Too often people try to interpret comments or actions from Saudi Arabia, without attempting to understand the issues from their perspective. I think it is a useful exercise to ask whether their specific actions or comments make sense; 1). From the Saudi perspective, and 2). In the context of the market.
For example, when Saudi said that they were having trouble finding buyers for their crude in the spring of 2006, I don’t simply look at the price and dismiss those comments as lies (as many did). I do a bit of digging. And when I uncovered that OECD crude inventories were high and rising at the time, that Iran said essentially the same thing at the same time, that any of Saudi’s customers could just pick up the phone and call then to confirm – yet nobody came out and suggested that they didn’t really have it – then I concluded that those comments were consistent with the available evidence available. (The final point is significant, because as soon as Saudi started putting Asian refiners on allocation later in the year, a number of Asian refiners leaked that news to the press. Certainly the same would have been true had Saudi falsely announced that they had crude but no buyers).
I have debated this issue multiple times, for example here, and I don’t intend to do so again. But the issue still comes up on a regular basis – and often in a derisive manner – and I wanted to share the thought process I went through. (Of course I would add that when they started increasing prices later in 2006, the argument that there were no buyers was obviously no longer true).
Along the same theme, I frequently consider how I would manage Saudi’s reserves if I was in the position to do so. I think those who feel Saudi should be pumping all the oil they can at these prices haven’t really thought it through from their perspective. So, let’s go through that thought experiment, keeping in mind:
1). The primary allegiance is to Saudi Arabia.
2). This depleting resource must serve future generations.
3). OPEC must be on board with the decisions.
My primary objective would be to extract the most money I could from the rest of the world, but not so much as to cause a worldwide recession that would destroy demand. So, how would I achieve this? Very cautiously. Each time oil prices moved into new territory, I would seek to stabilize the price for a while so I could judge the impact on the world economy. As long as the world economy could cope with the price, I would continue to let it creep higher.
How would I push the price go higher? By restricting supply. How would I soothe the markets? By adding incremental supply back a little at a time. What would I do if prices spiked high in a short span of time? Well, I would first wait a bit to make sure the price rise was sustained. After all, I can’t react every week to price fluctuations. But if the price rise was sustained – and I had the oil available – I would go ahead and increase production to stop the rise. That would give me a chance to evaluate how the world economy had adjusted to the new price levels.
This is what I would do if I did have the oil. I would have no incentive for ramping production back up quickly and risking a price crash – regardless of the price of oil. My moves would be deliberate and conservative. After all, Saudi is reaping an incredible windfall at current oil prices. But greed is human nature. If I determined that the world can live with $90 oil, I would want to see if the world could stand oil at $120. Wash, rinse, repeat, until I saw the world economy dramatically slowing. That’s where I would back off price by trickling in production.
On the other hand, if I was really out of capacity, and my reserves were truly overstated, my behavior would be somewhat different. First, I still don’t want to panic the world and cause a super-price spike that quickly causes a recession. So, I would engage in a series of delaying tactics. I would want to maintain the status quo as long as possible, because when the truth comes out I will enjoy a brief windfall as prices spike much higher, likely followed by a worldwide recession and potentially the end of the world as we know it. To stall, I would point to other factors as the reason for the price rise (fear, speculation, the weather, etc.) I might make token increases in production in an attempt to placate the market, but I would mostly look for other scapegoats.
But the jig would be up when world oil inventories started getting pulled down into uncomfortably-low territory, prices were spiking, and I didn’t respond with more supply. At that point, the cat is out of the bag. Well, I suppose I might have one more card to play, and that is OPEC. I could let news leak out that Saudi wanted a production increase, but the rest of OPEC outvoted us. After all, Venezuela, Nigeria, and Iran are all on record as saying $100 oil is where they like it. So that could then be my final stalling tactic, but stalling tactics that don’t involve putting more oil on the market won’t stop the steady price climb.
So, how then do I read Saudi’s actions? First, I recognize that they won’t necessarily behave as I would. But that’s all I have to go with. In that case, there are elements of both possibilities in their actions. Saudi was reportedly the driving force behind the recently announced 500,000 bpd increase. The increase wasn’t huge, but this is exactly how I would play it even if I had the reserves and spare capacity, but was trying to avoid crashing prices. (Although if I didn’t have spare capacity, I would not have offered to shoulder the bulk of the increase as they reportedly did).
But it also looks like they are engaging in a series of delaying tactics. They could act on prices at this weekend’s meeting, but they have already announced that they won’t discuss it until their December meeting. They blame speculators, and say there is nothing they can do about prices because the rise isn’t being driven by fundamentals. First, speculators are a part of the reason for the price rise. They aren’t the whole reason, but those who say they have nothing to do with it are also wrong. But Saudi can’t be serious when they say they can’t do anything about price spikes due to speculation. If they wanted to crush the speculation, it would be easy. If you have 2 million barrels of spare capacity, show the world. Push production up to 10 million bpd for a while. The price would come crashing down, which would be contrary in the short term to maximizing your revenues, but you would have eliminated the speculation. After all, there would be no more doubt: You can do what you say you can do.
We are certainly very close, IMO, to the truth. While IEA demand projections have been revised downward due to the high prices, they still show a need for more crude than is currently being pumped. Looking forward, inventories are still projected to fall, albeit not as fast as previously projected. But I will note that projections all year long have been for OECD inventories to crash in the near future, and those projections have been mostly incorrect. Inventories have been pulled down recently, but the dire scenarios we heard about all year long were projections for where inventories would be in the future. (See the EIA’s projection for OECD stocks on Page 17 here, and then look at the IEA’s Oil Market Report to see that what transpired was contrary to those EIA projections).
Those are my thoughts on Saudi production management, and I try to interpret their actions from that perspective. So, how would you manage Saudi production; 1). If you were sitting on top of a 100-year crude reserve; and 2). If you were truly tapped out?
12 thoughts on “How Would You Manage Saudi’s Reserves?”
I would produce no more than I needed to develop a healthy economy and balanced. I would not encourage short-term or excess consumption.
So actually, at high prices (with my increased revenues) might back off.
(I would be an austere King.)
Your analysis, Sir, relates to an universe without competition. Oil has competition and money is pouring to prepare alternatives. What I would do is to fake peak oil and let prices rise, and then, out of the blue, increase production to crash prices and budding competitors.
On the other hand, Sir, we may be exaggerating the management skills of the Saudi clan. In many historical analisys it is revealed that the diabolic intelligence that contemporaries attributed to their enemies, was in fact, how to say it politely, incompetence hidden by secrecy. In no area of Saudi life can I find an example of intelligent management like you suppose does exist in your field of expertise – oil.
FWIW: Saudi Prince To Purchase World’s Largest Private Jet
What if they can’t fake peak oil because it is true?
Quite simply, I would husband my resources no matter how much I had left. That would be best for me and for the rest of the world. I don’t think the Saudis are stupid, but are they any smarter than Americans? The US has largely squandered its wealth and destroyed its environment, so I don’t expect much more of anyone else.
i don’t know what they would do. but should i care? i believe that whether they can or can’t in the short run, manipulate, the long run results will remain the same. so long as the projected demand/consumption and worldwide growth stays status quo, their ability to manipulate is limited.
their best case reserve surplus can’t meet consumption expectation. without a significant recession, the “game” remains unchanged. we may be in several O/T periods,however.
given the cycle from find to ship[6+ yrs?] if any large find is made, the mgt manipulation period would seem limited.
what might i be missing?
KSA has said many times it has huge reserves (not even counting heavy oil) and it will go to 12 mbd productive capacity in a few years. I tend to believe that. They do have enormous investments in the USA, and so may have conflicting interests themselves.
Kuwait and Dubai are also boosting output capability.
These things take time.
There is no doubt KSA is a backward backwater, where women are subjected to 200 lashes for getting raped, if they happened to be riding in a car with a man not their relative. You read that right.
KSA is routinely listed as one of the worst despotic governments anywhere. Why Bush is so tight with the KSA is a wonder.
How will they make decisions? Who knows? There could be rancid internal politics at work.
The bif answer is that they are not reliable. The sooner we do not need their oil the better.
Good analysis. A couple of points to add are:
1) Have you run across Harold Hotelling? A Stanford Professor, he wrote back in the 1930s the idea that the optimal production rate was that where the price of oil rises equal to the interest rate, so a producer is indifferent whether to pump and bank the proceeds or leave the oil in the ground for next year.
2) Matthew Simmons suggests that overproduction is possible for short periods but damages longer-term yield (Twilight in the Desert, pp. 63-65). Short-term additional Saudi production could be a way to say, “see, we have the additional capacity”, but then be cut back under the guise of “we decided not to pump it”.
3) Per J’s universe without competition, that is likely the case. What other producer has extra capacity, and what near-term alternative has much capacity at all?
My primary objective would be to maximize ultimately recovered reserves, and, consistent with that, my secondary objective would be to maximize money obtained from the rest of the world.
As a side note, if I were in a position of influence in any Gulf state, I’d be putting everything I could (both financial and human capital) into developing solar in every way possible: electricity (PV/CSP), solar thermal, desalination, everything. Because no matter when the oil runs short, there will still be huge amounts of open space getting huge amounts of insolation. And I can think of no better way to use the oil (and its attendant revenue) than getting ready for the post-oil world.
Robert: If I cannot fake peak oil because it is true, I would produce just enough to delay the appearance of competition. Darrel: Competition is always hiding on the margins, we dont know what it is. A workable battery could kill much of oil demand. Odograph: thanks for illustrating my appraisal of Saudi managers. But most of the current oil windfall is being spent in Pharaonic urban development projects.
So, how would you manage Saudi production; 1). If you were sitting on top of a 100-year crude reserve; and 2). If you were truly tapped out?
Clearly the truth is somewhere between these two options, but probably a lot closer to 2) than 1). I suspect the Saudis realise the writing is on the wall and are managing production to extract the maximum amount of dollars out of their remaining reserves for the next 10-20 years.
IMO Robert’s analysis is pretty close to the mark. The real test will come when there’s an oil-price induced recession. We will find out then if the Saudis really have the capability to raise production and lower prices.
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