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Oil traders vs. the Saudis

It's a simple question, one which many people are likely asking as the price of crude oil and gasoline continue to hit new highs: If the Saudis plan to unilaterally boost their supply of crude oil, regardless of what the OPEC cartel decides to do — a promise the Saudi Arabian oil minister made last week — then why have crude prices continued to climb? Oil fell somewhat on Tuesday, but it is still trading close to a record high of over $41 (U.S.) per barrel.

As it has many times in the past, Saudi Arabia finds itself in a tug-of-war with oil traders, a battle that revolves around the empire's credibility, and that of the OPEC oil cartel itself. By pushing crude over $41 even after the Saudis said they would increase production, the oil market is sending the kingdom a message: it either doesn't believe the supply boost will actually occur, or doesn't believe it will help.

One interesting point that has come out in the past week is that even if crude comes down from its lofty perch, Saudi Arabia and others believe it could remain high for some time. According to the Saudi oil minister, when strong demand from Asia is taken into account, the realistic market price for oil — that is, after the speculative portion of the current price is removed — may be in the $30 to $35 a barrel range, which is still sharply higher than the average over the past several decades.

The latest comment to drive the markets was made by Saudi Arabian oil minister Ali al-Naimi on Sunday, in an interview with an Arab newspaper. The minister said that his country had already started producing more oil in an attempt to bring prices down, and that it was ready to turn the taps on even further if necessary. He also said that the Saudis would pressure their fellow OPEC members to boost official quotas at their next meeting in June. And yet oil continued to trade above $41.

One of the things traders might be counting on in is dissent within OPEC, something that is always beneath the surface. In the wake of Mr. al-Naimi's comments, for example, several OPEC sources grumbled about the Saudis making a unilateral decision without consulting the rest of the cartel. Others said they were concerned that if production is increased dramatically to cover a short-term gap, it might help send prices sharply lower.

For some members of OPEC, this brings back memories of 1997, when crude prices sank as low as $10. The oil cartel had boosted its official quotas at a spring meeting because it was worried about increasing demand, but instead demand from Asian markets fell off a cliff and supply ballooned. Many of the OPEC countries that are dependent on oil revenue found they were short of money — even Saudi Arabia, which is perceived by some (erroneously) as impervious to such pressures.

Needless to say, there is a strong interest in avoiding that kind of outcome. As one producer put it, "The fear is that when prices start going down, it won't be $1 or $2, it will be $10." There also appears to be some tension within OPEC over how much Saudi Arabia's pledge is related to its support of U.S President George Bush. According to a recent book by Bob Woodward, a member of the royal family told the Bush administration that the Saudis would make sure oil prices came down in advance of the U.S. election.

Oil industry watchers remain divided, however, on whether the Saudi pledge will actually help or not. Mr. al-Naimi said that the country could raise its production by 1.5 million barrels a day in June, which would take it to 10.6 million barrels (it is already producing about 500,000 barrels a day more than its previous quota of 8.6 million). The Saudi minister also said that his kingdom would press OPEC to pump another 2.3 to 2.5 million barrels a day.

The oil cartel is already estimated to be pumping about 2 million barrels a day over its official quota, however. Do the Saudis plan to simply legitimize that over-production by raising the official quota? If they do, then OPEC's actual output may not even budge. In any case, any boost in production has to come from the Saudis, since they are the only OPEC nation that isn't producing at its maximum already. And even if Saudi Arabia follows through on its promise, there are those who believe the high-price die is cast for crude.

For example, the Saudi oil minister said that if necessary, his country could increase production by as much as 2 million barrels a day over its current output, which would put it at about 11 million barrels a day. But it would take some time to do so, since that would involve bringing portions of certain oil fields back into production — and it would also be dependent on finding tankers to transport the oil. According to industry sources, the supply of tankers is extremely tight, and it is possible that even if the Saudis boost production by as much as promised, it will not get to market for several months.

Can the Saudis succeed in talking the price of oil down? They might — but it certainly won't be easy.

Editorial Notes: Questions have been raised about whether Saudi Arabia can actually increase it's output significantly. See Is Saudi Arabia Still the King of the Oil? By Julian Darley

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