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The Saudis are blowing smoke again

People don't know the trouble we go to, to balance the market. Without us, the oil market would be chaotic
     —Ali Al-Naimi, December 15, 2006

You may fool all the people some of the time, you can even fool some of the people all of the time, but you cannot fool all of the people all the time.
    —Abraham Lincoln

Shortly after the oil price shattered the record inflation-adjusted high set in 1980, OPEC decided to sit on its hands and let events take their course. No doubt some of the recent price rise is due to investors flocking into commodities, which are viewed as a safe haven in the sagging financial markets. Some of the price rise is also due to the rapidly deflating dollar. Despite these financial considerations, most of the oil price results from a fundamental disequilibrium between supply and demand in the oil markets. How did we get into this current mess?

OPEC Basket Price One reason for the current price shock is that Saudi Arabia1 scaled-back crude production by 1 million barrels per day (b/d) between September, 2005 and February, 2007 to 8.6 million b/d. Only since September, 2007 has the Kingdom started to increase production, which currently sits at 9.2 million b/d in February, 2008 according to Mr. Ali al-Naimi, Saudi Arabia's oil minister. The OPEC basket price was $99.16 on March 7th. The longer-term basket price trend is shown in the graph (left) which shows a rise of about 360% since 2002.

Saudi Arabia is pumping less oil and making more money, despite the falling value of the dollar. If you want to point to a single factor that has contributed the most to oil's steep price rise since the 1st quarter of 2007, you needn't look further than this—the Saudis and the other OPEC countries kept oil off the market that winter to prevent an irrational price slide below $50/barrel just as production in the OECD nations continued its steep decline and other countries, like Russia, struggled to maintain production levels or put small new increments on-stream. Global supply fell further short of demand with each passing month and the volatile oil price has gone up ever since.

Higher prices did not affect inelastic demand, which is subsidized where it is growing fastest, Russia, China and Saudi Arabia itself, which must float all those unemployed young people who might otherwise be turning to Wahhabism and Jihad. For the Saudis, the OPEC basket price exhibits a happy trend. This isn't rocket science.

Blowing Smoke About Prices

De facto OPEC head Ali al-Naimi, along with other officials (or paid flunkies) who take their marching orders from him, is fond of telling us the market is "well supplied" or "in balance," blaming price rises on refinery bottlenecks, speculators, geopolitics, or whatever comes to mind. Statements after last week's meeting were typical

Saudi Arabia's Oil Minister Ali al-Naimi, who sets policy in the world's largest exporter, said supply and demand are stable...

Maintaining current production is a "goodwill'' gesture to customers made despite a certain drop in demand, said Qatari Energy Minister Abdullah bin Hamad al-Attiyah. "We are confident there is no shortage of supply at all,'' he said.

"It's not reasonable2 to expect OPEC to provide more oil in the market than is needed,'' said Johannes Benigni, managing director of Vienna-based JBC Energy. "There's no shortage.''

A goodwill gesture to consumers! Your pocketbook is telling a different story, isn't it? You can ignore all this talk. You can also ignore statements about OPEC's target price as reported in the tireless Jad Mouawad's OPEC Finds Price Range to Live With, New York Times, December 6, 2007.

Since abandoning a target of $25 a barrel long ago, the Organization of the Petroleum Exporting Countries has not said where it would like to see prices go. Analysts say the group’s new target price is $70 to $80 a barrel.

“OPEC’s floor price keeps rising,” said Jan Stuart, an energy economist at UBS in New York. “You have to assume that’s a strategy. Their actions speak louder than their words”...

OPEC said the reason prices rose to nearly $100 a barrel in recent weeks had little to do with supply and demand but was a result of trading by commodity investors and hedge funds, as well as geopolitical instability.

“We have enough stocks in the market,” Abdalla Salem el-Badri, the secretary general, told reporters. “There is no reason for the price of oil to go to $100 a barrel.”

When OPEC refuses to raise production, as they did just last week, they are supporting the current price, which is $108.71 at this moment. OPEC could move to lower oil prices by raising production, but there's not much of that vaunted spare capacity to spare (ASPO-USA, September 19, 2007). There is some, however.

Simple arithmetic can tell us what Saudi Arabia's spare capacity is now. (All references are to crude + condensate only.) Saudi Aramco's production capacity target is 12 million b/d by the end of 2009 and they get another 500,000 barrels from the Neutral Zone they share with Kuwait. Saudi Arabia is putting an additional 2.05 million b/d of productive capacity on-stream by the end of 2009, which makes their production capacity = 10.45 million b/d now. They are producing 9.2 million barrels, so their spare capacity is 1.25 million b/d, give or take a hundred thousand barrels, most of which is very sour (sulphur-laden) crude they can't sell.

About 1 million OPEC barrels are potentially in play altogether, and almost all of it3 comes from the Persian Gulf (the UAE, Qatar, Kuwait and Saudi Arabia).

Hence OPEC, and thus Saudi Arabia, can not exert much control on the oil price while it is rising. The floor (target) price that OPEC defends is the price at which they will cut production to preserve their revenues. If the oil price goes up, the OPEC floor price will go up with it as it has done for years now. It's that simple, and has nothing to do with preposterous claims that the market is "well supplied" or "in balance."  Saudi Arabia's new production capacity could have some impact on the situation in the near future, but that's the big issue being considered here (see below).

Billions and Billions, Trillions and Trillions

Beyond blowing smoke about the chaotic oil markets, a number of highly-placed Saudis, including Mr. al-Naimi, Saudi Aramco President and CEO Abdullah Jum'ah, and Dr. Nansen Saleri, formerly head of reservoir management for Saudi Aramco, delight in trashing the "peak oil" theory. Their statements appear coordinated, which is likely not an accident. Consider these examples—

[Abdullah Jum'ah] said that in a bid to tackle the perception of peak oil, both conventional oil as well non-conventional resources such as tar sands must be considered. He placed the world's in-place endowment of conventional oil and non-conventional fuels at between 13 trillion and 16 trillion barrels [UPI, February 12th, 2008]

[Ali al-Naimi] also said that [Saudi Arabia] ... planned to add another 200 billion barrels of oil to its proven reserves figure. He said this was "to reassure the world that we are not going to run out of oil in the next five to ten years as peak oil theorists say." [AFP, March 1st, 2008]

[Nansen Saleri said] What are the global resources in place? Estimates vary. But approximately six to eight trillion barrels each for conventional and unconventional oil resources (shale oil, tar sands, extra heavy oil) represent probable figures -- inclusive of future discoveries. As a matter of context, the globe has consumed only one out of a grand total of 12 to 16 trillion barrels underground. [WSJ editorial, March 4th, 2008]

Well, is it 12 trillion on the lower end (Jum'ah) or is it 13 trillion (Saleri)? If you're all going to tell the same story, at least get your story straight. But as SNL's Emily Litella used to say, "never mind."

These statements create a smokescreen that has no bearing on peak oil or rising diesel fuel costs that are forcing long-haul truckers off the road. Let's have the knowledgeable and levelheaded Dr. Sadad al-Husseini, who joined Saudi Aramco in 1972 and held various high-level executive positions before retiring, comment on the pertinence of extraordinary claims about trillions of hydrocarbon barrels.

Dr. Saleri's speculation [in the article quoted above]4 regarding remaining hydrocarbon resources skirts several hard realities. These include the very slow timing and massive cost for converting unconventional resources into economic reserves, the cost of new production capacity and finally the cost of refinery processing to generate suitable transportation fuels. The question is not what volumes of tar sands or coal are sitting out there but rather how fast can they be converted to relevant fuels and at what cost.

We have seen oil prices quadruple over the past five years and expected an avalanche of new exploration discoveries and production capacity. This did not happen. In fact the outlook for the next decade is even less encouraging.

The reasons are simple - the industry has reached a ceiling in its ability to discover new reserves and to generate timely new oil capacity to offset accelerating production declines.

Enough said. It's often the retired experts who aren't afraid to tell you what's going on.

Whither Saudi Oil Production?

In A Paradigm Shift, the case was made that the Saudis, along with the rest of OPEC, "are determined to never see the low prices of the late 1990's ever again" (ASPO-USA, June 20, 2007). The underlying reason was stated by Dr. al-Husseini.

There has been a paradigm shift in the energy world whereby oil producers are no longer inclined to rapidly exhaust their resource for the sake of accelerating the misuse of a precious and finite commodity. This sentiment prevails inside and outside of OPEC countries but has yet to be appreciated among the major energy consuming countries of the world. 

2008 OPEC Start-ups Saudi Arabia's lack of effective spare capacity now clouds the issue—one could still argue that with new light crude coming on-stream from Khursaniyah (0.5 million b/d), Khurais (1.2 million b/d) and other fields by the end of 2009, the Saudis could "open up the taps" and raise oil production another 1 million b/d or more in the near term to 2010. And it's not just Saudi Arabia that is bringing new capacity on-stream within OPEC (graph left, see footnote 3). Another 0.9 million b/d of heavy sour crude is scheduled to come from Manifa sometime in 2011. Processing this low-quality oil will fall on the Saudis, who will consume or export the refined products.

The Saudis could put the Khursaniyah oil on the market as soon as it becomes available. Sometime in the near future the world will finally know how much OPEC really cares. We will know just how hard Mr. al-Naimi and friends are working to "balance" the oil markets. We will know whether the "paradigm shift" should be a working assumption of energy analysts in the OECD countries.

OPEC is in the driver's seat. If recent history is a guide, the only thing Saudi Arabia is balancing is oil flows and cash flows.

Khurais and Manifa are very likely the last large (≅ 1 million b/d) increments that Saudi Arabia will be able to put on-stream—ever.  A "paradigm shift" means the Kingdom is not going to knock itself out raising crude oil production to (best case) levels beyond 10.5 million b/d in the medium term out to 2012 or so, and will likely not be able to do so thereafter—Ghawar will not last forever, despite what Mr. al-Naimi or CERA think. Investment in additional capacity available after 2011 would have to be on the drawing board now, but there is no indication that Saudi Arabia has thought that far ahead.

On a related note, does the EIA know something that we don't about future Saudi crude production? That's doubtful on the face of it, but consider the table below that contrasts the reference case total liquids production (in million b/d) expected from Saudi Arabia in the 2006 and 2007 International Energy Outlooks (IEO).

Report 2010 2015 2020 2025 2030
2006 IEO 14.4 14.8 14.5 15.1 17.1
2007 IEO 8.9 9.4 10.4 12.9 16.4

The values out to 2015 in the 2007 report are far too low. All the values in the 2006 report are far too high. But why this huge across-the-board decrease in the 2007 IEO? If Saudi Arabia is producing only 8.9 million barrels per day in 2010, or only 9.4 million in 2015,  it's all over but the crying, as Hank Williams used to say, for the OECD economies. If anybody can shed light on these crazy numbers, please do so.

The Saudis and OPEC as a whole are likely to wait for the peak and decline of non-OPEC oil production, which is close upon us, before making any large production increases. Once the non-OPEC bloc is exhausted, the most likely scenario has OPEC adding enough oil to the world's supply to maintain the current plateau (≅ 74 million b/d) give or take ½-a-million barrels per day for some number of years as crude oil production outside the cartel declines. (Again, we are ignoring natural gas liquids here.) This is essentially the position of Dr. al-Husseini. This view is also known as "peak oil."

OPEC moves or does not move according to its self-interest. Misguided attempts to bamboozle the public with silly statements about trillions of barrels, or keeping the "well supplied" market "in balance" are ... counterproductive, to say the least. Here's some free advice for Mr. al-Naimi and his like-minded colleagues—actions do speak louder than words, as UBS economist Jan Stuart said. In addition to his wisdom about fooling the people, Abraham Lincoln also had this to say: "The time comes upon every public man when it is best for him to keep his lips closed."

Contact the author at [the original article].

Notes

1. For the sake of argument, this article assumes that Saudi Arabia can do everything they say they can do. So, Ghawar is still going strong, Khurais will supply a dependable 1.2 million barrels per day, etc.

2. Benigni falls into the flunky paid consultant category. Here's a quote from JBC Energy's website

“We’re recipients of a number of JBC Energy publications and have always found them to offer a concise and timely brief on key developments in both crude and product markets"

— Mohammad Alipour-Jeddi , Head of Petroleum Market Analysis Department, OPEC Secretariat

In other words, Benigni makes his living by telling OPEC what it wants to hear. Returning the favor, OPEC's website presents an obsequious video interview with Benigni before the recent meeting.

3. — and therefore Mr. Jum'ah's and Mr. al-Naimi's speculation as well. Dr. al-Husseini's on-the-record remarks were received via an e-mail to ASPO-USA.

IEA OPEC Capacity4. The IEA's February, 2007 Oil Market Report assessed "effective" OPEC spare capacity at 2.4 million b/d. It's not clear where all this oil could come from at this time. The breakdown for all spare capacity is shown in the graph left. The IEA adds the caveat that "these occasional updates of capacity are, at best, a highly imperfect snapshot of current physical supply potential, such is the paucity of consistent, field-specific data." Indeed.

Saudi Arabia's sustainable production is listed as 10.90 million b/d, not the 10.45 calculated in the text. It is possible that some of the difference is made up by declines in Saudi production capacity between now and the end of 2009, but that could only amount to a few hundred thousand barrels at most unless one of the Kingdom's mainstay producers falls off a cliff between now and then. I stand by the calculation made in the text.

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