By Jeff Mason and Richard Mably
WASHINGTON/LONDON (Reuters) - It was to be a swap felt around the world -- a plan privately discussed by the world's largest oil exporter and the globe's biggest consumer to take the heat out of $120-plus oil prices.
In the weeks leading up to the failed June OPEC meeting, U.S. and Saudi officials met to discuss surprising the market with an unprecedented arrangement: exchanging urgently-needed high-quality crude oil stored in the U.S. emergency reserve for heavier, low-quality oil from Saudi Arabia, according to people familiar with the plan.
The idea involved shipping some of the light low-sulphur, or "sweet," crude out of the U.S. Strategic Petroleum Reserve to European refiners, who needed it after the war in Libya cut off shipments of its premium crude varieties coveted for making gasoline and diesel.
In return Saudi Arabia would sell its heavier high-sulphur or "sour" crude at a discount back to the United States to top up the caverns that hold America's emergency stocks.
It was a striking suggestion, one that would have demonstrated Washington's readiness to put the SPR to extraordinary use and Riyadh's willingness to work creatively with consumers to quell high prices.
But it did not make it past the drawing board, four sources familiar with the talks confirmed. The sources disagree on which country proposed the plan. Two said it fell apart because Riyadh was not willing to subsidize European or U.S. customers by discounting its crude prices below market value.
PAIN IN THE POLLS
The swap idea illustrates a recently deepening engagement between Saudi Arabia and the United States on oil affairs under President Barack Obama, and shows how high the stakes were ahead of the meeting of the Organization of the Petroleum Exporting Countries on June 8 in Vienna.
With gasoline prices topping $4 a gallon in many parts of the United States, Obama was seeing his support ebb in opinion polls, just as the White House was beginning to focus on the 2012 election.
The Saudis were concerned about the health of the global economy with oil prices surging above $100 a barrel. Riyadh knew that high prices, while good for short-term income, would cut fuel demand over the longer term.
Washington had pressed Saudi Arabia to boost oil production at least twice ahead of the OPEC meeting that ended in failure, sources told Reuters.
After war broke out in Libya and its oil output fell, the Saudis complied with the initial request, but they weren't happy when European refiners didn't jump to buy their crude, even a "special brew" of lighter quality, an Arab official said.
"We need someone to take our crude. We don't just want to store it," the official said.
Industry sources described a "difficult" Riyadh meeting that a U.S. delegation held about a month ago with Saudi Oil Minister Ali al-Naimi.
"They were told, 'If you're going to find us extra refineries that are asking for demand, we'll supply that,'" the Arab official said.
Deputies from the U.S. Energy and Treasury departments also visited Riyadh to make the case for stepped-up oil production, a source close to the Saudi government said, although the timing of this meeting was unclear.
One of the officials who attended that meeting was Jonathan Elkind, Principal Deputy Assistant Secretary for Policy and International Affairs at the Energy Department, a source told Reuters.
Within days, Elkind was flying to Paris for a regular meeting of the board of governors of the Paris-based International Energy Agency, which speaks for 28 industrialized oil consumer countries.
After that meeting, the governing board released an unusually blunt statement urging OPEC to raise output and announcing that it would consider using "all the tools" at its disposal -- a clear reference to emergency reserves.
The U.S. State and Energy Departments would not comment on whether the meetings took place or offer other details, while the White House has acknowledged regular talks with producers without being specific about their content.
Set up in 1974 to protect oil consumers after the Arab oil embargo, the IEA has held an open and cordial dialogue with OPEC ever since the Gulf War in 1990-1991, one of only two times it has authorized a global release of strategic stocks.
But the May 20 missive suggested a new cooling in the relationship between the world's big oil consumers and producers, and provoked a backlash from some in OPEC.
"Strategic reserves should be kept for their purpose and not used as a weapon against OPEC," OPEC Secretary General Abdullah al-Badri told the Reuters Global Energy and Climate Summit on Tuesday.
"We never interfere in the IEA and really we don't want them to interfere in our business. They should do it in a professional manner. We should not talk to each other through the media."
Washington appears to have mostly heeded that comment, and kept quiet about its engagement, in contrast to previous administrations.
In April, Obama -- who has several times blamed speculators for the run-up in prices -- made a rare public call for world oil producers to boost production.
"We are in a lot of conversations with major oil producers like Saudi Arabia," he said in a Detroit television interview.
The tension within the cartel boiled over last week in Vienna, when seven members of the group balked at a Saudi-led plan to increase production. While ministers said the breakdown was caused by differing views over the market outlook in the second half of this year, Iran blamed unspecified "consumer countries" for influencing the debate.
"What happened shows OPEC is an independent organization," OPEC governor Mohammad Ali Khatibi told Reuters. "If one wants to exert pressure to make the others give up -- no."
The Kingdom declared it would go it alone. Sources say Saudi Arabia is raising production in July by nearly 1 million bpd to around 10 million bpd, although Brent crude oil prices have continued to press higher, reaching a five-week peak of more than $120 a barrel on Tuesday.
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