Saudi Arabia - Oil Industry

More about the Economy of Saudi Arabia.

Brief History

Abd al Aziz ibn Abd ar Rahman Al Saud, the first king of Saudi Arabia, had not gained control of the western part of the country when he granted the first oil concession in 1923. A British investment group, the Eastern and General Syndicate, was the recipient. The syndicate gambled on the possibility that it could sell the concession, but British petroleum companies showed no interest. The concession lapsed and was declared void in 1928.

Discovery of oil in several places around the Persian Gulf suggested that the peninsula contained petroleum deposits. Several major oil companies, however, were blocked from obtaining concessions there by what was known as the Red Line Agreement, which prohibited companies with part ownership of a company operating in Iraq from acting independently in a proscribed area that covered much of the Middle East. Standard Oil Company of California (Socal), which was not affected by the Red Line Agreement, gained a concession and found oil in Bahrain in 1932. Socal then sought a concession in Saudi Arabia that became effective in July 1933. Socal assigned its concession to its wholly owned operating subsidiary, California Arabian Standard Oil Company (CASOC). In 1936 Socal sold a part interest in CASOC to Texaco to gain marketing facilities for the crude discovered in its worldwide holdings. The name of the operating company in Saudi Arabia was changed to Arabian American Oil Company (Aramco) in January 1944. Two partners, Standard Oil Company of New Jersey (later renamed Exxon) and Socony-Vacuum (now Mobil Oil Company), were added in 1946 to gain investment capital and marketing outlets for the large reserves being discovered in Saudi Arabia. These four companies were the sole owners of Aramco until the early 1970s.

The original concession called for an annual rental fee of 5,000 British pounds (�) in gold or its equivalent until oil was discovered; a loan of �50,000 in gold to the Saudi government; a royalty payment of four shillings gold per net ton of crude production after the discovery of oil; and the free supply to the government of specific quantities of products from the refinery Aramco was to build after oil was discovered. (In 1933 the British pound was worth about US$4.87; there were twenty shillings to the British pound.) The company received exclusive rights to explore for, produce, and export oil, free of all Saudi taxes and duties, from most of the eastern part of Saudi Arabia for sixty years. The terms granted by the government were liberal, reflecting the king's need for funds, his low estimate of future oil production, and his weak bargaining position.

The original concession agreement was modified many times. The first modification was made in 1939 after the discovery of oil in 1938. This change added to Aramco's concession area and extended the period to 1999 in return for payments substantially higher than those specified in the first agreement and for larger quantities of free gasoline and kerosene to be supplied by Aramco to the Saudi government. In 1950 a fifty-fifty profit-sharing agreement was signed, whereby a tax (called an income tax, but actually a tax on each barrel of oil produced) was levied by the government. This tax considerably increased government revenues. Further revisions increased the government's share--slowly until the 1970s and rapidly thereafter. At the beginning of 1982, Aramco's concession area amounted to about 220,000 square kilometers (189,000 onshore and 31,000 offshore), having relinquished more than 80 percent of the original area of almost 1.3 million square kilometers.

Once the existence of oil in quantity was ascertained, the advantages of a pipeline to the Mediterranean Sea seemed obvious, saving about 3,200 kilometers of sea travel and the transit fees of the Suez Canal. The Trans-Arabian Pipeline Company (Tapline), a wholly owned Aramco subsidiary, was formed in 1945, and the pipeline was completed in 1950. Many innovations were required to keep costs down and to make operations competitive with tankers. Tapline linked the Lebanese port of As Zahrani, close to Sidon to Al Qaysumah in Saudi Arabia (a distance of more than 1,200 kilometers), where it connected with a pipeline collecting oil from Aramco fields. Initial capacity was 320,000 bpd, but capacity was expanded, eventually handling 480,000 bpd in the mid-1970s. Tax problems with Saudi authorities and transit fees due Jordan, Iraq, and Lebanon plagued Tapline for many years. The line was damaged and out of operation several times in the 1970s. And while operating costs of Tapline increased, supertankers were reducing seaborne expenses. By 1975 Tapline was no longer used to export Saudi crude via Sidon. In 1982 the line was again damaged. In late 1983, Tapline filed formal notice to cease operations in Syria and Lebanon, although small amounts of crude would reportedly continue, albeit temporarily, to supply a refinery in Jordan.

From the very start, Aramco had to concern itself with more than just oil. Its company presidents were virtually United States ambassadors in Saudi Arabia and played a significant role in shaping United States-Saudi relations in the early days of the oil company. Moreover, the undeveloped infrastructure and facilities demanded that Aramco construct virtually everything it needed. A port to bring in equipment had to be built; water had to be found and delivered to work areas; and housing, hospitals, and offices had to be constructed to launch development. Few Saudis were familiar with machinery, local construction firms hardly existed, and the unavailability of most materials locally necessitated long supply lines.

Aramco adopted the long-range policy of training Saudis to take over as many tasks as possible, although major management positions (culled from the ranks of the parent companies) were not intended to be relinquished, until Aramco could not resist government pressure to do so in the 1970s and 1980s. A wide variety of training programs, including sixty annual scholarships to foreign universities, and social service programs were established by Aramco. Saudis, for example, were trained as doctors, supply experts, machinists, ship pilots, truck drivers, oil drillers, and cooks. Many of these Saudis later fanned out into the local economy to establish businesses and entered the growing bureaucracy in Jiddah and Riyadh. Others remained with Aramco and advanced in responsibility. Aramco was also one of the first foreign companies in Saudi Arabia to employ labor from a variety of countries other than the United States. By 1980 about 22,000 of the 38,000 Aramco employees (excluding some 20,000 workers employed by Aramco contractors), were Saudis. More than 45 percent of management and supervisory positions were occupied by Saudis. In 1982 Ali Naimi, who had started with Aramco at age eleven and had risen through the ranks, became first executive vice president in charge of operations; two years later, Naimi became the first Saudi president of Aramco. The United States presence declined over the years. By 1980 there were only 3,400 United States citizens with Aramco. The remaining work force consisted of nationals from about forty-four countries. In 1989 the total number of company employees was 43,248. Of these, 31,712 were Saudis whereas the United States work force had shrunk to 2,482, and other foreign workers were slightly more than 9,000.

To divest itself of supply and service sidelines, Aramco had always subcontracted work to local entrepreneurs and at times provided technical, financial, and material assistance. At the request of King Abd al Aziz, Aramco teams helped find water and develop agricultural projects. The Saudi government paid the company to build a modern port at Ad Dammam and to supervise the construction of a railroad linking the port to Riyadh.

In the 1970s, Aramco's activities expanded greatly. Part of the expansion was associated with the facilities needed for the more than threefold increase of crude oil production during the period. Well drilling, pipeline installation, and construction of gas-oil separation plants, storage tanks, and tanker-loading terminals accelerated tremendously. As the world's largest oil company, Aramco frequently had to design and build installations larger than those used elsewhere. During the 1970s, Aramco was also entrusted with developing a gas-gathering system (currently referred to as the master gas system), which reportedly cost between US$10 billion and US$15 billion for the first phase alone and was completed in 1982. The company was also charged with producing the Eastern Province's electricity supply through managing the regional electric power company.

In 1968 Minister of Petroleum and Mineral Resources Ahmad Zaki Yamani first publicly broached the idea of Saudi participation in Aramco. In December 1972, long negotiations were completed for the Saudi government to buy 25 percent ownership of Aramco, effective in 1973. Negotiations during 1973 resulted in Saudi participation increasing to 60 percent, effective the beginning of 1974. In 1976 arrangements for total ownership of Aramco were reached, and in 1980 payments to the four Aramco parent companies were completed. By 1988 Aramco was converted to a totally Saudi-owned company called Saudi Arabian Oil Company (Saudi Aramco). By the 1990s, Saudi Aramco had responsibility for all domestic exploration and development--its mandate was expanded to include all Saudi Arabia--engaging in downstream joint ventures overseas, purchasing on-land storage facilities closer to key consuming markets for its crude oil, and expanding its tanker subsidiary, Vela Marine International.

The General Petroleum and Mineral Organization (Petromin) was established in 1962 as a public corporation wholly owned by the Saudi government to develop industries based on petroleum, natural gas, and minerals by itself or in conjunction with other investors, foreign or domestic. Although its activities predominantly centered on the country's hydrocarbon resources, Petromin also explored for and developed other mineral resources.

Petromin's original charter suggested that it would eventually become the country's national oil company. After the mid-1960s, only Petromin received concessions for exploration and development. Petromin, however, assigned its rights, but not its concessions, to companies formed with foreign oil companies. A joint venture was formed with an Italian state company to explore part of the Rub al Khali, or Empty Quarter, but activity ceased in 1973 after the company failed to discover oil. In 1967 Petromin joined a number of foreign oil companies in an equally unsuccessful exploration of areas of the Red Sea claimed by the kingdom.

In the 1960s, Petromin became responsible for domestic distribution of petroleum products, partly by purchasing Aramco's local marketing facilities. It became part owner with private Saudi investors in domestic refineries in Jiddah and Riyadh. It also began marketing crude oil abroad and became involved in tanker transport. By 1975 some of Petromin's activities were curtailed as part of a ministerial reorganization. Among the reasons for limiting its scope were its unsuccessful attempts at further oil exploration, the incompetence of its operations, and the diffusion of its activities. A clearer distinction between its activities and those of Aramco also occasioned the restriction. Some businesses in which Petromin held part ownership, such as a fertilizer plant and a steel mill, as well as responsibility for the many large petrochemical plants that were in the study stage, were transferred to the new Ministry of Industry and Electricity.

Although its responsibilities shrank somewhat after 1975, Petromin's activities increased. It supervised the construction and became responsible for operation of the crude oil pipeline from the Eastern Province oil fields to the new industrial city of Yanbu on the Red Sea coast. In joint-venture partnerships with foreign oil companies, it rapidly expanded refining facilities for domestic use and export. Petromin had responsibility for the supply, storage, and distribution of domestic petroleum products, for which the demand was growing rapidly. Petromin marketed some crude oil and petroleum products abroad and exported natural gas liquids. It also continued exploration and drilling activities well into the 1980s.

By the late 1980s, however, the government decided to create a company to take over Petromin's activities. The Saudi Arabian Marketing and Refining Company (Samarec) was created in 1988 to produce and market refined products in the kingdom and abroad. It assumed control of the joint ventures with foreign oil companies. Moreover, the government ordered Samarec to implement the major upgrading of domestic refineries, believed to cost well over US$5 billion during the first half of the 1990s.

Among the pivotal concessions Saudi Arabia awarded were those made to two small independent oil companies to explore for oil in the Divided Zone. In 1949 the Getty Oil Company (formerly Pacific Western Oil Corporation) was granted the right to explore in the Saudi share of the Divided Zone. Aramco had relinquished this area in 1948 partly because the ruler of Kuwait had won very favorable terms for a concession in his share of the Divided Zone, and Aramco did not want to match it.

Production from this concession (since the 1970s partly owned by Saudi Arabia) averaged 60,000 bpd during the 1980s. During the Persian Gulf War, production came to a halt because Getty's facilities were heavily damaged by the Iraqi occupying forces. The oil fields were mined while wells and gathering centers were seriously damaged or destroyed, as were the refinery and ten of fourteen crude oil storage tanks.

The second pivotal concession was granted in December 1957 by Saudi Arabia to the Arabian Oil Company (AOC), owned by Japanese business interests, giving exploration rights to the Divided Zone offshore area for two years, subject to extension. If oil were discovered in commercial quantities, an exploitation lease was to be granted for forty years. Subsequently, Saudi Arabia and Kuwait each became 10 percent owners of AOC. By the mid-1970s, Saudi Arabia had increased its stake to 60 percent, and in the early 1990s still controlled the company.

During the 1980s, average production was 125,000 bpd. After Iraqi attacks on storage facilities and the removal of personnel during Operation Desert Storm, output was shut down; production returned to peak levels by early 1992.

Oil industry

Saudi Arabia is the world's most important oil producer. Given its relatively high production levels, accounting for nearly 13 percent of world output and 35 percent of total OPEC output in 1991, and, more significantly, its small domestic needs, the kingdom's dominance of international crude oil markets is unchallenged. Although reluctant to play the role, Saudi Arabia has become the "swing producer," balancing international oil demand and supply. Therefore, within limits, Saudi oil production policies can have a profound impact on international prices. Since the early 1970s, the kingdom has occasionally used this dominance to influence oil prices, usually to further its objectives of sustaining long-term oil consumption and ensuring economic stability in the industrialized world.

The oil sector is the key domestic production sector; oil revenues constituted 73 percent of total budgetary revenues in 1991. Precise statistics for expenditures on sector development were not available but some estimates placed the annual figure at US$5 billion to US$7 billion, or less than 10 percent of total budgetary expenditures. Export oil revenues accruing to Saudi Aramco, a large portion of which is allocated to the budget, accounted for 90 percent of total exports in 1991. Only in the number of jobs was the oil sector relatively unimportant to the economy; the capital-intensive nature of the oil industry required few workers--less than 2 percent of the labor force in the early 1990s.

Oil Industry in the 1990s

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