No. 8 — February 25, 2000


Weekly Review

--- by Marc Castellano

Efforts by Arabian Oil Co., Ltd. and Riyadh to hammer out a deal to renew the Tokyo firm's drilling rights in the Saudi-controlled part of the Khafji oil field in the Persian Gulf have reached a fever pitch. With the active backing of the Japanese government, the desperate oil provider is trying to convince Saudi Arabia to extend its concession, which will expire at the end of February. Because talks held over the last few years have been unsuccessful and have left the key sticking point unresolved, the looming deadline has made Tokyo increasingly nervous. Ironically, the Saudi government owns 10.9 percent of Arabian Oil. The Kuwait Petroleum Corp. has an identical stake. They are the company's largest shareholders.

In the last major round of negotiations, held in mid-January, International Trade and Industry Minister Takashi Fukaya refused to give in to the Saudi demand that the Japanese government not only build but also operate a railroad in northern Saudi Arabia if it wants Arabian Oil's rights renewed (see JEI Report No. 2B, January 14, 2000). Construction of the railroad is estimated to cost about $2 billion, while annual operating expenses could run as high as $100 million. Japanese sources claim that the project is unlikely to be profitable. Thus, Tokyo has balked at the quid pro quo, saying that it cannot justify spending taxpayers' money on such an expensive and financially questionable venture. At the conclusion of the January meeting, Mr. Fukaya indicated that he did not plan to offer further inducements to encourage Riyadh to extend the concession; this was Tokyo's final position. Petroleum Association of Japan President Keiichiro Okabe agreed with the hard-line stance, stating that funding the railroad is "too high a price" to pay for continued drilling rights.

The Ministry of International Trade and Industry began to backpedal soon after, as Riyadh continued to insist on the trade-off. Tokyo made a new offer to provide an interest-free loan that would cover 70 percent of the railroad's construction costs, yet this seemingly compromise-oriented strategy backfired. Not only did the Saudi government reject the offer but one Saudi newspaper, which, like most media in the heavily regulated country, reflects official views, went so far as to characterize Japan as "stingy" and ungrateful.

Arabian Oil then stepped in to try its hand at ending the deadlock. Because Saudi officials have complained that direct investment from Japan, the second-largest economy in the world, is relatively small, the company offered a ¥600 billion ($5.5 billion at ¥110=$1.00) investment package. The money would be used to improve the working environment around the firm's drilling sites and to support new natural gas projects. Arabian Oil would borrow the money from the Japan Bank for International Cooperation — the recently formed quasi-public institution that combined the Overseas Economic Cooperation Fund and the Export-Import Bank of Japan. Another government-affiliated business, Japan National Oil Corp., would act as guarantor. This proposal overlaps the one made by Tokyo. It had offered an ¥800 billion ($7.3 billion) package of aid, including the interest-free loan for the rail project.

When it became clear that the Saudi government still was not satisfied, Arabian Oil went back to the central sticking point. President Keiichi Konaga proposed setting up an investment consortium and working with the Saudis on a feasibility study of the rail project. The plan also called for the two sides to look for ways to reduce the cost of the railroad's construction and operation. However, MITI and JBIC are highly pessimistic about the chances for the scheme's adoption because it is based on the assumption that Riyadh would give a tax break to Arabian Oil, which then could transfer the savings into the project. Reducing taxes is not an idea that Saudi Arabia is likely to accept.

The prolonged negotiations have drawn attention to Tokyo's overall energy policy and have highlighted its weak bargaining position. Japan relies on oil for more than half of its energy needs and, as a resource-poor island, must import 99.7 percent of its oil (see JEI Report No. 10A, March 13, 1998). The Middle East supplies about 85 percent of the imported crude, of which only 15 percent is produced by Japanese companies. Since the two oil crises of the 1970s, Japan has struggled to reduce its dependency on the region, but it has not been successful. In a further effort to develop greater energy self-sufficiency, MITI wants to raise the share of oil produced by Japanese companies to 30 percent.

Arabian Oil, Japan's largest oil supplier, is a key part of MITI's strategy. If negotiations with Riyadh ultimately fail, the oil concern would face dramatic restructuring. However, it would not be forced out of business in the near term because its drilling rights in the Kuwaiti-controlled part of the Khafji oil field extend until January 2003. Japanese officials concede that national oil supplies most likely would not be immediately affected, but Japan's relationship with Saudi Arabia, the world's top oil producer, surely would suffer.

Negotiations probably will continue until the last minute. The Saudis, who apparently are not interested in loans, are keen to hold to their demand that Japan pay for the construction and the operation of the railroad. Tokyo, for its part, slowly has been inching toward a concession. Indeed, with few other options on the table, it may have no other choice.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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