We won't be fooled again.
—The Who
With no oil price relief in sight, Saudi Arabia has promised to raise its production in July. Initial reports like the New York Times' Plan would lift Saudi output, claimed that the Kingdom would raise supply "by about half-a-million barrels per day [in July] ..., an increase [which] could bring Saudi output to a production level of 10 million barrels a day, which, if sustained, would be the kingdom’s highest ever."
These early reports proved to be overly optimistic. Saudi Oil Minister Ali Al-Naimi clarified the initial rumors in his meeting with Ban Ki-moon (AFP, June 16, 2008).
UN Secretary General Ban Ki-moon, after a weekend visit to Saudi Arabia, said Saudi Oil Minister Ali al-Nuaimi told him Riyadh would raise production by 200,000 barrels a day in July on top of a hike of 300,000 barrels made in June [together = 500,000 b/d]
"They will respond positively whenever there is a request from their customers, so there is no shortage," Ban said. "They don't want to be blamed."
Oil analysts give various numbers for Saudi Arabia's May production level. The EIA comes in at 9.40 million barrels per day (b/d), while Platts says 9.24 million b/d. The graph (left) shows the data series for 2007-2008 (through May) according to the EIA. I prefer OPEC's numbers, even if they are based on "secondary sources" like the others.
OPEC's June Oil Market Report lists the Kingdom's May output at 9.134 million b/d (Table 14). The July increase would put Saudi Arabia's daily production at 9.634 million b/d in July. If Saudi Arabia achieves their stated goal, the total
increase amounts to 1.05 million b/d above their average daily production in
the 3rd quarter of 2007 (8.584 million b/d).
If the EIA's latest official number for world crude + condensate production (74.472 million b/d) in the 1st quarter of 2008 is correct, and Saudi Arabia makes the promised increases, and all else remains the same, then the world will be close to 75 million b/d in July. This tally would shatter the February, 2008 record (74.628 million b/d).
Assuming these production gains come to pass, it follows that reports of a peak in world oil production back in 2005, and the hypothetical demise of Saudi Arabia's ability to raise output, were, like rumors or Mark Twain's death, premature. Now that we've got the dreary numbers out of the way, it's time to look at the Bigger Picture.
OPEC Changes the Rules
Only a single American press report (that I could find) included the most important oil supply news so far this year. The new information comes from a Fox Business reprint of a PR Newswire Europe story on the latest Platts survey published on June 11, 2008.
The survey shows the OPEC-12 exceeding their 29.673 million b/d target by 77,000 b/d. A senior OPEC delegate said Monday that OPEC ceilings and quotas had become largely irrelevant and that OPEC had a "tacit" understanding that those members capable of boosting crude production should supply as much oil as world oil markets needed.
OPEC has suspended, at least temporarily, its function as cartel. The exporting countries are free to pump flat out. If we reach the 75 million barrels per day mark in July, that's likely to be very close to the maximum useful capacity the world has at this time. This is a scary thought because we are only one Gulf of Mexico hurricane away from an economy-wrecking price spike.
The Texas Railroad Commission (TRC) ended prorationing in 1973. Why is this relevant? This quote from A Brief History of the Oil and Gas Practice in Texas explains the connection.
With literally thousands of wells in open flow, the Texas Legislature recognized that the oil patch needed to be regulated to deal with the problems associated with unbridled drilling and production. The Texas Railroad Commission was the best-organized regulatory agency in the state at the time, so responsibility for oil field regulation was passed to the commission. The legendary Ernest Thompson led the commission in the enforcement of correlative rights and the application of field rules to assure orderly production activities.
The Railroad Commission succeeded in curbing the chaos in the East Texas Field. In order to establish a floor on the price of crude oil, the commission introduced a system of prorationing. During that era, Texas was the swing state in oil production in the United States. By limiting the amount of production in Texas, a stable price for oil was established. The Texas Railroad Commission is reputed to be the model on which the OPEC oil cartel was based.
The TRC opened and closed Texas' [oil production] capacity between 1935 and 1973 to damp the boom and bust cycle in oil production and prices (Kaufmann & Cleveland, The Energy Journal, 2001). After U.S. production peaked in 1970, it was no longer necessary to regulate production to maintain a floor price for oil.
Like the Texas Railroad Commisson back in the day, OPEC has functioned in recent years to defend a floor price for oil. By lifting quotas, the cartel has acknowledged that rising prices are out of control and maintaining a floor price for oil is no longer an issue. OPEC now believes that very high prices may severely curtail oil demand eventually, as they did in the 1970s, causing a severe global recession which hurts the longer term outlook for the OPEC countries who want to sell us oil.
OPEC is intervening to drive down the oil price, but the damage has been done, its too late. Allow me to quote from my The Saudis Are Blowing Smoke Again (ASPO-USA, March 12, 2008).
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.
[See my ANWR Is Not the Answer for an explanation of the "irrational price slide below $50/barrel" that occurred between August, 2006 and January, 2007, ASPO-USA, June 4, 2008]
Given their production increases since August, 2007, it is now obvious that Saudi Arabia responded far too late to steeply rising oil prices in the 3rd quarter of that year. Saudi Arabia can no longer put enough oil on the market to lower the oil price much, or slow its rise much, although they might have been able to do so last summer.
Do Refiners Want More Saudi Crude?
Saudi Arabia is offering greater volumes of Arab Light (33.4° API, Sulfur 1.77%) and Arab Extra-light (37.2° API, Sulfur 1.15%) in the June/July production hike. Arab Light crude is called "sour" because of its high sulfur content. Refiners who can process this oil will take it only if Saudi Arabia lowers the asking price. US refiners see extra Saudi oil offer [as] too pricey tells the story (Reuters, June 16, 2008).
"They [the Saudis] can offer all the oil they want. The fact is they want too much for it. There's cheaper oil out there right now," said a trader with an independent U.S. oil refiner.
Saudi official selling prices for the United States currently list Arab Light ARL-OSP-N at a nearly $3 per barrel premium to comparable U.S. domestic crude grades like Mars MRS- -- even before the cost of shipping oil from Saudi Arabia is taken into account.
Traders said they would be willing to increase purchases of Saudi crude, if prices were lowered.
Asian refiners like China's Sinopec, who are operating at a loss, are "choosy" about the the oil they buy in order to keep their costs down (Reuters, June 16, 2008). Many "simple" refiners in Asia would prefer a crude mix that includes more medium or heavy oil, not the pricey Arab light Saudi Arabia is offering. They also want these lower quality grades at a reasonable price.
Although margins for processing the kingdom's heavier grades have plummeted, Aramco has also cut the discounts it offers on these grades to their lowest levels this decade, while keeping prices of its lighter grades at relatively high levels. [emphasis added]
In addition to keeping oil off the market in 2007, the Saudis have raised prices on all of their crude grades beyond what the refining market could bear. The Kingdom obviously cares deeply about the detrimental effects on global economies of the 2008 oil price shock.
A "Summit" on High Oil Prices
Along with the ½-a-million barrel increment the Kingdom the putting on-stream in June and July, the Saudi King has planned a handwringing festival to be held in Jeddah on June 22nd, where Mr. al-Naimi can blame speculators—certainly not himself—for intractable high oil prices.
The key part of the AFP story quoted above is Ban Ki-moon's startlingly honest statement that "[the Saudis] don't want to be blamed" for soaring oil prices. (This just goes to show that the Secretary General is new to oil industry politics, and does not understand the fine art of spin.) Avoiding blame appears to be Saudi Arabia's main reason for holding the summit.
Traders will be watching for the outcome of a June 22 meeting of oil producing and consuming nations in Jeddah, called by the Saudis.
"As we look ahead to this week, all eyes will be on Sundays 'oil price summit' in Jeddah," said analyst and trader Stephen Schork, in his Schork Report. "If the Saudis do not succeed in popping the balloon here, then off to $150 we go."
I've got a tip for you Stephen—it's likely to be "off to $150 we go." How exactly are the Saudis going to pop the balloon? Can they roll back fuel subsidies in growing China? No. Can they put ½-a-million barrels of light sweet crude on the world market? No. Can they buttress the sliding dollar? No.
This is not to say that there won't be a small price slide after the Jeddah summit. I expect that some very important people—everyone who is anyone is attending to show us how much they care—will raise the art of bloviation to new, unprecedented levels. This empty talk may move the markets lower for a few days. One can only hope that the Saudis will lower their prices to accommodate struggling oil refiners. This move, at least, would not be a token gesture.
The truth is that the Saudis know all this—no significant price relief is possible on the supply-side alone. After the Saudi increases, oil production near 75 million b/d will be close to the world's maximum output. It will take months for these Saudi increases to affect the markets, and by the time they do a few hundreds of thousands of barrels per day will amount to a small ripple in a big pond. We are living on a knife's edge.
The duplicity of Saudi Arabian officials in oil-related matters seems endless. It is suspicious that they have not been willing (or able?) to raise production until new Arab Light crude came on-stream from the Khursaniyah field. Saudi made too little investment in new oil fields earlier in this decade, and raising production now comes too late to alleviate the 2007-2008 oil price shock, a behavior pattern we will no doubt see repeated over and over again in coming years. They take no responsibility for their decisions. They insist, contrary to reality, that the oil markets are "in balance" and the price shock is merely a result of speculation.
There is a growing recognition that the oil crisis is not going away anytime soon. You wouldn't know that from listening to the Saudis. Here's my advice: Tune them out. We won't be fooled again.
Contact the author at dave.aspo@gmail.com
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