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Desert Dilemma
New York: February 28, 2011
By John Stephenson

No other commodity is as visible, as important or as prized as oil. Access to cheap, readily available oil is more than a convenience—it is the linchpin to the world that we live in. For more than one hundred years, oil has meant power and those who control it control the lifeblood of global commerce. So important is oil to the world economy that the United States maintains the Strategic Petroleum Reserve, which holds up to 727 million barrels as a first line of defence against supply interruptions.

So entrenched is cheap oil to our way of thinking that the idea of going without is just too difficult to contemplate. Oil has shaped our lives—from the automobile, or two, in our driveway, to suburbia. Plastics, rubber, chemicals and even cosmetics all are made from oil, yet on a per gallon basis it costs less than orange juice. Surely, more oil will be discovered, or alternative energy will ride to the rescue, say the pundits. Yet, more than one hundred years into the oil era, no viable alternative has materialized. It may still happen, but I wouldn\\\'t bet on it.

According to the IEA\\\'s World Energy Outlook 2008 , production from currently producing fields is expected to start declining in 2009. The call on OPEC spare capacity is about to get louder, but the only producer claiming to be able to bring on additional capacity is Saudi Arabia, a country that does not allow independent third party verification of its oilfields. If Saudi Arabia has exaggerated its production capabilities, there is no plan B for an oil-hungry planet.

But Saudi Arabia wasn\\\'t always the dominant force in oil that it is today. The Arabian Peninsula was dominated by warring tribes and was in political disarray by the turn of the past century. Once controlled by the Ottoman Turks, Saudi Arabia had languished and by 1900, most of Arabia was under the control of the Rashid Arab clan while the Saud family, the traditional rulers of the area near Riyadh , were in exile in Kuwait . This all began to change in 1902, when Abdul Aziz, or King Ibn Saud as he was known, gathered together various tribesmen and warriors to regain control over Ridyah.

Over the next 30 years, Ibn Saud battled rivals for control over the peninsula and by 1932 he had succeeded in his quest to unify what today is Saudi Arabia . So poor was Saudi Arabia that for much of his life the future king of Saudi Arabia could carry the whole national treasury in the saddlebags of a camel.

It wasn\\\'t until the mid-1960s that oil revenues began to grow and to become significant for the kingdom. Under the stewardship of King Faisal, one of Abdul Aziz\\\'s eldest sons, the country grew into an oil superpower and today oil contributes more than 80 percent of state revenues and around 95 percent of export revenue. Just five giant oilfields have been responsible for producing 90 percent of Saudi Arabia\\\'s oil for the last sixty years. Today, Saudi Arabia is the dominant producer in OPEC and the largest oil producer in the world with “proven oil reserves” totaling 259.4 billion barrels and annual production rates of 9.3 million barrels of oil per day. But the kingdom\\\'s most crucial role within OPEC is as a swing producer, capable of ramping up production in response to increases in global demand. And while the Saudis are quick to point out that they are capable of producing up to 25 million barrels of oil per day, the most they have ever produced is 10.6 million barrels per day in 1980.

But today, chaos is sweeping the Middle East and once again talk is turning to the political risk associated with oil. While the focus is now on Libya and Egypt it doesn\\\'t take much imagination to see that tomorrow the focus could be on Nigeria , Saudi Arabia or Algeria . But behind the political science of regime change, is a more worrisome possibility—that the Saudi oil miracle may be over. And if it is, the supercharged prices of crude oil we\\\'ve been witnessing lately may be just the beginning.

After more than 50 years of pumping oil, Saudi Arabia\\\'s great oilfields are beginning to show signs of decline and the country that holds the largest oil reserves and is OPEC\\\'s most important producer has little more to give. And with global oil demand surging by two million barrels per day to 87 million barrels per day as the global economic recovery takes hold, OPEC will need all the spare capacity it can muster.

The official capacity of Saudi Arabia has steadfastly been maintained at 12 to 12.5 million barrels per day, but current production rates are consistently below 1970s levels and the kingdom is struggling to produce between eight and nine million barrels per day.

Recently released confidential cables published by Wikileaks confirm the sorry state of Saudi Arabia \\\'s aging oilfields. The transcripts of conversations between U.S. embassy staff in Riyadh and Sadad al-Husseini, the former executive vice president of exploration and production at Saudi Aramco, make clear that neither Saudi Arabia \\\'s oil reserves nor stated production capabilities can be believed. And for an oil hungry planet, without an energy backup plan a global energy crisis may be in the offing sooner, rather than later.

With no spare capacity in OPEC and non-OPEC producers running flat out, crude prices will surely spike as political uncertainty gives way to economic reality and pushes oil prices once more into the stratosphere. And while Saudi officials might talk tough about their ability to balance the global crude oil markets, speculators will surely test the Saudi myth of oil invincibility. And when they prove that the Saudi assurances are nothing more than hot air, the wave of political reform we\\\'ve witnessed in Egypt and Libya will sweep across the desert Kingdom and the world will witness another massive oil shock. Prices will climb above $150 per barrel and remain there for good.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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