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(email exchange)

Yes, that’s the issue when there is more excess capacity than any one producer can afford to ‘allow.’

The excess production capacity (until recently) has been under 2 million barrels per day. This has allowed the Saudis to be ‘price setter’/swing producer as all other producers could produce flat out,
and the Saudis could set price and let their output fill the remaining demand of about 9 million bpd.

In July, however, Mike Masters triggered a massive inventory sell off as passive commodity players and specs hit bids to reduce positions, and the demand for physical inventories also fell as it seems many physical inventories probably had been held at relatively high levels in anticipation of higher prices.

This meant the Saudis could not control price without major and obvious production cuts- maybe $5 million bpd- to speed the inventory adjustment and retain their position as swing producer/price setter.

I looked at (guessed) the latest announced OPEC production cuts as a sign the Saudis thought the inventory liquidation was largely past and that they were again able to set price and let production adjust to the residual demand. With other OPEC members cutting output some, the Saudis could set price and expect the residual demand that determines their output would be that much higher.

Yes, demand is down in many regions, but so far no figures released on world demand for crude has indicated an outright decline in demand. Yes, some supply indicators are up some, but others are down. The balance is not clearly tipping to a large enough cut in net demand to dislodge the Saudis as price setter.

Note that West Texas crude is over $3 higher than Brent- a wider spread than the shipping charges might indicate. This implies a shortage of WTI. But at the same time the WTI futures markets are in contango, indicating comfortable inventory levels. Also, the gasoline crack has gone negative vs WTI, indicating perhaps it is being prices off of Brent which means the marginal supply is currently imported gasoline as domestic refiners continue to produce well below capacity.

Russia is the large non-OPEC exporter, and the recent meetings with the Saudis and the below commentary indicate some form of cooperation is in process.

What the oil exporters should be hoping for is a world wide move to restore aggregate demand without an immediate policy to reduce fuel consumption. That will enable the oil exporters to increase their real terms of trade via price hikes.

The darker side is that instead of looking to optimize their real terms of trade, their primary focus may be on keeping the western economies ‘weak’ to keep them focused inward and allow the Russians freedom to operate as they please in their regions of choice, and hasten the exit of the ‘infidel’ from Iraq and the rest of the middle east. In this case, price hikes will be used to keep the western economies weak and off balance, as they confront inflation, weakness, and deteriorating real terms of trade and standards of living, with real wealth moving towards the oil (and other energy) exporters.

On the other hand it is possible the oil exporters want to keep prices low enough to discourage moves away from petroleum, especially in the auto industry.

Point is, currently and for at least the next several years, the Saudis/Russians control price, and we can only guess to what end.

>   
>   On Tue, Nov 11, 2008 at 7:16 AM, wrote:
>   
>   One bit of news, brought to our attention by our friend, Mr. Elio Ohep, the
>   Editor/Publisher of the always interesting petroleumworld.com, is that of the
>   anger on the part of Russian Prime Minister Putin regarding the current price
>   for crude, and Russia’s apparent inability to do anything about it. Clearly
>   Putin & Company are upset by crude’s weakness, for much of the current
>   military build-up taking place there, and much of the infrastructure growth
>   taking place is predicated upon high priced crude oil. Speaking over the
>   weekend, Mr. Putin said that Russia must do what it can to influence oil
>   prices. He said, in an interview on Russian national television, that We need
>   to work out a whole range of measures that will allow us to actively influence
>   the market…As one of the major exporters and producers of oil and
>   petroleum products, Russia cannot stand aside from formulation of global
>   prices for this natural resource. There is little that Russian can do however
>   other than cut production and hope that others… especially OPEC…follows
>   suit. The problem that Russia, and Venezuela, and Mexico, and Ecuador, and
>   Indonesia, and Saudi Arabia and seemingly all of the oil producing
>   nations….especially Iran…. face is that they need the cash flow from crude
>   oil to keep buying the support of their restive populations. They’ve no choice,
>   and low prices make their jobs all the harder, for in hoping to keep their cash
>   flows high they need to pump more, not less, crude. Putin and Ahmadinejad
>   find themselves as uncomfortable brethren in economic arms, hoping that the
>   other will cut production.
>   


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6 Responses

  1. Again, isn’t the recent dollar crunch a big factor here. If international players are scrambling to build up dollar reserves as evidenced by the FED swap lines, wouldn’t the oil exporters have to continue selling more oil to build up reserves.

  2. yes, but if they can sell all their production at ‘market’ prices and saudis set price and let their output adjust to demand the price stays where ever the saudis set it.

    only if the saudis want lower prices or won’t let their production adjust to demand will prices fall. both are possible

  3. Lots of factors drive crude prices. Why the 60% collapse in oil prices since July, who exactly knows. Slumping demand, hedge funds unwinding futures positions all contributed to price declines. But, as I mentioned earlier, if Isreal makes a move on Iran watch out. Crude prices will explode. Isreal is the wild card right now. Oh yeah, China’s economic slowdown doesn’t support high crude prices.

  4. yes, but if they can sell all their production at ‘market’ prices and saudis set price and let their output adjust to demand the price stays where ever the saudis set it.

    only if the saudis want lower prices or won’t let their production adjust to demand will prices fall. both are possible

    I know you’ve said that the saudi’s are the only players with
    excess capacity. But now that demand has faded somewhat. What if someone else like venezuela / nigeria start hitting bids below the saudi ask because they need more hard currency than before.

  5. I was thinking the russians with their 25000 nukes might have some say as to what price the saudis set.

    also, as long as some of the saudi production is needed at the margin by the rest of the world, the price won’t go more than a very small amount lower than where they set it.

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