Sunday, April 13, 2008

Interesting Times for Saudi Oil Production

Two interesting developments in Saudi Arabia this week. First, sources tell us that their oil production has decreased from9.2 million barrels per day to 9.0 million barrels per day. Second, and more interesting, the Saudi king is now publicly stating that they are delaying the development of some new oil finds because "our children need it."

While this may seem fairly innocuous, a bit of analysis leads to some very interesting possible motivations.

Let's look first at the decrease in oil production. A 200,000 bpd decline is pretty significant. The source quoted by Gulf Daily News claims that this decline in production "reflects the demand from our customers." Well, maybe at $110/barrel. But compare this to President Bush's recent request to the Saudi king to ease prices by increasing demand. It's a bit disingenuous to say that you're pumping 200k bpd less because that reflects demand at $110+/barrel, when putting an additional 200k barrels on the market each day would invariably decrease prices and increase that demand. If they offered those 200k barrels each day at $80/barrel, I'm pretty sure there would be buyers! So it seems apparent, at least to me, that IF the Saudis are voluntarily cutting back production, it is because they want to increase prices, or at least they want to keep prices at present levels, not because they can't find buyers.

This begs the question, of course, of whether this cut-back in production is voluntary. Consider the interesting timing with the claimed start of production from their Khursaniyah field. Saudi Arabia claims that production from that field will reach 300k barrels per day within a month, and eventually 500k barrels per day. In combination with the planned addition of an additional 250k bpd from Shaybah field set to come online later this year, the timing of the current production decline is odd. Some possibilities:

1. They're shutting in more expensive production (e.g. very high and increasing water cut) to make way for Khursaniyah without driving down oil prices.
2. They're shutting in quickly depleting fields, or fields at risk of advancing water flood stranding oil pockets, in favor of the more technically sound Khursaniyah and Shaybah.
3. The timing of Khursaniyah is a ploy--the field has "been coming on line soon" for years now, yet hasn't produced any significant oil to date, and this latest round of Khursaniyah press releases provides cover for them to either a) cut production to continue to increase oil prices, or b) cover the decline from aging fields (as in "we still have 2mbpd of spare production potential, but we didn't anticipate this latest round of Khursaniyah delays, so we're temporarily behind...").

We simply don't know which--if any--of these motivations led to the cut of 200k bpd of production.

Now consider the statement by the Saudi king that they are also intentionally holding back on the development of new oil production capacity. No details are provided about which fields, which discoveries have been mothballed to provide for posterity. Instead, it sounds to me like a PR move to explain why they can't ramp up production right now to bring down oil prices, despite their claim that they have plenty of spare production capacity. It's one thing to ask them to put on line more production to ease oil prices and help America out of economic troubles. It's an entirely less reasonable request to ask them to sacrifice their children's future to help us now! More troubling, to me, is that this is exactly the kind of PR move that would also precede a voluntary reduction intended to maximize near-term revenue, or to conceal the near-term onset of oil production declines. After all, if the Saudi king really cared so much about posterity, he would be well advised to reduce current spectacular levels of conspicuous consumption by the royalty and consider addressing the kingdom's population explosion that is creating a demographic tidal wave that will soon overwhelm their economy--even IF oil production remains steady.

The revenue curve for oil production for a producer like Saudi Arabia is an unusual animal. Because of the current tight global markets, and the high inelasticity of demand for oil, cutting production probably increases prices enough to maintain stable total revenue. There is probably some sweet spot where a cut in production will actually increase revenue. Either way, these are certainly interesting times for Saudi oil production. We simply don't have enough reliable information to know whether this is the onset of irreversible oil production declines, whether this is a new phase of self-interested revenue maximization, whether this is a natural part of the transition from aging fields to new production coming on line, or some combination. Maybe we will get sufficient information in the next few months to better understand where Saudi production is going. The greatest problem is that the Saudis have no motivation to be forthright with their disclosures, and attempts (like this one) to read between the lines will almost invariably result in the conclusions that "it's some combination of factors." Most likely we won't have a definitive answer until it is provided by a clear historical record. The problem with this is that it will be much more difficult to sell the necessary economic adaptations necessary to compensate for a significant decline in Saudi production AFTER that decline has already happened. The Saudis are possibly the only people who could, with a unified shift in policy, quickly convince the majority of skeptics that the world is facing an ongoing 5%-10% annual decline in oil production beginning very soon. They also appear to be one of the last groups that will come out and say this...


Rice Farmer said...

Certainly there is much room for speculation here. We can only guess at their true motivations and the state of their oil reserves. But one thing is for sure: If the Saudis openly admitted that their reserves are fast depleting and production capacity is declining, it would send shock waves throughout the world. It could also leave them wide open to a military attack as the big players panic and try to grab what's left.

So my guess is that there are several factors at work.
1) The Saudis regret that they sold so much of their oil at bargain basement prices, and now want to get a better return.
2) They want to husband their remaining oil resources because the near-future world will be one of oil haves and have-nots, and they want to be among the haves.
3) Falling production is inevitable, and they want to manage a graceful decline.
4) They want to avoid shocking the world, so present various plausible reasons for cutting production ("the market is well-supplied," etc.)

Tom Konrad said...

Good post.
Too bad American politicians haven't thought about slowing down production "because out children need it."

Every time oil execs say "we need to increase production of domestic oil" I wonder, "What's the hurry? If we don't drill now, it will still be there (and be more valuable) in a decade or three."

Jeff Vail said...

And now Saudi Arabia is putting out feelers on a whole new concept in economics:

"Saudi Arabia, facing calls from oil- consuming nations to pump more crude, has no plans to raise output because increased supply wouldn't damp record prices, Argus reported, citing Oil Minister Ali al-Naimi."

Really? Increasing supply won't change the price? Isn't that the very basis of what price is--an equilibrium point between supply and demand? Maybe they know something I don't. Sure, increasing supply by 100,000 barrels per day might not have any real effect, but bringing on line their claimed 2 million barrel per day spare capacity sure would.

It seems like they're just throwing things against the wall and seeing what sticks... it's a good time to test the public's acceptance of these theories, as they'll likely need to pull out all the stops on the PR front shortly.

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