Another Brief Look at Oil Prices

Saudi Arabia is ramping up oil production in response to appeals from European governments to moderate oil prices. But it may be that no matter what Saudi Arabia does, oil prices will remain well above the level that ordinary market mechanisms of supply and demand would place them. Here is more on the Saudi move, followed by further excerpts from the FT article which reveal a deeper dimension to how oil prices are set.

Speaking to reporters in the Qatari capital Doha, Mr Naimi [the Saudi oil minister] said he wanted to “dispel this pessimism in the market” and the widespread fear that the world could see a repeat of 2008’s oil price increase which was a harbinger of the global recession.

“I think high prices are unjustified today [on] a supply-demand basis,” he said. “We really don’t understand why the prices are behaving the way they are.”

Supply was “much more firm today than in 2008” when crude rose to $147 a barrel, he said, with global supply now exceeding demand by 1m-2m barrels a day.

Saudi Arabia had 2.5m b/d of additional production capacity, which it could bring online if necessary, he said. The kingdom is likely to be producing about 9.9m b/d of oil in April and exporting roughly 7.5m-8m b/d of that, he said.

Asked if it could ease prices by exporting more oil, he said customers were not asking for additional crude. “We are ready and willing to put more oil on the market, but you need a buyer,” he said.
_FT

The statements of the Saudi oil minister are interesting enough, suggesting that the Saudis are still capable of achieving a 25% increase in oil production. Continue reading, to understand why even a 25% boost in Saudi oil production might not knock oil prices off their pedestal:

...the relatively modest move in the oil prices was a sign of some scepticism in the market.

“I don’t think it’s much of change for the market,” said Mike Wittner, head of oil research at Société Générale [investment bank] in New York. “The problem is the more they produce the less spare capacity they have. If they want to try to bring down prices not only do they have to keep on producing at very high levels they need to show the world that they are bringing on extra spare capacity.”
_FT

Can you see the hidden assumptions in Mr. Wittner's comment above? Mr. Wittner thinks that he knows the "true" spare capacity of the Saudi's oil production sector. Speaking as an investment banker and oil speculator, Mr. Wittner is as much as saying that the uber-investors will not allow oil prices to come down until insider (and public) assumptions about spare capacity can be beaten down with a big stick of reality.

This is the self-fulfilling peak oil mentality writ large, currently installed at the highest levels of New York investment banking. No matter how much oil OPEC decides to pump, Mr. Wittner and his cohorts think that they can set the global prices of oil based upon their beliefs in OPEC "spare capacity."

A very interesting prelude to financial disaster, once again, for pension funds, university endowments, and the life savings of countless numbers of retirees and near retirees. But a huge windfall for the top investment bankers and uber-investors.

Up until now, Saudi Arabia has kept silent on the price rally, although it is pumping oil at 30-year highs. But a statement issued by the Saudi cabinet on Monday could signal a more active policy. The cabinet said that it had noted the risk high oil prices posed to economic growth and the kingdom would work individually and with others if necessary to “return oil prices [to] fair levels”.

When asked, however, Mr Naimi declined to specify what specific measures Saudi Arabia could take to moderate prices.

The minister, who was in Doha for a meeting of the Gulf Co-operation Council, acknowledged that he had been approached by a number of ministers from European and developing countries complaining about the effect of high oil prices on their economies.

The weak global economy was tempering demand for oil, he said. Europe’s economy was “iffy” and growth was moderating in Asia. “I don’t think an economy that’s sick today is all of a sudden in the third and fourth quarter going to turn around,” he said.
_FT

Under an oil-pricing regime where top investors can manipulate spot prices via the futures market -- using leased storage facilities as well as a backward-propagating manipulated shortage of market supplies when futures prices are bid up -- it takes far more oil production to overcome artificially inflated prices caused by the intercession of big money investors.

It is rare for investment banks to admit as much, but if you listen closely you can hear their confessions. But the investment banks, in their quasi-Peak Oil fervour, are deluding themselves about "spare capacity." Spare capacity is not worth anything to oil producers until it is needed. In fact, spare capacity can be a huge economic drain, if it is maintained when not needed, particularly in an oil kingdom with a massively corrupt extended royalty, and a need to placate the unruly masses.

Are high oil prices "bad?" No, if high oil prices would only stay high, the proper investment in substitutes and unconventional fuels would be made, and we would enter a new era of liquid fuels supplies (and a higher use of nuclear power) -- at a stable but higher level of fuel prices than we have been used to. But such a transition requires a huge investment, which will not be made until it is clear that it is necessary. Capital intensive industries such as CTL, GTL, KTL, BitTL, BTL, etc. can be easily wiped out by the type of oil price drop that occurred in 2008 / 2009.

That huge price drop of oil in late 2008 and early 2009 was no accident. It was the natural aftermath of the same investment bank policies which are being used currently to artificially boost prices, but which are unsustainable due to significant changes which are beginning to occur on both the supply and demand sides.

Smart investors and investment bankers can ride these artificially generated waves to high profits. But the majority of investors and investment brokers are not that smart, and will lose huge amounts of money once again.

Previously published at Al Fin Energy

Supply and demand are enormously important in setting the price of oil on global markets. But we need to remember that public impressions of supply and demand can be manipulated by powerful players -- both in governments and in finance.