SLICKLY SAUDIS, STICKY PRICES

The following table summarizes the supply-demand model for crude oil since 2005, showing the yearly averages for the last 6 and 3 years.  The essential findings from the exercise are that:

  1. North America, Europe and Pacific countries are seeing their combined crude oil demand decline roughly 0.5 mmbbl/d per year.
  2. “Emerging” countries are increasing crude oil consumption at the rate of 1.5 mmbbl/d per year.
  3. As a result, total demand grows roughly by 1 mmbbl/d per year on average.
  4. Non-Opec production has been rising some 0.8 mmbbl/d per year on average, supplying 80% of total demand growth.
  5. Opec supply has been minimal, even before taking into account the recent MENA unrests, and insufficient to balance the markets, especially since 2009.

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As a result, crude oil prices have been rising in a pretty steady fashion if one smooths out for the 2008-09 extreme fluctuations and the spike that followed the Libyan unrest that began February 21.

Non-OPEC has demonstrated an impressive production performance over the past couple of years given the significant depletion to overcome. Buoyant oil prices have provided the ammunition imagenecessary to spur global exploration, while the development of unconventional resources, including the Bakken shale in North Dakota and Eagle Ford shale in Texas, has revived on-shore prospects. In fact, US crude oil production has increased 0.5 mmbbl/d (11%) in the last 2 years after steady declines since 1986. There is, indeed, a decent chance that Non-Opec supply could grow somewhat faster than 0.8 mmbbl/d in future years.

Opec, far from playing its assumed role of swing producer, is in fact smartly controlling its production in order to gradually push prices upward.

In the aftermath of the MENA uprisings, OPEC has avoided an emergency meeting, electing instead to adhere to its scheduled meeting on June 8 in Vienna. Saudi Arabia’s Oil Minister, Ali al-Naimi, has attempted to calm oil markets by offering reassurances that the Kingdom is well endowed from a capacity and reserve standpoint—and ready and “willing” to address physical shortages.

Shortly after the civil war in Libya erupted on February 21st and halted much of the country’s 1.3 million barrels a day of oil production, Saudi Arabia promised to quickly fill the gap. On February 28 Saudi officials said they would raise production to 9 million barrels a day–swift action that reassured oil consumers that unrest in the region wouldn’t result in supply shortages.

The reality is that Saudi Arabia cut production in March, claiming reduced demand, right after Libya and Yemen stopped producing, taking 1.4 mmbbl/d off the market.

Our production in February was 9.125 million barrels per day (bpd), in March it was 8.292 million bpd. In April we don’t know yet, probably a little higher than March. (Ali al-Naimi, Saudi Arabia’s oil minister, told Reuters  April 17)

The reality is that Opec, particularly Saudi Arabia, has used China’s and other emerging countries’ growing appetite to let the world price rise, simply maintaining production steady around 9 mmbbl/d while world demand grew 14% or 11 mmbbl/d since 2001.

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(Chart from RBC Capital Markets)

In the early 2000s, one could have explained Opec’s and Saudi Arabia’s reluctance to meaningfully boost production by their relatively low official spare capacity (keep in mind that Saudi Arabia has 265 billions barrels of proved reserves). This is no longer the case since 2009.

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The Saudis have always claimed to be the swing producers, protecting consumers from supply shocks and sharply higher prices. Yet, oil prices have appreciated fourfold in the last 10 years.

Analysts and the media are starting to realize something is amiss here. From the (WSJ):

So did the Saudis really pump more oil to make up for the loss of Libyan crude?

Analysts at Goldman Sachs and Barclays Capital say no. “They were producing at nine million barrels a day since November in response to the strength of demand,” said Barclays analyst Amrita Sen.

Goldman analysts said in a note: “While Saudi Arabia announced a boost to production to offset the [Libya] shortfalls, the production increase had likely already happened some time ago.” (…)

If you take these (Saudis) statements at face value, major inconsistencies remain. By crunching the numbers above, Saudi Arabia’s March production should have averaged around 9.4 million barrels a day. But Mr. Al-Naimi said it produced 8.3 million barrels a day in March. The only way you can get to Mr. Al-Naimi’s figure is to assume that in the second half of March the Saudis slashed production to just 7.0 million barrels a day. This is a level not seen since the 1990s and it is scarcely credible that Saudi Arabia would cut so deep at a time when oil demand is still growing and prices have been hitting two-and-a-half year highs. Independent estimates from the International Energy Agency and OPEC put Saudi Arabia’s production at 8.9 million barrels a day in March.

And from the FT:

Opec oil cartel is producing at its lowest level since two years ago, when the global economy was still emerging from its worst economic recession since the 1930s.

The International Energy Agency, the western countries’ oil watchdog, estimated Saudi Arabia oil production at 8.9m b/d in March. Now, the Paris-based agency will have to revise its figures down and show that Riyadh, at least in March, did not replace the loss of Libyan oil. Opec total production could have dropped then to just 28.6m b/d, a huge decline from more than 30.1m b/d in January and the lowest level since April 2009. The IEA estimates that Opec needed to supply an average of 29.5m b/d during the first quarter to balance the market and avoid a drop in inventories. (…)

The Kingdom has always spoken as a friend of consuming nations:

“We are not comfortable with oil prices where they are today,” al-Falih said. “We’re concerned about the impact it could have on the global economic growth.”

Saudi Oil Minister Ali al-Naimi “has made it clear that the kingdom will continue (sic) to act in support of oil market stability,” al-Falih said. The minister on April 19 described the recent gains in prices as “unjustified.”

The only problem is how to define stability. What and whose stability?

There is little coincidence in the fact that Saudi Arabia has needed ever increasing oil revenues to balance its budgets and rising world oil prices. Ten years ago, Saudi Arabia was able to balance its budget with oil prices in the low $20s. The Institute of International Finance now estimates that the Kingdom required $68 in 2010 and $88 this year and will need $110 in 2015.

Higher oil revenue will be needed to pay for the packages of social spending totaling $129bn (50% of SA’s oil revenues in 2010) aimed at averting the spread of dissent that toppled several MENA leaders. Other Opec nations have announced increased spending to appease their people and avert even more significant geopolitical changes in the region.

These countries’ population have little means to foot these bills but as long as the world will be accepting higher oil prices, Opec leaders will keep tapping the international subsidy well! After all, it is for their own good, isn’t it? Supply and price stability has a price after all.

Another well Opec producers are tapping is their own. By heavily subsidizing domestic petroleum prices, a growing proportion of their production is needed to satisfy runaway growth in domestic oil demand (see my table above). This is reducing exportable production and contributing to higher prices.

But who’s to complain about these subsidies? Certainly not Americans, Chinese and Indians, which are not only among the biggest oil consumers, but also among the countries with the lowest taxes on gasoline. China’s and India’s low per capita income may justify low gas prices but the US government is clearly fiscally and environmentally irresponsible.

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(Chart from RBC Capital Markets)

Unless the largest consuming nations get serious about reducing consumption (don’t hold your breath!), oil prices will keep rising since:

  • Opec, particularly the Saudis, are not the friends they claim they are. They are not willing/capable to raise production and are totally content to let prices rise in a relatively orderly fashion.
  • Consumption grows 1 mmbbl/d plus each year on average but Non-Opec producers are scrambling to raise production by 0.8 mmbbl/d.
  • Geopolitical risks will remain a major overhang and there is no real buffer.
  • Russia accounts for about 11.5% of Non-Opec supply (25% of its incremental supply since 2008) but is having increasing trouble delivering incremental barrels owing to geology but also to energy policy, pipeline constraints and politics. Russian production is forecast to decline starting in 2012.

Too bad for Ben Bernanke. Barring a major economic setback,  this one does not look transitory.

 
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