It never ceases to amaze me just how quickly people can develop amnesia. Take the case with oil production in Saudi Arabia. A year ago, their production was declining. A number of people argued that this was because they were experiencing an irreversible, involuntary, geological decline. My position was always that the evidence looked to me like they were managing their production to keep oil prices high, and that they had spare production.
By March of 2007, their production had stopped declining, which was supportive of my theory. After all, if their decline was involuntary, how can we explain that production suddenly flat-lined, and remained steady for the next 10 months? Furthermore, in March I said that I expected Saudi to raise their production later in the year when demand picked up.
What happened? Saudi did start to increase production in the fall, and those arguing for the geological decline suddenly developed amnesia. “Well, we always knew that they had some spare capacity.” But my favorite was “We knew Khursaniyah was going to come online in the 4th quarter, and that’s where this production is coming from.” I challenged several people on this claim, asking for evidence that the production increase came from the Khursaniyah startup. The best anyone could come up with was that the new production was coming from Khursaniyah, because where else would it come from (since Saudi had no spare capacity)? This is of course just circular logic, and a prime example of failing to think critically and skeptically about the situation.
Well, today Saudi answered the question on Khursaniyah:
Saudi Aramco Delays Production Start From Khursaniyah
Jan. 3 (Bloomberg) — Saudi Aramco, the world’s largest state- owned oil company, delayed the start of production from its 500,000 barrel-a-day Khursaniyah oil-field project and said it will meet market demand with existing spare capacity.
“Saudi Aramco stands ready to meet market demands with ample spare capacity, including 1 million barrels of Arab Light crude,” the company said in an e-mailed statement today.
Khursaniyah will commence “upon completion of commissioning activities,” Saudi Aramco said. The company didn’t say when production would start, after it missed a December deadline.
But amnesia comes in very handy, and I doubt too many will attach much significance to this, conveniently forgetting that this was their explanation for the 4th quarter Saudi production boost.
I do maintain that extra crude capacity is in very short supply, and will remain so as far out as I can see. While I don’t think oil production has quite peaked, I think increasing demand from India and China will eat up any new production that comes online. Thus, I think the evidence continues to favor Peak Lite – where new production can’t come online fast enough to meet demand.
I don’t get it. Shouldn’t this news alone send speculators running? There is potentially over a million barrels of spare capacity that COULD come on line if the Saudis chose to do so.
The last time we had a price crash (late 1990’s) there was just 2 million barrels of spare capacity in a 75 million barrel per day market.
The Saudis could decide that current prices are destroying too much demand and leading to alternatives. Including this: Athabasca Oil Sands . That is a potential of 4 million barrels per day for 400 years. Once the capital is spent the marginal operating costs insure production -permanently.
Agree with the King. Speculators should pay attention. On the other hand, I think the Saudis are becoming comfortable with $100 oil. What level will they test next?
There has been surplus capacity in Saudi Arabia since the late 1970s — rising to about 7 Million BPD in the mid 1980s. Saudi has been playing the market-balancing role that the Texas Rail Road Commission played while the US was the world’s largest oil producer. And thank goodness for the Saudis!
And yes, the optimum price profile from Saudi’s perspective is generally high, with occasional precipitous drops to discourage competition.
The other side is that Khursaniyah is hardly a new discovery. Oil has been produced in that field for at least 30 years. The planned big expansion in capacity is just another sign that the easy oil is behind us.
The demand side of the equation may be more complex than we sometimes think. We talk about high prices leading to “demand destruction” — but there are many gradations there.
Demand deferral, such as when we turn down our thermostat because the price of gas is high — quickly & easily reversed when the price drops again.
Demand transfer, such as when petrochemical plants in the US and Europe shut down and production moves closer to plentiful gas supplies in the Middle East. Demand for fuel has been permanently destroyed in the EU or US, but global demand has not been much affected.
Demand destruction, when plants are shut down and not replaced. When the price drops, the demand will not pick back up again quickly.
Since more of the incremental demand is now coming from marginal users in China & India, I wonder if any drop in demand due to high prices will be more quickly reversible than was the case after the Second Oil Shock in 1979. This could put a floor under price drops.
And yes, the optimum price profile from Saudi’s perspective is generally high, with occasional precipitous drops to discourage competition.
Please list the “occasional precipitous drops to discourage competition” since I can’t seem to recall any.
Why bother with that? Why not live with alternatives (which will be small potatoes for the foreseeanle future) and high profits? Everybody wins.
Of course, at present alternatives are more of a joke, than anything else. Note how the ethanol glut is closing ethanol plants and taking projects off the drawing board – all while crude marches on to infinity (or at least $100/bbl) and beyond…
The preciptious drops would be in the 1998 when crude dropped to below $10 /bbl and then again around 1998 when it dropped again and averaged $15-20 for most of the year. Oil Price History
A fair amount of crude is still used for power generation and home heating. For those of you in the Northeast, I am paying for natural gas the equivalent of about $1.40/gallon to heat my home. You are paying twice as much. That is a powerful incentive to convert to natural gas.
What we need is an oil import fee or other floor to protect the US domestic oil sands or coal to liquids projects that can’t compete at $30 / bbl.
There are no ready alternatives to liquid hydrocarbon fuel for transportation. Electrics and plug hybrids might fill some of the gap but they won’t completely replace liquid fuel.
Call it “peak lite” or whatever, but high crude prices are already having a serious impact even here in Japan, a rich nation. For example: (1) Food is already expensive, but this morning (January 4, the day that Japan “starts up” after the new year) we were told that because of increased energy costs major corporations have announced they are again jacking up prices, in many cases 10-20%. Food is the primary item. (2) The transport industry — which finds it hard to pass on costs — is screaming bloody murder. If the trucks stop running, the economy will come to a standstill, food will not be distributed, etc. (3) Heating fuel prices are so high that the government announced emergency subsidies for low-income people and small businesses. Some farmers who grow crops in heated greenhouses have already succumbed, and have shut down their operations.
On the surface, it looks as though the Japanese are absorbing these higher costs with aplomb, but take it from me that the system is creaking.
Surely the Saudis monitor the effects of high crude prices. If this is what they call “testing the market,” it’s a extremely dangerous game.
The preciptious drops would be in the 1998 when crude dropped to below $10 /bbl and then again around 1998 when it dropped again and averaged $15-20 for most of the year.
Was that 2 drops in one year?
The drop in 1998 was due to a drop in demand when the Asian Tigers tripped over their tails. It had nothing to do with suppliers trying to beat back the competition.
What we need is an oil import fee or other floor to protect the US domestic oil sands or coal to liquids projects that can’t compete at $30 / bbl.
But we don’t. The only way we’ll see $30/bbl again is if there is a HUGE drop in demand, indicating serious economic meltdown somewhere in the global economy. Under those circumstances it will be impossible to support floor prices.
There are no ready alternatives to liquid hydrocarbon fuel for transportation.
True enough. Hopefully $100/bbl will help to get some BTL going.
The transport industry — which finds it hard to pass on costs — is screaming bloody murder. If the trucks stop running, the economy will come to a standstill, food will not be distributed, etc.
In a free market the only thing keeping prices down would be competition. Eventually fuel cost will be passed along to the consumer. If Japanese transportation is not a free market, you might be in for some rough times.
High food prices should encourage local consumption, which in turn might help to stabilize food prices.
Surely the Saudis monitor the effects of high crude prices. If this is what they call “testing the market,” it’s a extremely dangerous game.
I doubt the Saudis monitor the local news in Japan, but I could be wrong.
Anyway, it sounds like the Saudis are in favor of increasing production, but the rest of OPEC, especially Iran and Venezuela are not interested. So, don’t hold your breath.
I am mildly disappointed to see that RR also subscribes to the idea that we have “high demand” for fossil oil. Jeez, in 2006 global demand was up 0.7 percent (BP stats). In 2007 probably less. I submit that in 2008, we will see declining demand for fossil crude.
We have mildly waning demand for crude. How long can Thug States keep oil prices up? That is the question. Time will tell.
I am mildly disappointed to see that RR also subscribes to the idea that we have “high demand” for fossil oil.
I suppose it is more accurate to describe my position as “excess capacity has decreased.” The reason for this is debateable, but 5 years ago we had several million barrels of excess crude capacity, today we do not. That’s because over that time demand has grown faster than new supply has come online.
Ow, come on Benny! Are you still harping on about Peak Demand? Ever heard of China? India? As King pointed out, subsidized prices mean they have no incentive to conserve. I am beginning to get a bit beyond the “mild” disappointment with your persistence.
How long can Thug States keep oil prices up?
Let’s hope it’s for a long time, since we don’t have the self-discipline to do the right thing when energy is cheap…
Couple of things.
In China prices are fixed, not subsidised. Hence from time to time people can’t actually get petrol because the oilcos don’t want to increase supply.
Nominal oil prices look different to real prices. In nominal terms, the whole 1990s were quite low. I seem to remember OPEC trying to punish Norway and the UK for trying to increase production. 1998 was when they ruined the Russians. Oil supply increased as oil demand decreased (the latter because of the Asian economic issue). Good time to put the screws on. MENA production costs are still way lower than Russia’s, so it was an effective way to remain the price setter and stymie Russian investment (which still picked up eventually, but who’s talking about Russia’s influence on prices now?)
‘Thugs States’ – what, ones that invade oil-rich states? Or ones that are undemocratic but have been propped up by democratic states because they have oil? Stop thinking in black and white.
Oh, and on Japan – yeah, they’ve come on leaps and bounds in terms of energy efficiency. But they still need to import virtually all of their oil and gas. And their alt energy solutions are still heavily subsidised to remain competitive. So don’t make out as if they’re immune, or that their breakaway from hydrocarbons is imminent.
I think the optimists said High food prices should encourage local consumption, which in turn might help to stabilize food prices.
every time I, hear people (especially city people) talk about “local food” it reminds me how out of touch they are with farming. the two things that affect energy use with regards to crops are season of availability and storage lifetime. as a rule, any given food crop is in season for 3-6 weeks out of the year. Staggered plantings is a useful technique in spreading out when a crop is in season but is bounded by the cold of spring and fall as well as the heat of summer.
Food storage energy costs are not just energy costs of refrigeration but for how long the food can be stored? Leafy greens (lettuce, spinach etc.) can be stored for a week or two. Tubers (turnips, potatoes, etc.) can be stored for 6-9 months.
if anything, I believe food prices will not stabilize but instead will have a much greater range. For example, salad makings will be very cheap in the middle of the summer but very expensive the rest of the year. Foods that store well will be relatively constant in price for about three quarters of the year with their price spiking in the months before the new crop.
What will be interesting is seeing if people can adapt to living the dietary lifestyle people did in the mid-1800s. Fresh food for a month or two and preserved food for the rest of the year. If they can, then the energy cost should be manageable and relatively predictable according to the food and the season.
Astonishingly, “optimist” wrote:
Please list the “occasional precipitous drops to discourage competition” since I can’t seem to recall any.
If you cannot recall any, then you are either very young or rather under-informed. In either case, the solution is for you to inform yourself. Do some reading, and remember to go back to the early 1970s, so that you have the right perspective.
Try to keep in mind some Sun Tsu — the most successful battle is won without having to fight. Saudi Arabia is really the only oil producer with effective surplus capacity. Yes, Kuwait has some too, and there are places like Venezuela & Iran which could have surplus capacity if the people in charge were not such idiots.
The global market price for oil is heavily dependent on decisions made by a handful of individuals in Saudi Arabia, and everybody should be grateful that they have behaved so responsibly. But they are (quite reasonably) considering their own long-term best interests.
Then again, “optimist” also wwrote:
Of course, at present alternatives are more of a joke, than anything else.
There is hope for you yet. You may not have much historical knowledge, but at least you can recognize what is in front of your face — more than many are willing to do when it comes to the strongly desired world of alternate energy sources.
China – fixed prices, subsidized – same thing. Chinese oil companies pick up the difference between the market price and the fixed price.
Either way it distorts the market. Capital flows to energy intensive manufacturing that benefits from cheaper costs.
The US experimented with price controls in the 1970s. It led to regional gasoline shortages. Venezuela is learning the painful lesson today with shortages of meat, milk, sugar, and other staples.
Non-OPEC production peaked in the late 1980s, early 1990s at about the same time as the asian currency crisis.
If you cannot recall any, then you are either very young or rather under-informed.
OK, so Kinuachdrach couldn’t recall any either. Thanks for the compliments on my age, by the way. I’m old enough to start appreciating those.
OTOH, maybe Kinuachdrach didn’t read the fine print: I did not contest the occasional precipitous drops, but rather occasional precipitous drops to discourage competition. Go ahead, provide the list if you can.
Next, explain to me where all that additional capacity (what ~3 million bpd?) is going to come from, overnight so to speak. It’s not like King Abdullah makes a call to Mohammed over there to open the spigot. It takes a while to get the infrastructure in place.
I maintain that the only way we will see oil below $50/bbl is if there is a serious drop in demand, the kind that alternatives can’t cause, the kind that would indicate widespread economic downturn. While widespread economic downturn is not out of the question (Thank you, Mr. Greenspan!), I certainly hope against it, and for continued high energy prices.
Katy – wasn’t picking a bone with you per se. Fixed prices =/= subsidy, because with fixed prices the state-owned companies stop providing, whereas with subsidies they keep providing. Major difference. Happy to give examples.
Re other comments – I’m pretty young (29), didn’t see the last oil spike but have enough nous to read up about it. Seems self-evident that one would have to?
Anyhow – long term we’re running out of oil; short term a bunch of new capacity is being developed but (as in the case of Khursaniyah) not yet being brought on line. I saw a chart recently showing how much capacity would be brought online in 2008 provided all the projects get completed. Stupidly didn’t save a link but it was significant. I remember writing about all these new projects getting financing back when I was covereing the Middle East a couple of years back.
I did not contest the occasional precipitous drops, but rather occasional precipitous drops to discourage competition.
Saudi Arabia flooded the market in early 1986 knowing it would destroy competitors. This is not in dispute.
I don’t see any parallels between now and 1986. Back then the Saudis had cut production an incredible 65%, yet prices were still sagging due to increasing competition and a lack of demand growth. Today Saudi Arabia is near max output, and the competition remains defanged.
Saudi Arabia flooded the market in early 1986 knowing it would destroy competitors. This is not in dispute.
According to the link provided by King above: From 1982 to 1985, OPEC attempted to set production quotas low enough to stabilize prices. These attempts met with repeated failure as various members of OPEC produced beyond their quotas. During most of this period Saudi Arabia acted as the swing producer cutting its production in an attempt to stem the free fall in prices. In August of 1985, the Saudis tired of this role. They linked their oil price to the spot market for crude and by early 1986 increased production from 2 MMBPD to 5 MMBPD. Crude oil prices plummeted below $10 per barrel by mid-1986. Despite the fall in prices Saudi revenue remained about the same with higher volumes compensating for lower prices.
Sounds to me like the Saudis were trying to bring other members of OPEC inline. You could hardly call other OPEC members competitors of Saudi Arabia – what would be the point of OPEC, then?
Point #1: Saudi, OPEC or anybody else has never flooded the market to destroy a competitor.
Today Saudi Arabia is near max output, and the competition remains defanged.
Point #2: There is no spare capacity, right now, to flood the market.
Point #3: As RR constantly reminds us, there is no alternative that could simply be brought online and replace oil in a significant way.
Put these three together and you have a rational response for OPEC (and Saudi) to alternatives: Ignore it and enjoy the high prices.
Saudi Aramco is a great company… I would like work there someday…