By Tamara Walid and Andrew White
As Aramco celebrates its 75th anniversary, the state oil company is under pressure to boost production.
As Saudi Aramco celebrates its 75th anniversary, the world's largest state-owned oil company is under pressure to boost production as the price of crude soars to new highs. Yet these expansion plans are far from secure, as the oil price is offset by equally significant increases in the costs of adding capacity.
As birthday parties go, Saudi Aramco did it in style. Last week the oil giant's 75th anniversary celebrations filled the streets of Riyadh with bright lights and loud music, as Saudi Arabia saluted its rebirth as one of the world's wealthiest nations.
Aramco has plenty of reasons to celebrate. The state-owned national oil company of Saudi Arabia is the largest oil corporation in the world, and also the world's largest in terms of proven crude oil reserves and production.
Saudi is sticking by its analysis of the market... which is that further capacity is not needed.
Its output capacity is scheduled to reach 12 million barrels per day (bpd) by the end of 2009, and the company has committed to investment exceeding US$129bn on new energy projects over the next five years.
The massive spending programme comes as oil and petrochemical companies are hit by soaring costs caused by escalating material prices and a shortage of so-called EPC contractors - responsible for the engineering, procurement and construction of refineries.
The prices charged by oil engineering companies have risen at least 70% since 2004, according to research from Merrill Lynch.
In today's market, the rise of China and India, alongside the Gulf's own construction boom, means that boosting capacity represents a significant challenge - even for giants such as Aramco.
"In the Middle East, the increase in capacity has certainly been sluggish, and that's a reflection of the fact that some of the projects are getting increasingly complicated," says David Butter, chief energy analyst at the Economist Intelligence Unit (EIU).
"Construction costs are becoming very high, and there's a shortage of engineering skills and capable contractors."
Global steel rebar prices broke through the US$1000-a-tonne barrier in late March of this year.
They shot up from US$600 a tonne to well above US$800 a tonne in the three months to end-January 2008, reflecting the huge demand for long products from the booming Asian construction industry. Concrete prices have soared 30% in the last year alone.
"We've seen in the last few years that oil supply problems have been bringing new projects into the marketplace, and that the rising cost of steel - among other things - has been a major factor in slowing down the development of these projects," echoes Gerard Burg, a commodities and energy analyst at National Australian Bank.
"I think there is a possibility that some attempts to bring new supply will be delayed, and I think that all the major oil companies are facing similar challenges in bringing production into the market."
A recent study by Cambridge Energy Research Associates concludes that the cost of building refineries has risen by 76% since 2000.
Aramco has earmarked US$70bn to be spent by international and domestic joint ventures, and the remaining US$59bn on projects solely undertaken by the Saudi company, but some of these projects could be slowed or even scrapped if costs rise too quickly.
"OPEC and the Gulf oil producers are not immune from escalating costs and a shortage of available skilled labour to expand capacity," agrees Harry Tchilinguirian, a senior analyst at BNP Paribas in London.
He notes the example of Aramco's 500,000 bpd Khursaniya field expansion, which was initially scheduled to come on line in 2007, but has been delayed repeatedly.
Start-up has now been postponed because the construction of a plant to process associated gas from the oilfield has yet to be completed, according to Khalid Al-Falih, Aramco's executive vice president of operations, who admitted that the delay was "really a disappointment".
He added that the plant would be "ready in a few months".
In addition, Tchilinguirian argues that the same construction cost increases mean that the overheads of oil reserve assessment are also on the rise.While some of that extra expense is absorbed by the higher oil price, it nevertheless makes oil companies more prudent when it comes to hunting for future fields.
"In the world today you have around roughly 2.3 million barrels a day of effective spare capacity - by which we mean capacity that can be brought on in less than a month and then be sustained for at least three months," says Tchilinguirian at BNP Paribas.
"What's more, most of it is located in Saudi Arabia and the UAE."
"Saudi knows that maintaining and developing fields is an expensive proposition, and so it is being rather conservative about the targets of production capacity that the country is willing to develop," he adds.
"We are looking at a situation where non-Opec producers are looking at access to reserves, but at escalating costs."
As a result of this caution, it is debatable whether Aramco will have received many birthday congratulations from the world's oil-importing nations.
Critics point to the record oil price as evidence that Gulf oil-producing countries could - and should - do more to satisfy global demand.
The price of a barrel of crude has soared from US$33 in 2004 to touch US$133 before retreating to about US$129 on May 26, and while the Gulf rides high on the back of the petrodollar, oil-importing nations are forced to deal with inflationary pressure.
Of course, high prices do not necessarily mean that the global market is undersupplied in the first place. In the week before Aramco's anniversary celebrations, US president George W Bush visited Riyadh to appeal to HRH King Abdullah to increase Saudi's oil output.
The US is the world's largest energy consumer, so has been hit particularly hard by the oil price rises - and that on top of an economy already reeling from a housing slump and the credit crunch.
"I said very plainly, I said you've got to be concerned about the effects of high oil prices on some of the biggest customers in the world," Bush told reporters.
"And, not only that, of course high energy prices is going to cause countries like mine to accelerate our move towards alternative energy."
The thinly-veiled threat appears to have fallen on deaf ears. In the days after Bush's visit Saudi said it had raised output by just 3.3%, and was willing and able to raise output further but said it saw no customer demand.
"Customers, where are you? I want to sell oil but where are the customers? I can't sell oil just to be stored at sea," Saudi Foreign Minister Prince Saud Al-Faisal told a news conference.
"The kingdom sees... that the production capacity can meet any additional and real energy needs."
Aramco's output for 2007 actually dipped by an average of 400,000 bpd, or 4.5% from 2006, after the kingdom cut output per the agreements that were reached by Opec.
Average daily oil production reached 8.5 million bpd in 2007, resulting in a total production of 3.11 billion barrels for the whole year, versus 3.25 billion barrels in 2006.
Indeed, many analysts are convinced that supply is not the problem; that the oil-producing nations are already pulling their weight - at least in 2008.
"I think the focus on Middle Eastern production is less about what's happening right now than what happens over the medium to long-term scenario, because the market at the moment is not that different than it has been for quite a few years," says Butter at the EIU.
"There seems to be a small surplus of supply over demand, though while there's slightly more spare capacity in the market than there has been for some time, it's still relatively tight."
If the Middle East upped production overnight, he suggests, it would only serve to saturate an already oversupplied market. Companies such as Aramco are constantly in touch with their customers, and will obviously avoid producing additional oil when there isn't yet the demand.
"Clearly Saudi is investing a huge amount in increasing capacity, but after the current programme of capacity increases comes to an end in a couple of years' time, the next big projects will be purely about replacing depleted capacity," Butter continues.
"Saudi doesn't have any active plans for further capacity increases after that, and it is sticking by its analysis of the market, which is that [further capacity] is not needed."
If Aramco does indeed struggle with soaring building costs and a dearth of capable contractors, then the Saudi giant will hope that demand remains at manageable levels. If not, then the time for celebration will be over.For all the latest energy and oil news from the UAE and Gulf countries, follow us on Twitter and Linkedin, like us on Facebook and subscribe to our YouTube page, which is updated daily.