OREANDA-NEWS. Recently appointed Saudi oil minister Khalid al-Falih, discusses the oil market, co-operation within Opec, and Saudi Arabia's oil policy.

Various Opec ministers have expressed optimism that the market is strengthening. What is your view on that? How do you see the market?

All along, Saudi Arabia has been of the view that the market is on its way to rebalance. There are two components to the rebalancing: demand and supply. On the demand side, we have seen how responsive demand is to price, despite a variety of factors impacting the global economy that would have led people to surmise that demand growth would behave otherwise.

Yet we have seen that moderate prices have helped demand pick up.

This is despite the full effect of lower prices not being passed on to consumers, besides a weaker global economy having its negative impact. As we have seen, demand growth was robust in 2015, and the first quarter of 2016 has also been healthy.

On the supply side, we have seen the pace of growth of high-cost oil declining. In fact, in my view, as the positive effect of healthy industry investments of the past decade wanes with the passage of time, the supply of expensive oil will be impacted even more.

This declining supply trend becomes even more pronounced if we were to compare the current supplies of marginal barrels, such as shale oil, with the rapidly expanding growth of many years prior to 2014.

So we believe the net result of the demand growth and the significant fall in expansion of high-cost oil is the start of rebalancing.

We believe inventory drawdown is taking place as we speak, and we think it will accelerate going forward, as demand continues to grow and supplies continue to lag.

As you know, a number of unplanned events have further contributed to shaping this market situation, which we hope will not last.

Some non-Opec producing countries witnessed unforeseen events, such as the fires in Canada, but some Opec countries have also experienced supply disruptions.

Even if we were to normalise for these supply disruptions, I think the supply and demand trends and the move toward rebalancing is unmistaken.

Having said this, the falling investments and their impact on supply is of concern to us. In fact, just as we saw the investments of the past decade supporting supplies during 2014, 2015 and to an extent now, the real impact of falling investments will be felt more with the passage to time.

This situation needs to be managed.

Clearly, a key factor in attracting back investments is healthier prices.

Including Saudi Arabia?

No, I know that Saudi Arabia has maintained its investment programme. We have stretched and deferred some projects but they are of support and discretionary nature, not our core upstream or downstream projects. In addition, we have taken advantage of cost improvements.

It is no secret that the service industry, EPC contractors and suppliers of materials and equipment have been able to reduce their costs. We have taken advantage of these cost reductions, and as a result, our dollars are going further than before.

All in all, we still have a very robust programme. Projects are coming on stream and in progress.

Our Shaybah crude expansion to 1mn b/d and the large Shaybah NGL project has recently come on line. We are continuing to fund our Khurais project, and maintaining potential drilling across all of our fields is ongoing.

Also, a very major item that receives less press is our world-class gas programme, which will double our gas supply to 23bn ft?/d of feed gas over the coming decade. A major effort in unconventional gas is complementing our large conventional gas programme.

In fact, our gas expansion has a spillover effect into global crude capacity, because more of our crude supply becomes available for export.

That means, the less liquid fuels we put into power generation, water desalination and the industry in Saudi Arabia, the more flexibility we have in terms of being able to respond during periods of market imbalance and/or unforeseen circumstances.

Also I think the efforts that Saudi Arabia has made to reform the domestic energy sector — which includes energy price reforms and the great efforts that Prince Abdul Aziz has made in energy efficiency and conservation — all of this in the mid-to-longer term is leading to reducing the local demand requirements of Saudi Arabia.

Have you any figures for the impact on the reduction of consumption?

We are already seeing demand moderation. However, it would be premature for me to quote specific figures. For us to have a full picture, we need a few months, especially during the summer.

Do you have a b/d figure for how much Wasit will save once it is fully on stream?

About 300,000 b/d of oil equivalent.

What sort of crude is used in the direct burn?

There are essentially three categories of liquid burning.

One is steam turbines. In the Central, Western and Eastern regions of the Kingdom, they consume mostly fuel oil and Arabian Light and some Arabian Heavy.

The second is gas turbines, which use mostly Arabian Light.

The third category of liquid use by utilities is diesel that currently totals around 240,000 b/d, but we are actively reducing it. We expect it to fall to less than 100,000 b/d over the coming five years.

Has the policy of defending your production share changed as a result of the cabinet reshuffle, and how do you evaluate the development of oil prices in the short term?

The kingdom's policy is not linked to individuals or personalities.

The kingdom's policy is based on principles and long-term interests, which do not change with people.

That is a very important aspect that we must all understand.

Meanwhile, market circumstances do change, and the positions of other states change, and they sometimes necessitate that we adopt tactics or short-term positions that are an adaptation to market circumstances, or to the positions of other state.

But in the long term, our stance reflects our principles and interests.

For decades, we have said that we want to balance the interests of producers and consumers, and that we seek a balanced market, so that it grows and remains healthy, because that serves our long-term interests and that of consumers.

We always try to convince our partners in Opec that this is also in their interest.

But as a result of short-term pressures, at times, some countries prioritise their short-term interests over the long-term.

Saudi Arabia is in it for the long-haul, and our long term direction remains the same, although — as I said earlier — we sometimes are compelled to respond in the short order to market circumstances and competitive pressures.

There is a kind of free-for-all in Opec now, with everyone producing freely with no co-operation. Will this persist?

We regard Opec as an organisation and a group of states, some of which, irrespective of Opec policies, prices and production restraints, are experiencing gradually falling production for reasons related to their geology and reserves.

At the same time, there are countries like the kingdom that have a large capacity, massive reserves, and the ability to meet market needs in an optimal manner. This reality means that Saudi Arabia will gain a larger market share as global demand grows and production from other countries, both inside and outside Opec, falls.

I do not call it a free for all. That is what happens in efficient markets.

I say that Opec as a group is responsive. If you look at the last two years, Opec has gained market share. I am not saying Saudi Arabia gained market share. Opec has gained almost 2mn b/d of additional market share, and for the first time in a long time, we have started to see non-Opec output declining: shale oil, deep seas production, and even in countries like Mexico and in the North Sea.

Shale has experienced the biggest decline, especially if you were to compare it to the way it was growing prior to 2014.

The bottom line is that it is natural that the marginal producers of expensive oil that were growing the fastest when prices were healthy are now declining the fastest as prices have fallen and the economics do not work for them.

I think that this illustrates that the Opec strategy, which the Saudi government and GCC governments in general pushed for in 2014, is working and the long term will prove this. Prices will come to a healthy level.

What do you consider as a healthy level?

It is difficult for me to give you a specific price. But let me focus on the upside and downside ranges, so you could see the price bracket I envisage.

On the upside, the prices that we saw in the last decade meant that the large investment levels that were pouring into production increases — especially expensive oil — were not matched by demand growth, and the result was the 2014 price fall. So, I think the high end of that price level of the past decade may not be sustainable.

Similarly, as we know, the price levels we have recently seen are unable to attract adequate investments, so they are not sustainable either.

So, the equilibrium price is likely to be between these two levels, which would produce just sufficient supply expansion to meet demand growth.

The market needs to search for that price that would balance supply and demand, and we need to be flexible enough to find it and to steer the market towards it, rather than predetermine it.

Opec tried this before. Opec has to learn from this process. It is not scientific. It is some science, some art, some trial and error, unfortunately until we find that equilibrium.

I think beyond that, guessing at a specific price number is not productive or useful.

Is it still Saudi Arabia's policy to keep a cushion of spare capacity of 1.5mn-2mn b/d of spare capacity?

Yes, we have not abandoned our policy of keeping spare capacity, and that is why I mentioned earlier that we are continuing to invest, that is why we are building projects.

We just finished Shaybah. That is why we are building the Khurais expansion and that is why we are continuing to drill significantly.

Our number of rigs is high. Part of it is gas, but part of it is oil.

The reason is we want to keep a cushion. We think in fact that cushion will be needed pretty soon, because markets will tighten, as supply expansion lags demand growth.

Luckily we also have hundreds of millions of barrels of excess inventory that will cushion any supply disruption.

But in the long term, I think we will need spare capacity.

But Shaybah and Khurais will not provide net capacity increases.

That is intentional. Our crude programme is designed to maintain our capacity at 12.5mn b/d.

It is apparent that when prices are so low and capital is scarce, why would you build capacity above a level that already offers you a significant spare capacity.

Are you investing in more capacity?

No, as I just said, we are investing in capacity that would offset decline.

But not to increase capacity?

Not now, but I would not rule it out. We could build incremental capacity in the future, as global demand continues to grow.

Does this not contradict the policy of getting over the addiction to oil?

The statement regarding no addiction means that the economy of Saudi Arabia should not depend exclusively on oil. It does not say that Saudi Arabia will not optimise its revenues from oil, and it does not say that the world does not need oil supply from Saudi Arabia for decades to come.

The sense intended by His Royal Highness Prince Mohammad bin Salman when he mentioned the need to not be addicted to oil was from the perspective of the Saudi economy, and the way in which Saudi citizens view the role of oil in their lives, their economy, their role as citizens and as active investors in the economy.

The message was that there must not be an exclusive reliance on oil as the only economic engine in Saudi Arabia.

Economic transformation in any country takes decades to achieve.

We must initiate now what we should have initiated a long time ago: establishing large economic sectors that contribute to the kingdom's overall economy as well as to diversifying revenue sources.

That does not mean that the kingdom's opportunities of optimising its benefits from its natural resources, including oil, will receive less attention in the current economic phase than in previous phases.

Increasing our oil revenues will help us to build a range of other economic sectors in the Kingdom, besides international investments.

His highness Prince Mohammad strongly mentioned the role of investment, and the Public Investment Fund (PIF) in particular, as a new economic engine as part of the kingdom's 2030 Vision.

That investment engine requires liquidity, which will be provided by oil. We are not referring to three years, or five years.

The kingdom has almost one-fifth of global conventional resources, and maybe more, if we take into consideration that many of the declared reserves in other countries are unconventional and heavy crudes that are not economically viable when prices are low. They also have a heavier environmental footprint of production.

The kingdom is the country that will produce most oil. All indicators point to the fact that oil will continue to enjoy a considerable share of the market even 30 or 40 years hence.

We see demand especially in heavy transport — such as aviation, marine, trucks and rail — and chemicals to remain healthy, while alternative technologies compete in light duty vehicles.

So it behoves the kingdom to manage its oil reserves prudently and wisely, so that we derive material benefit from them and transfer that revenue into other Saudi economic engines.

When will Khurais come on stream?

In 2018.

How useful is Opec?

Oil is a unique commodity. It still strongly influences the global economy, and its production does not respond to falling or rising oil prices with the same speed as other commodities do — we just witnessed it over the past couple of years.

So there is a need for a co-ordinating apparatus that deals with markets.

Opec has proven its effectiveness in the past. That effectiveness is largely linked to the extent to which member countries co-operate.

It is clear that there is no co-operation.

I look at things positively. Opec countries experienced difficult circumstances. Libya experienced a civil war; there are disturbances in Nigeria; Venezuela has economic and political problems; Iran was under sanctions; Iraq experienced an invasion, occupation and reconstruction. So we must be realistic.

It is a good thing that Opec still operates, speaks, holds meetings given the circumstances that some countries have experienced.

It is an economic organisation, and we try to keep it economic.

Over 55 years, Opec overcame challenges more difficult than current circumstances. I think we will overcome this phase.

I believe, like other global organisations, we need to focus on areas of agreement and worry less about our differences.

After all, there isn't an organisation out there whose members agree on everything.

What can you achieve at this meeting?

I am confident that the policy adopted by Opec in 2014, led by Saudi Arabia and criticised by many parties at the time, has proven its effectiveness.

The market has begun to rebalance, and the prices have started to recover.

As long as we stick to the current market direction — and I think we can — we will be in decent shape.

The price is still low, Iran's output is rising, Iraq's output is rising, and Libya could also increase output.

True, the price is low, but much better than below $30. Expensive marginal supplies are declining, and this trend is likely to accelerate.

Between this supply decline and growing demand, I believe, the market will remain balanced or in fact tighten.

We hope that tomorrow's meeting will be the start of coming together, but I do not want to predict the results of the meeting. I am stretching out my hand in the interests of co-operation, and hope this will be matched by all parties.

Do you foresee Opec restricting production ever again to try and balance the global market, acting as the global swing producer?

I see a couple of scenarios here.

One is extraordinary, short term circumstances, such as the global financial crisis, when the US Fed intervened and other nations took appropriate measures. The fiscal crisis led to a sharp fall in demand and Opec responded by cutting millions of barrels of oil production.

I believe Opec could respond to such short term events.

The second scenario is the prelude to the price drop of 2014, when expensive oil was going gang busters, propelled by healthy prices and technologically advancements.

Just as Saudi Arabia and Opec responded to that situation by deciding to not cut production, I think Opec would not become a swing producer in such a long term situation that would amount to making room for expensive marginal barrels at the expense of its market share.

My hope is that the future price bracket in any case will be such that the supply and demand will remain within reasonable balance, and the market will not be faced by the situation we did in 2014, for example, during the financial crisis.

But you are not excluding the possibility of Opec playing a balancing role in the market again?

As I just described, there could be shorter term situations in which, in our view, Opec might intervene and yet other situations — such as long term growth of marginal barrels — in which case it should not.

We want Opec to continue playing its role, with all members participating and sharing the burden in the long term interest of everyone.

We want Opec to remain an effective organisation that continues to thoughtfully respond to market circumstances in the best interests of both producers and consumers.