State-owned energy company Saudi Aramco has worked hard for the past five years to bring crude oil production capacity up to 12.5 million barrels a day (b/d) from 9.5 million b/d in 2005.

But just as the kingdom enters the final stages of an extensive energy sector investment programme, Aramco's engineers have been told to hold back on ramping up production. With the global economy still faltering, the world is not quite ready to absorb additional supplies of Saudi crude.

In June, oil cartel Opec committed itself to keeping production levels unchanged at nearly 25 million b/d, having cut daily production by 4 million b/d since September last year.

While some Opec members such as Iran have consistently overproduced, the decision to keep output unchanged was led by Aramco, despite its recent strategy of increasing capacity.

Speaking at an oil and gas conference in Kuala Lumpur in 2006, Abdullah Jumah, then president and chief executive officer (CEO) of Aramco, outlined the company's hopes. "In the next five to six years, we will be adding production capacity," said Jumah. "Some of that capacity will offset natural decline of maturing fields, while the remainder will serve to expand our maximum sustained production capability, which by the end of 2009 will reach 12 million barrels a day."

Excessive target

The majority of Aramco's capacity expansion was carried out while demand for oil was high, as was the cost of construction equipment, materials and labour. In the bullish economy of 2006, the idea of reaching a production level of 12.5 million b/d did not appear excessive. But the timing of the most recent projects has been less than perfect.

Aramco is on course to start up two new fields by the end of June: the 1.2 million-b/d Khurais development and the 100,000-b/d Nuayyim field, followed by the 250,000-b/d Shaybah expansion in the third quarter. The 900,000-b/d Manifa heavy oil field, which was scheduled to come on line in 2011, will not begin production by until mid-2013.

Bringing additional capacity on stream now, amid a global recession, is poor timing for Aramco. With oil prices having hit a record high of $147 a barrel in July 2008, they now hover around $65-70 a barrel.

Few traders in the oil markets foresee any significant rise in oil prices in the short term as consumption remains weak in the US and Europe. According to forecasts by the International Energy Agency (IEA) in May 2009, which acts as an adviser to 27 of the largest oil-consuming nations, such as the US and Japan, global oil consumption could drop by 2.6 million b/d this year to average 83.3 million barrels a day, its steepest fall since 1981.

Aramco is now holding back on using its new production capacity following the Opec decision not to raise output. In March, Aramco completed drilling on 310 wells to bring the 1.2 million-b/d Khurais development into operation 10 months ahead of schedule.

Drilling on the field, which will produce Arabian Light crude, was shared between Aramco, China's Sinopec and US oil services company Halliburton.

Within the next three months, work on the 250,000 b/d Shaybah field expansion is expected to be completed, further raising Saudi Arabia's production capacity at a time of weak demand. "They were a little late in matching where demand would be going towards the latter part of the year," says Raja Kiwan, a Dubai-based analyst at US industry consultant PFC Energy.

The Opec cuts were therefore crucial for Riyadh as a way of rebalancing demand and supply in the market. "The cuts seem to be paying off to a certain extent," says Kiwan. "Demand is still very weak, but they are at the right production level to be able to bring this [demand] back into balance."

Supply disruptions

Saudi oil production figures are difficult to assess, with no independent monitors to verify Aramco's output. With production currently pegged back to 8 million b/d, according to the government, the Oil Ministry has consistently declared its intention to maintain a strategic spare capacity of 2-2.5 million b/d, enabling it to deal with any unexpected disruption to global supply.

The excess capacity also leaves the kingdom in a stronger position as a swing producer - able to influence the price of oil by raising or lowering its production in response to market con-ditions. "It is the only country that can sustain the cost of overproduction for any length of time," says one Dubai-based commodities trader.

Assuming production is currently about 8 million b/d, a spare capacity of 2.5 million b/d would be sufficient to deal with any unexpected disruption to supply. However, according to Abdulaziz al-Jumaidi, Aramco's vice-president for new business development, the maximum sustained capacity is 12.5 million b/d. The difference between the figures is an important one that can only be partially explained by technical definitions.

According to the IEA, spare capacity is crude that can be brought on stream in 30 days, and maintained for 90 days. But the IEA says that assessing production has become increasingly complicated by apparently conflicting statements about production levels from government officials.

Although Aramco says it has the capacity to produce 12.5 million b/d, it remains unclear how much drilling work would have to be done to get the oil out of the ground, how long this would take, and for exactly how long it could sustain production at such high levels.

Anyway, crude oil prices have more to do with global demand than Saudi production levels. And even the most bullish economic forecasts do not see a significant recovery in the world economy this year.

"They will have a huge amount of spare capacity this year, and even next year, even if there is a rebound in demand, which we see coming," says Kiwan. "The Saudis still have 4-4.5 million barrels a day of capacity, which is a huge amount."

When the kingdom embarked on its five-year oil and gas plan in 2004, few would have predicted such a collapse in demand. "The timing is not ideal obviously, but they have to look at things in the long term and it just sets them up for a much better position when demand does eventually rebound," says Kiwan.

Over-production

The failure of some Opec members to comply with production quotas has threatened to chip away at the oil cartel's otherwise strong resolve to rein in oversupply.

As the largest member and de facto leader of Opec, with responsibility for making almost 45 per cent of the combined cutbacks in production, Saudi Arabia's discontent with over-producers is likely to grow in tandem with its idle capacity.

While most Gulf oil producers have largely followed Saudi Arabia's lead in reining in output, there have been some exceptions in the region. Saudi Arabia's neighbour Qatar, for example, has defied the Opec quotas by over-producing. According to the IEA, crude production in Qatar increased to 780,000 b/d in April, up 40,000 b/d on March, on the back of strong demand for Qatari grades of crude.

Amin Nasser, Aramco's senior vice-president for exploration and production, says the company will meet its end of June target for raising its oil production capacity despite delaying refinery projects to take advantage of falling engineering, procurement and construction costs.

The company also has operational decisions to make. Khalid al-Falih, Aramco's newly appointed chief executive officer, described in January how it would reprioritise production as it is reduced.

The massive spare capacity will give Aramco the ability to slow production at some fields, such as the giant old Ghawar field, which has produced 40-50 per cent of the kingdom's crude oil in its 60-year life.

Aramco engineers are reportedly eager to reduce production from the field to carry out reservoir maintenance.

"It is a matter of juggling things internally," says Kiwan. "The spare capacity allows them to carry out more extensive maintenance, if any of the fields require it."

Energy analysts estimate that if the kingdom's crude production falls below 8 million b/d as a result of further Opec cuts, or maintenance work on fields, it will not be able to produce enough gas to meet its domestic power needs. About 60 per cent of the country's gas comes from associated fields.

In February, Saudi Arabia took the unusual step of securing long-term contracts for imported gas oil, agreeing to buy 3 million barrels from Japan's Itochu and 7.4 million barrels from India's Reliance Industries.

However, despite oil production being close to the minimum level required to extract sufficient gas for domestic needs, it seems Aramco has been able to produce sufficient amounts of associated gas to meet the current demand of 7.8 billion cubic feet a day (cf/d).

Respite period

"Since the beginning of the year, [Saudi Aramco] has begun closing down mainly the fields with little or no associated gas, prioritising production from fields with more associated gas, as well as closing down fields that require lots of gas reinjection," says Samuel Ciszuk, Middle East energy analyst at US-based consultant IHS Global.

The global economic slowdown has given Aramco a respite period in its ambitious projects programme. While the kingdom's heavy industrial projects and industrial clusters planned by Riyadh were premised on the availability of cheap gas, the majority of gas allocations made before 2006 were to petrochemicals projects.

"Petrochemicals are having a really tough time," says Ciszuk. "But falling production is probably helping, as the lower feedstock usage will probably alleviate the pressure on gas for the rest of domestic demand."

Aramco remains confident of adding 5 trillion cubic feet a year of gas production to Saudi Arabia's gas base, with plans to reach 9 billion cf/d by 2013, up from 7.2 billion cf/d in 2008.

In March, Aramco said it would invest $60bn in boosting onshore and offshore oil and gas production over the next five years, with the bulk of its capital investment going into 17 mega-projects. This update to Aramco's spending plans shows that the national oil company is planning for the long term, rather than reacting to fluctuating global and domestic demand for oil and gas.

Having targeted production levels of 12.5 million b/d for 2009, when planning its energy investment programme in 2005, Riyadh would have preferred its investment to produce returns on time. But due to the global economic downturn, Saudi Arabia will have to wait for demand to rise before it produces oil at full capacity.