So now the Saudis did it

Some people remain intent on believing that falling oil prices are the result of a conspiracy to keep Republicans in power. No sooner had I addressed the theory that Goldman Sachs had somehow initiated the huge price swings currently underway than a new theory pops up to replace it.

Today’s Washington Post carries an article titled “Conspiracy Theories Abound as Oil Prices Fluctuate” written by Steven Mufson. This article advances a number of conspiracy theories under the journalistic cover of reporting “this is what some people are saying,” as opposed to presenting any evidence to support them. In addition to repeating the Goldman Sachs hypothesis (without mentioning any of the pertinent facts detailed here at Econbrowser or at Gumby Fresh), the Washington Post article devotes most of its attention to the possible role of Saudi Arabia:

According to this theory, the Saudi government is doing Bush a favor by trying to bring down prices before the election. The evidence? Some say the Saudi government has a long-standing relationship with the Bush family. They also cite the 2004 book by author and Washington Post assistant managing editor Bob Woodward, “Plan of Attack,” which said that then-Saudi ambassador to the United States, Prince Bandar bin Sultan, promised to keep oil production high enough to moderate fuel prices and bolster the U.S. economy during the presidential election year.

Now, with crude oil prices tumbling and OPEC members calling for production cuts, Saudi officials — at least publicly — are saying they will wait until the next meeting of OPEC oil ministers, which happens to be scheduled for December. “OPEC will be meeting I think within a month or two to review these factors, and we will discuss these things with countries like Venezuela and Nigeria,” the Saudi ambassador to the United States, Prince Turki al-Faisal, told reporters after giving a speech in Washington on Wednesday.

But oil traders are worried that Saudi Arabia won’t wait. Yesterday, oil prices closed slightly higher on reports that OPEC, including Saudi Arabia, has decided to cut output. A well-placed trader in Europe said the kingdom has quietly trimmed its output to 9.15 million barrels a day, from 9.3 million barrels a day, and that it has been talking about shaving a bit more if other OPEC members also cut back to stop the rapid slide in oil prices.




Data source: EIA
<saudi_prod_oct_06.gif



So let me see if I’ve got this straight– the evidence is that (1) Bob Woodward says that somebody told him that the Saudis made a promise in 2004 and (2) the Saudis could have reduced production by even more than they already have, if they really wanted to keep prices from falling. As for (1), the Saudis have made plenty of promises — publicly, for all the world to see– that came to nothing. And as for (2), what sort of economic theory is this? That the Saudis have been decreasing production over the last year is indisputable. If an even bigger production cut than the Saudis have already made would have been necessary in order to keep prices from falling, doesn’t that prove rather conclusively that the cause of the price drop must be something other than what the Saudis have done?

Sometimes I feel like Econbrowser is playing Whac-a-Mole.


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28 thoughts on “So now the Saudis did it

  1. Lawrence

    Some of the folks over at the Oil Drum are speculating that the Saudi’s are not “cutting” production but rather their oilfields have reached their limits of production and are in decline. Another plausible scenario?
    Time will tell.

  2. donna

    Well, considering they were producing full out last year during Katrina and cut back this summer, it looks more like they cut production this summer to raise prices. So yeah, they could be producing more now to lower them.
    More likely since our reserves were full and we didn’t have a major hurricane this summer, thanm goodness, there is actually less demand for oil.
    The real question is when are we going to shift our economy off dead dinosaurs and into alternative energy sources, and will we do it before the real crisis hits us…

  3. brad setser

    This is not on topic — at least non entirely, but the EIA production data for 2005 has S. Arabian production about 1 mbd below the BP number in their world energy review — BP has S. Arabia at well over 10 mbd in 05. do the oil experts have any sense of which number is more accurate? Again — this is about backward looking data, not what is happening now.
    Saudi Production cuts right now certainly make more sense to me than the Saudis flooding the market right now in a strategy to influence the US election — i think the FT had a story earlier in the week saying the Saudis were upset that others in OPEC were so publicly announcing their production cuts, since the Saudis wanted to do it quietly so it wouldn’t be a US election issue.
    Plus, if the Saudis were trying to shape the midterm elections, they should be really, really upset at the Houseleadership. Foley is costing them real $$$.

  4. realist

    you people act as if oil prices have something to do with the law of supply and demand. i contend, that when bush threatens iran, oil prices go up. when bush stops threatening iran, oil prices go down. so, what’s a “decider” to do before an important congressional election, if he wants the voters to feel a tad optimistic?

  5. matt

    to donna:

    The EIA number includes crude oil only, whereas it appears that the BP number includes things like condensate and natural gas liquids. If you add these other liquids to the EIA number, then the two are very similar.

  6. Dick

    The real question is when are we going to shift our economy off dead dinosaurs and into alternative energy sources, and will we do it before the real crisis hits us…
    Donna,
    This is an easy one. When alternative fuels become cost effective. I doubt that will take a crisis as you mean. But it will require the depletion of oil in the world and contrary to the alarmists every decade reserves increase. We have been warned of oil supply shortages since oil was first used.
    I would welcome a real oil shortage, not one created by government (remember Richard Nixon) because it would stimulate real research into alternative fuels, but the prospects right now appear to favor oil for a long time in the future. Some battery technology is making me hopeful, but it isn’t there yet.

  7. T.R. Elliott

    Dick says: “I doubt that will take a crisis as you mean. But it will require the depletion of oil in the world and contrary to the alarmists every decade reserves increase. We have been warned of oil supply shortages since oil was first used.”
    I disagree. Obviously, it depends on what one means by a “crisis.” The transition from wood to coal, and from coal to oil, occurred due to the simple fact that each transition went from a lower engery yielding source to one that was significantly higher in energy density–and easier to extract and transport. Orders if magnitude higher, if you look at the details. Amazingly higher.
    The next energy transition will be to a source that is lower in energy yield–at least it looks that way.
    And the comment that predictions have been made in the past: the best advice is to ignore all the predictions of the past and instead look at the geophysics, energy physics, technical evolution, and economics. The significant improvement in computer modeling in the past twenty years makes all past predictions largely nonsense. Looking to them in any way is futile.
    The models are speaking much more clearly and consistently now. Energy production looks to be approaching a plateau. I predict that demand destruction and economic dislocation (increasing expenditures on energy instead of other matters) will result in severe recession and unemployment that will be defined as a crisis.
    So it really depends on how one defines “crisis.” The human race has lived in an environment of increasing energy for the past 10,000 years. That’s about to end. I think it will take a crisis of sorts to adapt to the lower energy regimen.

  8. guest

    i contend, that when bush threatens iran, oil prices go up. when bush stops threatening iran, oil prices go down.
    Except that Tradesports/Intrade is trading event futures on “US/Israeli Overt Air Strike against Iran”, and the price of such contracts has been fairly stable, showing little correlation with crude oil prices. The prediction markets are not playing along with Bush.

  9. donna

    “The models are speaking much more clearly and consistently now. Energy production looks to be approaching a plateau. I predict that demand destruction and economic dislocation (increasing expenditures on energy instead of other matters) will result in severe recession and unemployment that will be defined as a crisis.”
    I think it’s probably going to be more like a world war over the last of the big oil fields, myself. If we were to use the existing oil to move to alternatives, building nuclear plants, windmills, tidal power stations, solar cells, geothermal, or whatever, we could avoid that, but since oil is so “cheap” (ignoring the wars we fight for it, the global warming costs, etc…), and so easy to transport and use, it’s going to take a crisis, as you say.

  10. Dimmy

    Deae Dick I like your “the simple fact that each transition went from a lower engery yielding source to one that was significantly higher in energy density” but I’m not sure all the computional – possibility in the World makes better forecasts. (Though since the average depth of a land – based O and G rig has gone from say 800 to 2000 in twenty years, for a standard boe, I agreee we are “running short on cheap oil)

  11. Dimmy

    For what its worth, if u plotted depth drilled per boe, over time, and assumed the cost per foot was sufficiently constant; it would outline, vaguely, what I believe was called “the long – run average – cost curve envelope”; or something like that. Mebbe.

  12. Karl Hallowell

    I disagree. Obviously, it depends on what one means by a “crisis.” The transition from wood to coal, and from coal to oil, occurred due to the simple fact that each transition went from a lower engery yielding source to one that was significantly higher in energy density–and easier to extract and transport. Orders if magnitude higher, if you look at the details. Amazingly higher.

    It’s about a factor of three increase in energy density from dry woodchips to diesel fuel. And since we burn lots of coal for energy, apparently it’s easy enough even in the absence of some sort of oil shortage. I certainly don’t see the claim of “orders of magnitude” being relevant as we would go to coal or something similar before we go to hauling wood out of the forest with animal power.

  13. T.R. Elliott

    Karl: You are right. My facts are wrong. The energy available in one kilogram of matter are all on the order of 10**7 joules, with factors of 2, 3.5, and 4 for wood, coal, and oil respectively.
    My mistake was in thinking of the transition from manual labor (or water/wind power) to the chemical energy contained in wood/coal/oil, which was an increase of approximately 10**6, and then the increase from chemical energy to nuclear energy, another factor of approximately 10**6.
    These can be considered the three major energy regimes of the human race. Pre-industrial revolution, industrial revolution (coal and oil), and nuclear.
    My main point being that there isn’t any more energy dense source out there (EROEI and all that). And I think crises of some sort will result as society adapts to the lower energy regime. Adapt we most certainly will, but I expect some turbulence.
    That said, my comments on energy density were totally delusional. Thanks for correcting.

  14. dominick

    The real question is when are we going to shift our economy off dead dinosaurs and into alternative energy sources, and will we do it before the real crisis hits us…This is an easy one. When alternative fuels become cost effective…
    we can artificially make alternative fuels more cost effective by taxing the be-jesus out of oil.

  15. Aaron Krowne

    I don’t think these Saudi allegations have any merit for fundamental reasons; the Saudis dont want oil prices that are too high, so they won’t restrict output for extended periods of time. Thus they aren’t too keen on output cuts right now either (unlike their OPEC brethren), as $55 is really not a bad oil price (still high when compared even to a couple years ago)!

    From your description, the Post article also ignores the fact that there has been even more effect on price-at-the-pump from the change in the gasoline market.

    Speaking of which, I think it is disingenuous to dismiss the GSCI re-weighting outright. This clearly must have had a sell-off effect in the market (and we know it would have been largely after Aug. 9); I’ve heard this was at least to the tune of $6 billion. I don’t know about conspiracies, but it should be pretty clear this would result in a lower price for unleaded futures. Especially with the tinderbox of hedge fund speculation.

  16. JDH

    Aaron, I believe that gasoline prices depend ultimately on the fundamentals of supply and demand. If that is correct, then even $6 billion could only have a small and temporary effect. If instead prices are ultimately determined by irrational speculation, then, as I noted in my original post on the Goldman Sachs question, they could change at any time by an arbitrarily large amount for any reason, and one story of why they changed seems just as good as any other.

  17. Aaron Krowne

    JDH: I do agree the fundamentals will ultimately prevail. In fact even this “correction” is but a vacillation on a very consistent uptrend since the early 00′s.

  18. Terry S

    As one who has worked in the oil refining industry for 29 years and has worked for three major oil companies the idea that gasoline prices can be so easily manipulated is absurd. Outside of the seasonal aspects in gasoline prices, there are numerous variables that result in cost at the pump. Refining capacity, which for each refinery is different based on age and environmental constraints. The crude market, variations in crude quality and accessability, sweet vs. sour crude cost. The breakdown in refined product (gasoline vs. distillate production), storage capacity within the refinerires. Refineries don’t stop producing gasoline when distillates are in demand or stop producing distillates when gasoline is in demand. Both are made simultaneously. Which is a juggling act based on seasonal demand, equipment breakdowns and storage constraints. This is just the tip of the iceberg. If there is one aspect in todays higher prices that oil companies can take credit for manipulating it is the shutting down of excess refining capacity in the late 70,s and early 80′s. Profit margins were slim and oil companies were looking to get out of the refining business. It only took twenty-five years for oil refineries to again be highly profitable and become a desired part of the oil industry.

  19. Jack

    JDH,
    DO you think the recent bump in the stock market is due to hedge funds pulling $$ out of the energy futures in light of the Aramath (sp?) and dumping them into US stocks, or is that just circumstantial.
    Thanks.
    Jack

  20. JDH

    Jack, in my opinion the correlation is not a coincidence, nor do I believe that it is causal in the sense you are suggesting.

    With new perceptions about the lower likelihood of a recession and greater likelihood of inflation being contained, had stocks remained at their old prices, they would have been undervalued. The main question that may separate the way that I am thinking about these issues from the way that you might be is, how many dollars are available to bid up the price of an undervalued asset? The answer I give is that it is almost unbounded– equilibrium is restored not when all the people who want to hold an undervalued asset do so, but rather when the price of the asset rises to the point where it is no longer undervalued.

    Perhaps another way to recognize that a “flow of funds” theory of stock price determination is unnecessary and unpromising is to notice that the price of a stock can and does change, even if the ownership does not change hands. If it has suddenly become worth more, nobody will sell it now unless a higher price is bid. It does not require any new inflow of investment dollars for the price of a stock to be bid up.

    So, I think it is a mistake to try to attribute stock price increases to the changing asset position of investors. Instead, I believe that the causation runs in the other direction– because stocks became more attractive, more people wanted to hold them.

  21. Dick

    Dominick wrote:
    we can artificially make alternative fuels more cost effective by taxing the be-jesus out of oil.
    Dominick,
    You must live in an alternative universe. The total economy includes both the cost of fuel and taxes. Raising taxes on oil does nothing to the fundamental cost of energy production but it does increase cost by making everything less efficient.
    We have not come close to tapping into all of the energy sources that are available, shale oil being one of the most plentiful. When production prices rise to the point that extraction of shale oil is profitable you will see shale oil technology explode.
    But then that is assuming that we do not find a more efficient alternative.
    T.R.,
    To say that there are no energy alternatives and to imply that there never will be is much like the quote erroneously attributed to Charles Durell, Commissioner of the US Patent Office, 1899, that “everything that can be invented has been invented.”

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  23. Anonymous

    The energy available in one kilogram of matter are all on the order of 10**7 joules
    Actually, the energy available in 1kg of matter is 9×10^16 joules.
    The only problem is that because of the market distortions caused by certain religious cults (greenpeace, etc) we can no longer economically extract it as we did in the past.

  24. Nick

    T.R. Elliott,
    I would argue that the distinction between the pre-industrial and industrial eras is blurred beyond meaning by assigning wind and water power to the pre-industrial era. I believe most historians would agree that wind and water power were used extensively early in the industrial era, only to be replaced by fossil fuels later.
    More importantly, wind and water power can have very high E-ROI ratings using modern technology. In fact, at this point wind turbines have a higher E-ROI (20 to 60:1) than oil (10:1 per Robert Rapier). Finally, solar has a E-ROI of at least 10:1 (conventional silicon is probably 20:1 now, and thin-film even higher) and rising fast.
    Does this make sense to you? If not, I can give more detailed info and sources.

  25. JLK

    Dear Dick,
    your statement “The total economy includes both the cost of fuel and taxes. Raising taxes on oil does nothing to the fundamental cost of energy production but it does increase cost by making everything less efficient” is inaccurate in its implications.
    Most European countries have considerably higher taxes on fuel than the U.S. The cost of fuel is essentially 3 to 4 times higher in Germany than the U.S., but everything there is not less efficient. The economy is not less efficient and energy is used more efficiently than in the U.S. (car makers there sell more energy efficient vehicles, buildings and houses are better insulated and therefore less fuel is used in heating).
    Increasing taxes would simply change the economy, not make it any less efficient than other major market forces over the short term. In the medium and long terms there is no loss of efficiency.
    This is a political issue which is decided by voters every day.

  26. Matthew Kennel

    Europe’s higher taxes on fuel flow to the government and of course is recycled as spending in other areas.
    It is a reallocation, and one of the effects is to use less petroleum per person.
    As well, Diesel fuel, is taxed less than gasoline. Gasoline may average 2x the price of the USA, but Diesel 1.5x. Also, since Diesel engines are more intrinsically efficient (though with higher initial cost), the combination results in significantly less petroleum used, and CO2 emitted per person. In general they do not suffer that much in mobility as much of the excess energy consumption in USA personal vehicles is used to move more mass around, and temporarily quicker, from here to there. This has little productive economic value.

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