The price for a barrel of crude dipped below $47 today in New York futures trading, the lowest since early February. Among the proximate catalysts for the latest bout of bearishness for the commodity, which extends a sell off that began in early April, is news that U.S. inventories of crude continued to rise last week, according to the latest weekly petroleum report from the Energy Information Administration.

Supporting the inventory news is the ongoing efforts by Saudi Arabia to talk down prices. Mr. Market has for some time ignored the kingdom’s repeated attempts to cool the market with promises that dramatic increases in production were coming in the years ahead. But those promises no longer seem to be falling on deaf ears.
And the promises keep coming. Abdallah S. Jum’ah, president and CEO of the Saudi oil company Aramco, said on Monday at Rice University that his firm, the world’s largest oil company, stands willing, ready and able to double its current production in the coming years, reports Arab News.
Similarly rosy pledges of production hikes came afresh on Tuesday from Saudi Arabia’s minister of petroleum and mineral resources. “I want to assure you here today that Saudi Arabia’s reserves are plentiful and we stand ready to increase output as the market dictates,” assured Ali Al-Naimi at an energy conference sponsored by the Center for Strategic and International Studies in Washington, D.C.
The market’s heard it all before, of course, and then some. But the Saudi’s message carries a bit more resonance these days. The effective transfer of enhanced influence to move trader perceptions to the kingdom is a double-edged sword, of course, but it’s the new reality of the moment.
Meanwhile, in an another move to reassure the marketplace that all’s well with supply chains, the office of U.S. Energy Secretary, Sam Bodman, announced on Wednesday that a visit to by a representative of the world’s biggest oil consumer to the world’s primary supplier is scheduled for later this year, reports Reuters via CNNMoney. This after a visit last month by Saudi Crown Prince Abdullah to President Bush’s ranch in Texas.
Despite all the efforts in oil diplomacy these days, and its limited success of late, it’s worth remembering that Mr. Market is notoriously short sighted and skittish. As evidence, consider that oil prices have risen from around $40 last December to the upper-$50 range in this year’s early spring, but have since been heading back down—all without a material change in the known variables of supply and demand. Is Saudi Arabia saying something different today than it was in previous weeks and months? No, not really. All of which suggests that something less than absolute market efficiency prevails in the oil-trading pits.
If guesswork and speculation necessarily dominant the pricing of oil in the short term, a bit more clarity, though not necessarily comfort is found when surveying the long haul. On the latter subject, even the Saudi PR machine throws the market a bone of substance every now and again for those who’re inclined to read the full transcripts and dig below the headlines. Consider, for instance, the admission by Saudi’s oil minister at the CSIS conference earlier this week: “The previous era of overcapacity has ended,” Ali Al-Naimi said.
Indeed, spare oil production capacity in the world is estimated to be just above one million barrels a day in 2005, the Energy Information Administration reports. That slim margin of excess is forecast to slip again next year. As a measure of how thin one million barrels a day is within the global economy, consider that as recently as 2002 excess capacity in the world was well over five million barrels a day–from five to one in just three years!
One million barrels of spare capacity represents around 1% of global oil consumption, based on 2003 data. Given the rise in energy demand since 2003, the excess capacity margin is probably much lower today, perhaps one-half of one percent. The point being: the world economy’s oil production buffer has rarely been thinner in recent memory. As a result, the potential for serious supply disruptions looms large.
As troubling as that is, the problem is compounded by the fact that demand growth forges higher no matter the constraints and bottlenecks of elevating supply. EIA projects that world oil demand will grow 2.7% this year over 2004, and 2.5% in 2006.
Where will the extra supply come from? Saudi Arabia, of course. That is, there seems to be no one else in OPEC who can step up to the supply plate any time soon. According to April EIA numbers, all of
OPEC’s 900,000-to-1.4-million spare capacity resides in Saudi Arabia.
All of which suggests that the future price of oil will turn heavily on Saudi Arabia’s ability to ramp up production at a pace that keeps up with the rise in global demand growth. In past decades, that’s not been a problem since much of the quick and easy reserves on hand in the kingdom were sitting idle. Any increased demand could be met by drawing on the country’s ample excess supply that was available for tapping. But with that excess supply virtually exhausted, new oilfield/infrastructure development is necessary to satisfy demand growth.
Yes, in theory adding new production capacity isn’t a problem. But in practice it’s complicated for more than a few reasons, starting with the substantial investment dollars needed to complete the task. Given the size and scope of dramatically increasing oil output, it’s a task that’s inevitably a hot-button political issue of no small relevance in a country where the oil wealth is less than evenly distributed. Meanwhile, there’s the sneaking suspicion among some in Aramco and the Saudi government that the current bull market in oil won’t last, which translates into a reluctance to engage in expensive new production projects. Thus the emphasis on talk.
All that aside, a back-of-the-envelope calculation implies that the kingdom’s failure to meet global demand growth will result in a rise in oil prices. How to avoid that untoward future? The kingdom must come up with an additional two-million-plus barrels of oil a day each and every year, assuming a 2.5% rise in world oil consumption growth and no production increase outside Saudi Arabia, That amounts to raising production by one-fifth of current production every 12 months.
Of course, any production increases elsewhere in Opec and in non-Opec nations will lessen Saudi Arabia’s burden. The leading source for hope on that front beyond Saudi fields lies with Iraq, the world’s third-largest source of oil reserves. But getting more oil out of the country beyond current production of around two million barrels a day won’t be easy, warns Neil McMahon, oil analyst at Sanford C. Bernstein in London. The immediate problem is terrorism, which Bernstein and others say is rising this year in terms of the number attacks on pipelines and deaths in the country from insurgent activity. Meanwhile, rebuilding Iraq’s antiquated oil infrastructure will take time, oil-industry resources that are already in high demand around the globe, and lots of money.
Silver bullets, in other words, are in short supply. That leaves Saudi Arabia in the driver’s seat for the foreseeable future. How does Mr. Market digest that reality? To judge by the recent decline in oil prices, optimism is the new new thing in the pricing of oil. How long it lasts is quite another matter.