June 06, 2006
Saudi oil production
There's something fishy about the story in Monday's Wall Street Journal.
The Wall St. Journal reported Monday that Saudi Arabian oil minister Ali Naimi acknowledged that Saudi Arabia only produced 9.1 million barrels of crude oil per day in April. That's 400,000 barrels less than they have typically been producing over the last two years, which would be a significantly bigger supply reduction than that resulting from conflict in Nigeria in February and March.
The Journal reported:
In an interview after a meeting here of the Organization of Petroleum Exporting Countries, Ali Naimi said other cartel members are having trouble finding buyers for all the crude they are producing, at a time when global stores are near full and many refiners have closed facilities for routine maintenance. One Saudi official said an estimated three million barrels a day of refining capacity is out of action and unable to process crude, at a time when the world is using some 84 million barrels a day of oil products like gasoline and jet fuel.
"It's not just heavy oil. Even light oil is having problems" finding buyers, Mr. Naimi said, referring to premium grades of crude known as light crude that are highly prized by refiners because they have high gasoline yields.
Asked if the kingdom was easing up on supply because of concern about the buildup of inventories in the U.S. and other importing countries, Mr. Naimi rejected such a motive, replying: "At $70 a barrel?" Mr. Naimi suggested that producers will sell all the oil they can at such high prices.
The implication of Mr. Naimi's remarks is that Saudi Arabia would again open its oil spigots when buyers ask for more oil. For the past two years, the Saudis say, their policy has been to sell as much oil as buyers want, to the limit of the kingdom's production capacity.
Now, what's wrong with this picture? Oil is selling at near-record high prices, and the Saudis are complaining that nobody wants to buy their oil. Wouldn't you think, if that were the problem, they might consider offering to sell at a lower price? Well, the Saudis did just announce that they are indeed cutting the price at which they sell crude to the U.S.-- by 30-35 cents a barrel. However, they are simultaneously raising the price at which they sell crude to Europe by 45-75 cents a barrel. Sorry, but the claim that nobody will buy and the Saudis can't do anything about it just doesn't fly with me.
Nor do I believe that the classic story of a monopolist cutting back production in order to raise the price fits the facts any better. By itself, Saudi Arabia accounts for just a little more than 10% of global production, meaning that, unless you think that the elasticity of oil demand is less than 10%, their revenues fall whenever they unilaterally cut back production. I don't see their recent behavior-- for example, increasing production by 1 mbd in June, 2004, when prices were below $40/barrel-- as consistent with the monopolist story, either. And while I believe the Saudis are quite capable of letting output drift down in order to try to defend a price floor, wherever such a floor might be, it's not $70 a barrel.
If we are to accept Naimi's remarks at face value, the natural interpretation might be that Saudi Arabia is only able to maintain 9.5 mbd production by selling a significant volume of crude whose quality is sufficiently low that many refineries are unable to handle it. From this perspective, the drop in production might be viewed as a caution for those such as Cambridge Energy Research Associates who have been counting on big production increases from Saudi Arabia. Peak Energy lays out the case colorfully:
Cutting production, eh? As planned? Sure. The road past peak oil is coming into focus. Long time readers of this blog are likely aware that Saudi Arabia has a nasty habit of trying to sell their tar, asphalt, old tires, and camel dung on the global oil bourse. When they don't find buyers, they whine to credulous reporters.
Is that the story of what's going on? I don't know. But I must confess that the picture painted by the Wall Street Journal doesn't make a whole lot of sense to me.
Posted by James Hamilton at June 6, 2006 02:24 PMdigg this | reddit
Listed below are links to weblogs that reference Saudi oil production:
» Saudi oil production decreased in April from The Glittering Eye
James Hamilton of Econbrowser comments on a WSJ article which reported that April Saudi oil production was 400,000 barrels below its two-year average volume. James asks: why, when oil is selling at over $70 per barrel, would the Saudis cut producti... [Read More]
Tracked on June 7, 2006 08:43 AM
» Saudi oil production is down -- what does it mean? from BookBlog
Economist James Hamilton and commentors examines the possibilitie. Is it high inventory, like the Saudi's say? Hamilton doesn't buy it.... [Read More]
Tracked on June 11, 2006 07:11 PM
According to Naimi, Saudi Arabia is perfectly happy with $70, and not willing to discount below that to sell oil:
"He also ruled out the idea that Saudi Arabia is discounting its oil to sell more, saying ?we will not leave money on the table? for others, the newspaper said."
This was here: http://www.gulf-times.com/site/topics/article.asp?cu_no=2&item_no=90293&version=1&template_id=48&parent_id=28
Either they've peaked, and they're lying to cover it, or they've gotten greedy, and decided to take their chances on causing recession or promoting alternatives to oil. If the latter, that's pretty shortsighted for them, thought it would be a very good for the development of alternatives.
Posted by: Nick at June 6, 2006 03:15 PM
James, I had the very same response to that article. Couldn't make sense of it.
Thinking hypothetically, I would almost expect SA, at the moment its production goes into decline, to deny that fact. SA's current decline could be (and might not be) evidence of that decline. On my denial hypothesis, the WSJ article gives me no assurance the present decline is not that day.
Posted by: Thomas James at June 6, 2006 03:57 PM
Clearly a message to Iran that an embargo of Iranian oil could be met by Saudi oil.
Bluff? Maybe but at least it signals whose side the Saudi royal family is on.
Posted by: Joseph Somsel at June 6, 2006 04:53 PM
James, you say "unless you think that the elasticity of oil demand is less than 10%, their revenues fall whenever they unilaterally cut back production". Don't you think that if production is cut by 10%, then the price would rise by more than 10%? I would say it would rise by at least 30-40%, personally.
Why haven't they cut production in that case? Good question, but I suspect that they are still conscious of what happened in the 80's, when the price collasped.
At the moment, the best strategy for them is to see how high the price of oil will rise without any intervention in the market.
Posted by: Seer at June 6, 2006 06:22 PM
There really has been no evidence of a shortage of crude oil for some time, yet the price keeps climbing.
Is it possible that a commodity trading cartel has been at work through the futures market, manipulating the price of all commodities higher?
When I see that the wall street banks are making their money through private trading, I experience a strange feeling of dread. My mind rushes back through time as I recall all the schemes, ripoffs, and lawbreaking that these rascals have engineered.
Why not a commodities trading cartel ?
Posted by: si at June 6, 2006 07:08 PM
Seer, to cut world production by 10%, the Saudis would have to cut their own production by 100%, in which case their own revenues would fall to zero. Or, if they cut their own production by 10%, world production would fall by 1%, and, with your presumed elasticity, world prices would rise by 3-4%. Selling 10% less product at a 3-4% higher price doesn't pay. You need a much lower elasticity than you're assuming to make this work out to their advantage.
Posted by: JDH at June 6, 2006 07:21 PM
I read the same article and was scratching my head. My reaction was that the reporter must have been nuts to write such a thing without some acknowledgement to the readers who would otherwise be scratching their heads.
Posted by: touche at June 6, 2006 07:39 PM
James, I misread what you had originally said, I thought you meant that a 10% drop in production wouldn't result in prices rising by more than 10%.
Actually, I do think that the price elasticity is less than 10%, so far the oil price has risen 300% in a few years without much impact on demand.
Posted by: Seer at June 6, 2006 07:42 PM
Joseph, yours is the only explanation that rings a bell with me.
As to price elasticity, last summer some group called Securing America's Energy Future (SAFE) composed of former elected government officials and CIA and industry types (who else would come up with "SAFE") simulated an oil crisis whereby 4% of world production (coincidentally, the Iran's current production) was removed from the market. They projected a 177% increase in the price of oil, Bill Gates would have to sell a gold toilet, DJIA would lose 24% overnight, etc. Search oil shockwave in google.
Posted by: Thomas James at June 6, 2006 09:36 PM
Naimi frequently speaks in economic gibberish. Not so long ago he was claiming that new refineries (which represent new demand) that will come on line soon will reduce the price of oil.
An increasae in demand resulting in a decrease in price? Really?
Either he doesn't have a clue, or else he is cunningly exposing the collective economic dimwittitude of the business press by causing them to unblinkingly and unquestioningly recite the aforementioned gibberish.
My money is on the former, although the latter is much more amusing to contemplate.
Posted by: bartman at June 6, 2006 10:59 PM
Definitely a strange article written by a moderately clueless reporter . . . . . still:
1. Crude oil by itself isn't very useful. With the U.S. short refining capacity and Europe long refining capacity, at the margin it at least makes sense for the Saudi's to be cutting price to the U.S. and raising the price to the Europeans.
2. Unlike many/most major producers, the Saudi's have relatively little in-country above ground storage, feeling (rightly, I think) that crude oil in tanks is a tempting target for terrorists, rogue states and the like. When they overproduce, they have no place to put the crude.
3. By all accounts, Iran has produced an extra 20 mbls of oil and has sent it on tankers towards Asia at a very slow rate.
4. I'm suspecting that a bit of a distribution bottleneck has developed - with more tankers tied up hauling Iranian overproduction and US refineries running flat out and US inventories of crude at hight levels and the US still importing large quantities of refined products from overseas, the US doesn't need more crude oil . . . . . what the US needs is a lot more refined products, and of course the Saudi's and other Gulf states are very busy building additional refining capacity which isn't on line yet.
5. In these unusual and non-permanent conditions, the market may not be too responsive to small Saudi price cuts - to make tanker re-routing profitable, they might have to cut the price of their oil by a large amount per barrel.
6. Last, it is something of a mystery why the price of oil remains over $70 given high and rising global inventories. I would add that with the very high prices and uncertainty around the globe rising (consider: Ecuador, Nigeria, Venezuela and Iran are all risky producers these days), it makes economic sense for global crude inventories to be very high - the part of the "speculators and uncertainty have put the price up $20" argument of 2004 I never understood was that inventories then were relatively low - it's hard for speculators and uncertainty to put the price up if they're not holding physical inventory. Well, now they are as they should be. That said, inventories have now risen close to the point where it's darn expensive to store the stuff and interest rates are backing up too.
The price of crude should come under pressure, I think, but the article wasn't quite as weird as it appears.
Posted by: Anarchus at June 7, 2006 05:19 AM
Nick: "...or they've gotten greedy, and decided to take their chances on causing recession or promoting alternatives to oil." I think JDH's elasticity argument forecloses that possibility. Assuming that they haven't peaked, and that they believe anything remotely like the $50 fundamental that they claim (just below the quote in the article you cited), the rationally greedy thing to do (even if they completely ignore the recession possibility and long-run non-oil competition) is to discount, so they can sell as much as possible. Better to sell it now for $65 than leave it in the ground and wait for the price to go down to $55.
The quote really puzzles me. How does discounting constitute leaving "money on the table"? If they're serious about the $50 fundamental, then they're leaving money on the table by not discounting (and consequently not selling).
I didn't like Joseph's Iran theory at first, but the more I think about it, the more nothing else makes sense (except, maybe, that they are peaking and that the $50 figure is just a huge lie to help cover that up...or, now that I just read it, Anarchus' idea that a distribution bottleneck has temporarily brought the elasticity down).
Posted by: knzn at June 7, 2006 05:45 AM
Oddly enough, I think the Saudi story is true. Global refining capacity can barely keep up with what can be pumped out of the ground--that's been obvious for about three years.
Posted by: Matt at June 7, 2006 07:16 AM
[i]There really has been no evidence of a shortage of crude oil for some time, yet the price keeps climbing.[/i]
An economist might say there have been no signs of shortage [i]because[/i] price keeps climbing.
In any case, it seems highly dubious to assume that:
a) what the Saudi's say
b) what the Saudis believe, and
c) what the Saudis should believe if they were a rational value-optimizing producer (my experience is that National oil companies, being primarily political entities facing political constraints, don't think this way)
are all the same thing at any given time.
More than enough room here to explain all sorts of confusion about their comments.
That said, I'll bet a decent game theoretic argument can be made that the best of all worlds for them is to convince people there is a reasonable possibility they can't increase production while still leaving some doubt and confusion.
Posted by: dis at June 7, 2006 08:26 AM
Does anybody know more details about the refinery capacities here in the US and around the globe? I would not mind to know some more facts about that part of the argument.
Just looked SAFE up...amazing. Thanks for the hint and the link. May be after all not such a big surprise that the 4% is what Iran produces...makes me shiver to think all they already rehearsed that scenario...
Posted by: alex at June 7, 2006 08:53 AM
Well, something's not right with the Saudi's. Historically they have said:
1) It is our policy to be the swing producer, and keep prices where they should be.
Now they're saying:
2) We believe current prices are too high, both for the fundamentals of supply and demand, and for the long-term health of the oil market (given the possibility of recession or promotion of alternatives to oil), and
3) We have extra oil, and we could sell more by discounting.
If #1 were still true they should be discounting, even if it costs them a bit of revenue.
Now they're saying that they aren't willing to discount. That's a big policy change. Doesn't sound so consumer/U.S friendly to me. Also doesn't sound very foresighted.
If #1 were still true, then Anarchus's information about distribution would be irrelevant: they should be playing the role of the US Fed, and assuring the world that they will police prices. If they had to sell a few million barrels at $50 a barrel to attract the needed tankers, they should do so.
It seems to me that they either don't have the oil to sell (which seems a bit unlikely), or they've gotten greedy.
It seems likely to me that they don't believe #2, either. They're just saying it to pretend that #1 is still true: "gosh, we'd like to lower prices like we traditionally did as swing producer, but prices should be lower, and they aren't. Golly, we don't know why - must be those darn hedge funds. This market is just darn irrational, and doesn't respond to our offers to sell. Gee whiz, they're's just nothing we can do, so don't blame us for high oil prices."
The bottom line is that they're saying that they're not willing to discount, when they should be. Big change.
Posted by: Nick at June 7, 2006 09:01 AM
Alot more oil trades each day in the futures market than is actually consumed; i.e. there is a great deal of buying and selling of contracts and only a small part of it represents atually delivery of oil. I think a good part ($20/barrel?) of the current price is pure speculation.
Posted by: Barnabus at June 7, 2006 09:34 AM
Barnabus, speculation about what? That future prices are going up? Hey, that's good speculation.
Posted by: Thomas James at June 7, 2006 10:10 AM
Further on Saudi production, ASPO reports that an Aramco representative reported that Saudi Aramco's mature crude oil fields are expected to decline at a gross average rate of 8%/year without additional maintenance and drilling. Sayeth Mr. Campbell: "While the country claims to be able to increase production to 12 Mb/d, it is here thought more likely that it will be hard pressed to hold present production, which is here modelled to remain about flat for another twenty years before decline sets in at about 3% a year. It may not be able even to do that." There you have it. The latest guess.
Posted by: Thomas James at June 7, 2006 12:36 PM
The comments by the Saudi minister make sense if you include the point made that the Saudis are looking for diferential in relation to closing future prices. Lets call the differential $1.00 barrel premium above the closing futures price. If they can not receive this price then production is reduced. The most normal course of events in a market where there is a good deal of speculative demand like the current one for crude oil is first for all available storage to fill and futures markets exhibit full carrying charges for the cost of storage on forward months. Next the diferential or basis starts to decline when there no place to put the excess production. However if key producers choose to cut production rather reduce their differential relative to futures then the day of a sharp decine in price is delayed. This is one way as the minister said of not leaving any money on the table by just following the futures market.
Posted by: timberwolf at June 7, 2006 01:38 PM
It is certainly possible that the Saudis are exaggerating their reserves. But I seriously doubt they would say they have extra crude to sell if they don't. Any crude trader in the world can pick up the phone and confirm or deny that story by offering to buy some. If the Saudis quote some unreasonable terms - like $80/bbl, then it very quickly becomes public knowledge. I just don't think it is plausible that they are lying about this for these reasons.
Posted by: Robert Rapier at June 7, 2006 09:59 PM
That said, I'll bet a decent game theoretic argument can be made that the best of all worlds for them is to convince people there is a reasonable possibility they can't increase production while still leaving some doubt and confusion.
This is what I call my theory of optimal mendacity. If Saudi Arabia has plenty of oil, more than a consensus view would think, they have an excellent reason to lie about it in order to keep up the price. If Saudi Arabia has less oil than we think, they have an incentive to lie about it (so as not to trigger a rush to conservation) but not too much, of course. Whatever the real situation, lying is a better option than telling the truth.
Taking into account the high demand for oil (China factor) and general climate of dread, the market at the moment is just looking for an excuse to spike - so they don't need to lie very much in order to maintain optimal mendacity. That would seem to be what they are doing - just lying slightly to the upside of the spectrum.
Posted by: Alex at June 8, 2006 02:01 AM
Greenspan on oil:
"For those who were listening, Greenspan had few soothing words. The balance of world oil supply and demand "has become so precarious that even small acts of sabotage or local insurrection have a significant impact on oil prices," he told the senators. And, he added, while the U.S. economy "has been able to absorb the huge implicit tax of rising oil prices so far . . . recent data indicate we may finally be experiencing some impact."
The Saudi article is simply out to lunch. Pure and simple.
To put the real truth forward risks a real rise in oil prices. We are approaching peak oil; refinery capacity is tight. Demand is increasing.
Greenspan talking before a practically empty house is the safest place to mention this very unpleasant truth.
Posted by: Stormy at June 8, 2006 03:19 PM
The current net effect of Large commercials and Large speculators is a net short position so it should serve to depress the oil price not prop it up.
It is surprising that people still blame speculators when reality is something else.
Read the headlines about energy on bloomberg. They border on absurd.
Read the commentary. It is worse. "gasoline demand is up only 0.7% year over year". Oh yeah Einstein lookk at total product demand up 4.8%. That is after shifting to natural gas because it is cheaper.
Posted by: Saif at June 10, 2006 07:00 PM
It seems Saudi production is peaking, as has been stated on April 11 2006 by Saudi Aramco. This article generated very little interest but it significance could prove to be crucial.
Posted by: Hans Brugman at June 13, 2006 03:32 AM
James,you are correct in being skeptical....another thing to be skeptical of is "the price of oil is up because of refining problems/bottelnecks"....which is the same as saying "the price of wheat is up because of bakery problems/bottlenecks"
Posted by: dave at June 13, 2006 07:56 AM
It is simple enough: The sudden spike in early 2003 and the little sub-plateau of 2005 atop the main plateau of 2004-6, as shown, are all at the 9.6 mbpd level, and this means that Saudi production just cannot cross that particular threshold. This is a sign of optimum output and output limitation levels, and what better depiction can there be of this than graphic! The sudden spike 3 years ago coincided with the start of the Iraq war and the Chinese and Indian economies coming into their own. The plateau of 2004-6 showed the peak pumping levels the Saudi oil industry was capable of at this hectic time (9.5 mbpd), with one final push that enabled just 100,000 barrels extra over 2005, for various reasons like maintaining a stable oil price and the hurricane Katrina.... Then come 2006 and we see the inevitable decline begin all too clearly, while demand is on the rise. 2004-6 was definitely the worldwide Period of the Peak (Plateau), and as far as I'm concerned 2006 is thus the first Post-Peak year. This graph illustrates that very clearly.
Posted by: Arif H. Akhundzada at June 15, 2006 06:00 PM
Sounds like an excellent analysis of the situation.
Posted by: Steve Snyder at June 24, 2006 05:44 PM
Look ,fools, if you ever bothered to research changes in price formation you would not be so (over)determined by supply/demand relations and would grasp at least something about how the price(s) of crude have become financialized!
But noo, better to continue on with what are false assumptions -- same 'ol neoclassic bs in action
Posted by: juan at August 5, 2006 03:23 PM