Saudi arabia want to see oil prices at usd 80 or usd 100 a barrel – forbes r gasquet

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It’s necessary to scrutinize the talk that some OPEC members, and particularly Saudi Arabia, want to see oil prices at USD 80 or USD 100 a barrel, reversing a longstanding tradition of emphasizing market share over short-term revenues. Without question, the Saudi Arabian stance is a major influence on the price of oil, but even they do not have control of the price. Still, this talk could influence expectations of longer-term price trends (beyond 3-6 months) by suggesting to traders that the likely price range is higher than before.

OPEC did control prices at one time, more or less, from roughly 1975 to 1985 (ignoring the interlude of the Iranian Revolution in 1979-80). OPEC would meet and agree on a price for the ‘marker crude,’ which was Arabian Light, and other members would adjust their own prices to allow for differences in quality and location. Buyers could accept the price or go without.

As a result, oil prices were actually quite stable: the graph below shows the average price of crude imported to the U.S., the actual prices being paid not just OPEC’s announced prices. From 1975 to 1985, the monthly price moved relatively little from month to month, although there were minor fluctuations as producers sometimes adjusted their ‘differentials’ to respond to supply and demand. Ultimately, the Saudis were the ‘swing’ producers for much of this period, meaning they adjusted their production according to demand at the set price.

But after the oil market crash in the early 1980s, where rising non-OPEC supply, fuel-switching from oil to coal and gas, and conservation reducing petroleum demand, OPEC (and the Saudis) found demand for their oil in a historic free fall, with Saudi production dropping to a level so low that they had few cash sales. Their response was to end their role as swing producer and push for a lower price that would allow the market to expand. In this, they were successful and the price remained around $20/barrel for a decade and a half.

Fast forward to 2000 and market tightness sent prices over $30 for the first time since Gulf War I, with reported shortages of tankers and refinery capacity (especially upgrading for heavy oil) worsening the situation. At that time, some analysts openly worried high prices would translate into pressure on OPEC’s market share longer term, but the difference between $20 and $30 per barrel of crude for consumers proved to be relatively inconsequential and overwhelmed by booming Asian demand (especially from China).

In fact, most thought that the high prices would mean slower demand, and OPEC anticipated weaker markets in 2004 and scheduled output cuts for early 2004. The market instead tightened significantly, partly because of robust economic growth in the U.S. (4.4%), but also as robust Chinese economic growth outpaced coal deliveries and oil usage soared. The table below compares forecasts change in oil supply and demand from the IEA’s Oil Market Report in November 2003, with the ‘actual’ data from the July 2005 issue. The error is quite large, 2.2 mb/d, but reflected surging demand growth that caught everyone by surprise, not just the IEA or OPEC. (Me certainly.)

This certainly suggests that the difference between $60 and $70 will not have a major impact on oil demand, and another $10 above that wouldn’t mean much in the short-run either. However, the question of the supply response could dominate in the $80-100 price range, and that needs careful consideration.

For the most part, in the short term, higher oil prices would translate directly into greater cash flow for producers. Costs would not immediately rise, although tax payments presumably would. An extra $20 a barrel would mean $an additional 20 billion in cash flow for Permian producers, and about $40 billion for all U.S. shale production. Assuming a third of that reinvested, you could be talking about 300 tb/d additional Permian production and 200 tb/d from other U.S. sources.

More worrisome is the impact on upstream investment outside the U.S. One of the major challenges for supply forecasters has been to predict the impact of small-scale, incremental spending. A deepwater field in Brazil is closely monitored as it moves forward from discovery to production, and projects like that are easily compiled by supply forecasters. However, when a company with an existing field decides to drill additional wells, add gas or water injection, or take other steps to offset declining production, it usually does so with minimal publicity. If those investments were random, they wouldn’t matter but they appear to be correlated with prices: the first to be constrained when prices drop, and first to be renewed when prices rise. Their small scale nature makes them easier to ramp up or down, but harder to see.