February 24, 2011
That latest entrant to the “whorism” political class, Saudi Arabia, is getting desperate. After yesterday’s attempt to prostitute itself out to its people by literally handing out $37 billion in a glaring demonstration that it has never heard the “money can’t buy you love” saying, now the FT is reporting that “Saudi Arabia is in “active talks” with European oil companies to meet the production shortfall left by Libya, the clearest indication to date that the leader of the Opec oil cartel is about to boost supplies to stop further rises in the oil price, which surged to near $120 a barrel on Thursday.” The FT’s commentary is partially correct: “You can only expect the price to go up. It is fear of the unknown. The risks are all to the upside,” one senior oil trader said. “Saudi Arabia needs to respond.” It does, but not to fill the gap. Following the latest attempt at recreating Helicopter Ben’s monetary policy, Saudi Arabia suddenly finds itself clutching at cash straws. As UBS’ Andrew Lees points out: “Saudi’s USD37bn bonus to the population equates to USD10.45bbl on its 2009 production of 9.7m bpd. Saudi already needed USD74bbl to balance its budget in 2008. In December last year the talk was that its budget deficit would be 40bn riyals having been 86.5bn riyals the previous year as it spent heavily on salary increases for soldiers. With this increased spending it seems Saudi will need about USD85 – USD95bbl to balance its budget, or it will need to ramp up production by about 10% (more capital spending) without prices falling.” Oops. Do you see what happens Larry when a country hands out money it doesn’t have? We hope for Saudi’s sake that it has some POMO desk interns running things there as effectively as in the US. But until we get some confirmation, we continue to back the truck up with Saudi CDS, a process which started when these were first quoted in the double digits.
Full Andrew Lees must read note:
A few things worth considering on oil.
1. Saudi’s USD37bn bonus to the population equates to USD10.45bbl on its 2009 production of 9.7m bpd. Saudi already needed USD74bbl to balance its budget in 2008. In December last year the talk was that its budget deficit would be 40bn riyals having been 86.5bn riyals the previous year as it spent heavily on salary increases for soldiers. With this increased spending it seems Saudi will need about USD85 – USD95bbl to balance its budget, or it will need to ramp up production by about 10% (more capital spending) without prices falling.
- A d v e r t i s e m e n t
2. It is worth remembering that in the 1970’s it was food prices that initially rose and the Middle East rebalanced its finances with higher oil prices just as they are doing today. The present political situation should not therefore be a surprise particularly when Egypt’s production has fallen 20% since 1995 and its net exports have fallen 95%.
3. What is spare capacity? Whilst OPEC indicates on its website that it has several million barrels of spare capacity (about 4m bpd rising to 6m bpd over the medium term) http://www.energybulletin.net/stories/2010-12-20/will-2011-be-rerun-2008 suggests it is not actually clear that they have any more than 2007/08.
A lot of the spending appears to only be offsetting the natural decline of existing fields. There is probably the ability to meet an extra 1.5mbpd of oil demand; beyond that prices will spike.
4. Saudi’s oil production peaked in 2005 at 11.1m bpd. It averaged 10.4m bpd in 2007, briefly recovering for a few months in 2008 before subsequently falling to 9.7m as of 2009. The initial fall came when prices were making new highs in both nominal and real terms, which suggests that if it was a voluntary cut as Saudi intimated, then it was no less political than the “oil sword” of 1973/74. It seems far more likely that with Haradh 3 well productivity thought to be down 60% between 2006 and 2010 that they were struggleing to maintain output.
5. Over the last 10 years OPEC’s production has risen by about 2.5m bpd or just over 8% pa since 2000 but rising domestic consumption has meant that exports have been flat. They grew until 2005 but have been falling ever since. Last year Arab growth was expected to account for 11.7% of the global growth in oil consumption.
6. When people talk about higher oil prices acting as a tax on consumption, what they really mean is that the oil producers are consuming a higher proportion of the oil or the work done by that oil as per Saudi’s latest USD37bn bonus, leaving less available for the rest of us.
7. http://www.epmag.com/WebOnly2009/item41209.php, published in 2006, highlights that recessions correlate closely to the annualised change in oil prices . Whenever oil prices have increased by more than 50% y/y (trailing 12 month average divided by the previous 12 month average) a recession followed. Brent averaged USD80.34bbl last year. That would need oil to average USD120.51bbl this year. The 12 month moving average is about USD84bbl so if this was just a spike that lasted say 3 months rather than the whole year then it would require prices to rise to about USD228bbl (3/12 *228 +9/12 *84) which is possible, but I would suggest unlikely. It is also worth remembering that in the 1970’s oil induced recession there were no strategic reserves. They were brought in as a consequence of that and the IEA has already talked about releasing some of these on to the market if so required, so when people talk about Ben Bernanke printing oil, he can effectively for a few months by opening up the spiggots to domestic stores. Ofcourse this would only be a short term fix and by lowering the above ground reserves would increase the future volatility.
5. The real question to ask is whether high resource prices are a consequence of imbalances in the global economy as most commentators suggest – (ie unproductive and excessive consumption being kept alive by increased debt accumulation) – in which case we are seeing a repeat of the 1970’s when resource prices will rise until eventually this imbalance is sorted, or whether as I believe it is a genuine resource constraint story that is playing out. Either way the result is the same in the short term; removing the imbalance or finding new supplies (North Sea and then later Chinese coal) to allow the imbalance to continue further. The difference is that without scientific advancement (nuclear fusion), more and more present consumption will be determined as excessive and have to be destroyed under my geological decline story, raising questions as to which are the next dominoes to fall? First it was a few of the peripheries then US subprime, European austerity and now slower Asian growth as it tries to fight inflation. We also have to consider whether that demand destruction is smooth or whether government’s fight it through increased debt and transfer payments until they can fight it no longer. If it is smooth then oil prices don’t need to spike hiker to cause demand destruction; the transfer of capital from the rest of the economy can smoothly match the higher oil prices. This goldilocks scenareo is totally unrealistic however as governments can’t completely abandon unproductive assets when they are made redundant, and countries will fight each other economically to determine who gets those resources and maintains their standard of living and who dies.