(UNTITLED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000100650001-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 12
• Document Creation Date: January 12, 2017
• Document Release Date: February 23, 2011
• Sequence Number: 1
• Publication Date: March 31, 1986
• Content Type: MEMO

-- I
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86TO1017R000100650001-8 25X1
Central Intelligence Agency
DATE 4/2
DOC NO
OCR 3..... ..........
P&PD
DIRECTORATE OF INTELLIGENCE
31 March 1986
The Saudi Oil Offensive
Summary
Saudi Arabia appears determined to maintain its aggressive
oil marketing tactics despite the continued erosion in price. We
believe the Saudi objectives are to increase their own oil
revenues, regain Saudi Arabia's position as the world's largest
oil exporter, ensure a growing long-term market for oil, and to
squeeze Iran economically. In our judgment, a price of about $15
per barrel is most consistent with the combination of Saudi
objectives, but Riyadh may not be able to prevent prices from
falling further because of the complexity and size of the
international oil market. Where ever prices stabilize, we expect
Saudi Arabia to emerge with a much larger share of the market
than it had last year. Over the longer-term the Saudi strategy
of accepting sharply lower oil prices will lead to greater
Western dependence on Gulf oil supplies and to increased
vulnerability to future price shocks and supply disruptions.
This memorandum was prepared by
Energy Markets Branch, Office of Global Issues with a
contribution from OGI, and the Office of Near
Eastern and South Asian Analysis. The information contained
herein is updated to 31 March 1986. Comments may be directed to
hief, Strategic Resources Division,
25X1'
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
Introduction
In late summer 1985 Riyadh abandoned its role as OPEC's
swing producer because, in our opinion, it decided that lower
prices were more palatable than the risk of growing domestic
discontent with economic austerity (see Figure 1). Saudi Arabia
was struggling to cope with sharply lower earnings after years of
rapid development and high oil revenues. The Kingdom's oil
income had fallen from a peak of $110 billion in 1981 to about
$27 billion in 1985, but spending fell much slower. Because oil
earnings account for more than 50 percent of GNP and 80 percent
of government expenditures, Riyadh was forced to make a difficult
choice: increase oil production or sharply cut spending.
Saudi Objectives
We believe a combination of economic, political, and
security considerations is the catalyst for Riyadh's current oil
offensive. The Saudis want to:
o Increase near-term oil revenues to avert further deep
spending cuts and foreign reserve drawdowns.
o Capture a greater market share, preferably through
producer cooperation.
o Ensure a growing long-term market for oil by making
consuming countries more dependent on oil.
o Squeeze Tehran economically and hasten an end to the
Iran-Iraq war.
The relative importance Riyadh attaches to these objectives will
determine how far the Saudis are willing to see prices erode
before they compromise.
The Revenue Issue. By mid-1985 Saudi attempts to prop up
prices caused oil production to fall to a 20-year low. On an
annual basis, this level of output would have generated oil
revenues of only $13 billion. Without further drastic cuts in
spending Riyadh's liquid financial reserves would have been
depleted in only two years. Spending cuts also were affecting
Saudi citizens. Religious conservatives applauded the reduced
rate of Westernization, but many Saudi businessmen were worried
about bankruptcy. Furthermore, lower revenues lessened Saudi
Arabia's ability to disburse foreign aid--a key source of Saudi
influence--and eroded Riyadh's importance to consuming
25X1
25X1
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
J; J-- A- --S
Monthly
J F
1986
Revenues
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
From a financial viewpoint, increasing production was a no-
lose situation since, at any price above $5 per barrel, Riyadh
could produce enough oil to earn at least as much revenue as it
was making in mid-1985 (see Figure 2). The institution of
netback deals, aimed at keeping Saudi Arabia's oil exports
competitive, allowed Riyadh to more than double production in
just a few months. Aramco output averaged 4.7 million b/d in
February 1986, compared to only 2.2 million b/d in August 1985.
As production more than doubled during the period, exports more
than tripled. If the Saudis sustain this level of output and
prices this year average $15 per barrel, Riyadh would earn about
$21 billion, a substantial improvement over what otherwise would
have occurred in 1986. We believe that Riyadh can achieve
adequate short-term revenues with prices in the $15-20 range.
Although they would have to continue to draw down financial
reserves, from the Saudi perspective, the trend of rapidly
declining revenue would have been reversed.
Capturing a Greater Market Share.
we believe that by mid-1985 Saudi
leaders were also becoming concerned that the reduction in their
oil market share was also eroding the West's perception--and
perhaps their own perception-- of Saudi Arabia's strategic and
economic importance. With exports under 2 million b/d and
foreign exchange reserves declining rapidly, we suspect that this
concern was a serious one in Riyadh. The failure of US officials
to respond favorably to Saudi requests to get firms to buy more
Saudi oil last summer may have reinforced this concern. During
those meetings, Saudi officials were emphasizing the impact
declining revenues would have on Saudi internal stability as well
as their ability to fund special foreign aid programs.
The four-to-five million b/d production level the Saudis
have implied that they want would double Saudi Arabia's share of
Free World oil consumption needs to 10 percent and enable it to
resume its position as the world's largest oil exporter. Making
room for this much Saudi oil, however, still requires producer
cooperation or another sharp decline in oil prices (see Table
1). Last week's OPEC meeting allowed Riyadh to to reconfirm its
adamant stand on the market share issue and provided a forum for
the Saudis to determine whether other producers were ready to
compromise.
Saudi Arabia may believe that some progress has been made.
Although OPEC ministers did not formally agree to reduce
production last week in Geneva, they considered several proposals
to cut their overall production ceiling to between 14 and 15
million b/d and may reach agreement when they meet again on 15
April. Five non-OPEC LDCs in attendance at the meeting,
moreover, publicly urged production restraint to shore up prices,
and appear ready to reduce output with the right signal from
25X1
25X1
25X1
25X1
25X1
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
Figure 2
Saudi Arabia: Minimum Production Level
Needed to Earn $i3.3 Billion
20
i5 i0
(US$ per barrel)
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86TO1017R000100650001-8
OPEC: Winners ' and Losers.In A 'Price War
For each price level, this table depicts which OPEC countries hav'e-itore than
insufficent capacity (0),a
enough capacity to offset lower prices (0), just enough capacity (O), or
Oil Revenue Availabl~.;
Requirementa Capacity ; ..
Count
OPEC Middle East.
Saudi Arabiade
Kuwai td?
Qatar.
UAE
Iran
Iraq.
.. OPEC Africa
Libya
Nigeriae
Algeria
Gabon
OPEC Latin-America
Venezuela
.Ecuador
OPEC Far East
Indonesi ae
36.0 808
6.0 1.6
2.0 0.6
'.10.0 1 1.7
20.0 3.2.
10.0 . _1.8
12.0
2.0
. 8.0
TOTAL' OPEC REVENUE $139.0
TOTAL OPEC PRODUCTION
REQUIRED FOR REVENUE
6Availableor allowable capcity.is defined as. the, production rate of oil and
currency expenditures on imports. of goods and services and foreign debt.-remain at
1.8.
2.2
1,2
0.2
22.9 29.4 '.41.3
allnless stated otherwise, CIA estimate of "oil' revenue 'requirement assumes foreign
?.9uaays or a.governmenc aecgs1QI LU
'dIncludes oil revenue-'from share- of Neutral.-Zone'.product, ion and; aid;'to ;Ira
cGoverninent-stated revenue targets
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86TO1017R000100650001-8
(Billion US $) 's'' (million b/d) 520 bl $15/bbl., $10 /bbl
25X1
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
Securing Long-Term Markets. We believe that ensuring a
long-term market for its oil is also playing a role in current
Saudi oil policy. With, an estimated 170 billion barrels of
petroleum reserves, assuring a worldwide need for this resource
is critical to Riyadh's long-term interests.
o Despite a major effort to diversify its economy, Saudi
Arabia will remain dependent on its, vast oil
resources. At last year's production rate the Saudis
have a 150-year supply of oil.
o After waiting almost six years for the long predicted
recovery in demand for OPEC oil, Riyadh seems to have
accepted the fact that its support of the $28 OPEC
benchmark price was undermining the value of its chief
resource by slowing growth in oil consumption and
encouraging the development of non-OPEC oil supplies.
If prices remained in the mid-$20 range much longer, we
believe the long-term market for Saudi oil would have been
permanently damaged. Riyadh has probably reached a similar
conclusion given the rapid growth in oil supplies and alternative
energy sources outside the OPEC area. To correct this situation,
the Saudis would have to force prices down to a level that would
encourage oil consumption, reduce the economic benefits of
greater energy efficiency and conservation, and restrict
development of alternative sources of supply. If this is the
primary objective then pushing prices to $15 per barrel may not
be enough in their eyes.
Denying Iran Oil Revenue. Riyadh almost certainly is
pleased that lower prices are creating difficulties for Iran.
Lower oil revenues make financing the war effort more difficult
and lower prices partially offset the potential benefit of Iran's
increased export capability. At present Iran has the capacity to
market 2.5 million b/d; moreover, plans are on the books to
expand export potential. Since Iran has little borrowing
capacity and limited foreign exchange, oil revenue shortfalls can
have a direct bearing on the level of Tehran's purchases of arms
and equipment for use in the war. Riyadh may also want to
undermine Tehran's potential clout within OPEC. Saudi Arabia's
past willingness to lower output allowed Iranian production to
surpass the Saudi production level last August. The position,
however, quickly changed once Riyadh initiated netback contracts,
and the Saudis appear determined to retain their dominant
position in OPEC.
Iran has publicly) (warned Saudi Arabia that
intransigence on oil policy would risk Iranian military
retaliation. As a result, Riyadh has increased security at key
25X1
25X1
25X1
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
installations in the Shia-dominated Qatif Oasis,
So far the Iranian threats have not
shaken Riyadh's resolve to keep pressure on prices. We believe
the Saudis will maintain their high output levels despite Iranian
threats as long as Riyadh feels that it is politically and
militarily secure. Large-scale sabotage of oil installations,
terrorism or a successful Iranian military strike, however, might
lead the Saudis to cut production.
Market Implications and Future Saudi Oil Policy Directions
Each of Saudi Arabia's objectives entails different
implications for the market:
o If maintaining current oil revenues in the short-run is
Riyadh's prime objective, we would expect the Saudis to
begin soon to take steps to stop the price decline.
Average oil prices in the $15-20 per barrel range
probably would provide Riyadh with adequate short-term
revenues.
o If ensuring a growing long-term market for its oil is
the predominant objective, Riyadh probably would attempt
to keep prices in the $10-15 per barrel range for
several years.
o If Riyadh wants to force other producers to make room
for 4 to 5 million b/d of Saudi oil, it is probably
prepared to see prices fall to $10 per barrel or less
for several months. This would also serve the objective
of imposing a financial squeeze on Iran.
In our judgment, a price of about $15 per barrel is most
consistent with the combination of Saudi objectives. At this
level Riyadh would probably be able to obtain adequate revenue,
would improve its long-term market outlook, and might even obtain
limited producer cooperation--especially if prices drop sharply
for a brief period. With spot prices approaching the $10 per
barrel level and the average world price already below $17,
however, the Saudis would have to act quickly to reverse the
downward price path. OPEC meets again on 15 April and could help
the Saudis achieve this price level with an agreement to cut
output. Without a strong Saudi role in forging a consensus, OPEC
probably will be unable to formulate an approach to stabilize
prices.
US vulnerability to a future price shock or oil supply
disruption will be heightened considerably by the Saudi strategy
promoting sharply lower oil prices, regardless of the motive.
Lower prices will discourage investment in new exploration and
development. As one of the world's high-cost producers, the US
oil industry will suffer from Saudi actions even though Riyadh is
25X1
25X1
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
not specifically targeting it, in our opinion. At $10-15 per
barrel as much as 500,000 b/d to one million b/d of world oil
output could become uneconomic, with at least half of this amount
in the United States. Over the longer term, the US needs a very
active exploration and development program to stabilize
production.
The decline in US proved oil reserves is likely to
accelerate, eventually causing a further reduction in US oil
output. Drilling in the United States has declined 15 percent
since 1981; the active drilling rig count is down 80 percent.
Drilling activity was forecast to fall another 5 percent this
year, even before the latest price cuts which forced some oil
companies to cut exploration and production expenditures by as
much as 40 percent.
Although the degree to which lower prices will stimulate
greater consumption and substitution of oil for other energy
sources is uncertain, the trend toward a convergence of demand
and worldwide oil production capacity will be hastened. Because
of the high concentration of commercially exploitable reserves in
the volatile Middle East, current low oil prices will accelerate
a return to dependence on this region. By the early 1990s, even
a relatively minor disruption could produce another price
The Saudis' increased market share also would give them
considerable economic leverage, which they might at some point
use to advance political objectives. Although such actions would
appear unlikely in the current economic and political
circumstances, a change in regime or another outbreak of Arab-
Israeli hostilities might increase Riyadh's willingness to use
oil as a political weapon. An effort to gain policy objectives
through such means as an oil embargo would have severe economic
repercussions.
Finally, since the Saudi strategy of flooding the oil market
has increased tensions between conservative Arab states and more
radical oil producers like Iran and Libya, Riyadh's oil policy
could contribute unintentionally to the spread of hostilities in
the Persian Gulf. Although the probability of a major disruption
of oil production now appears low, such an event could cause a
dramatic turnaround in the international oil market. This, in
turn, would increase pressure on the US to intervene directly in
the region to ensure the flow of oil.
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
Some Key Indicators of the Objective
Driving Saudi Oil Policy
Revenue Maximization
? Reassess strategy and cutback output
as prices fall.
? Show willingness to canpranise on
production restraint without
concessions fran other producers.
? Help OPEC formulate new strategy
to stabilize prices.
Ensuring a Long-Term Market
? Keep a low profile in OPEC decision-
making process making it difficult
for the group to formulate strategy.
? Ignore attempts by OPEC to stabilize
prices.
? Increase production to lower prices.
? Maintain technical ability to raise
output within a wide range.
? Keep exports competitively priced to
keep output high for prolonged period.
Producer Cooperation
? Continue sharp rhetoric,
against non-members.
? Insist on OPEC compliance with
lover production quotas.
? Refuse accom?mdation without
production restraint.
? Encourage non-members to
canmunicate more with each
other.
? Embark on diplomatic missions
to major producing countries.
Deny Iran Revenue
? Give Iraq financial support
to continue war effort against
Iran.
? Try to deflect criticism for
strategy by blaming other for
market conditions.
? Elicit support fran other Gulf
states to counter Iranian
measures.
? Step up security at key oil
installations.
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8 25X1
Central Intelligence Agency
Washington. D. C. 20505
DIRECTORATE OF INTELLIGENCE
MEMORANDUM FOR: Charles Boykin
Deputy Assistant Secretary for Intelligence
Department of Energy
Attached is our assessment of Saudi oil policy and the
implications for the oil market. The paper outlines the factors
driving Riyadh's aggressive new oil strategy, and assesses Saudi
determination to hold firm despite rapidly falling prices and
lower revenues. Implications and risks for the United States are
highlighted in the paper's conclusion. If you or members of your
staff have questions concerning the report, please call
Chief, Strategic Resources Division, OGI,
25X1
25X1
25X1
25X1
25X1
Attachment:
The Saudi Oil Offensive
GI M 86-20084, March 1986,
25X1
25X1
25X1
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
 Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8
OGI/SRD/EMB,
(31 Mar 86)
Distribution:
1 - Charles Boykin, DOE
1 - John Brodman, DOE
1 - Guy Caruso, DOE
1 - Dave Tarbell, DOD
1 - Joseph Hatfield, Interior
1 - Bill Martin, NSC
1 - Lou Pugliaresi, NSC
1 - E. Allan Wendt, State
1 - Daniel Serwer, State
1 - Charles Higginson, State
1 - Robert Knickmeyer, State
1 - Marion Creekmore, State
1 - Doug Mulholland, Treasury
1 - Charles Schotta, Treasury
1 - Kenneth Glozer, OMB
1 - SA/DDCI
1 - EXDIR
1 - DDI/PES
1 - NIO/ECON
1 - CPAS/ISS
1 - DD/OGI, D/OGI
1 - OGI/PG/CH
3 - OGI/EXS/PG
5 - CPAS/ICB
1 - C/SRD
1 -
1 - SRD/EMB (Chrono)
25X1
25X1
Sanitized Copy Approved for Release 2011/02/23: CIA-RDP86T01017R000100650001-8