel. Saudi can also burn up to 200,000 barrels per day of crude at power plants, an industry source said.
Switching to fuel oil at power plants would clear some of the excess supplies that have weighed on crude prices, Kirsch said.
“This would clean up some of the residual fuel oil out there,” he said. “This is not the Saudis’ primary motivation of course, but it’s a useful consequence if they have to burn liquids instead of gas.”
OPEC’s second-largest producer, Iran, faces a more pressing problem with domestic gas supply as it cuts oil output, Kirsch said.
Iran’s economy is more dependent on gas, and unlike Saudi Arabia, it faces peak gas demand during winter.
Iran also has a high call on gas to inject back into oil fields, to maintain pressure and prevent water from flooding reservoirs. Flooding can lead to long-term damage to oil fields.
Gas and domestic refinery demand means Kuwait also faces a limit on how much more it can cut, industry sources say.
“It is very difficult to see Kuwait going below 2 million bpd,” said one oil industry source. Kuwait’s OPEC target is 2.2 million bpd.
SAUDI BUDGET DEFICIT
Saudi Arabia depends on oil for nearly 90 percent of state revenue. The slump in the oil price has led the kingdom to project its first deficit in seven years for 2009, at $17.3 billion.
That would be the deficit if output stayed at 7.7 million bpd for the whole year and the oil price averaged $45, said John Sfakianakis, chief economist at HSBC’s Saudi affiliate SABB bank.
Any cut in output, if the price fails to recover, would raise the deficit.
The kingdom could easily finance a bigger deficit after years of surpluses during oil’s rally, but would want to ensure other members of OPEC were sharing the pain, Sfakianakis said.
“I don’t think they will be able to support big additional cuts without seeing that others are heeding their own reductions,” he said.