In the oil wars it's the Saudis against the speculators--and so far the speculators are winning

03/23/2012 8:30 am EST


Jim Jubak

Founder and Editor,

Talk is cheap. Especially when you’re in the middle of an oil price war.

So Saudi Arabia’s oil minister Ali al-Naimi, certainly didn’t expect global oil markets to send the price of crude tumbling just because he said “I think high prices are unjustified today” in a March 20 press conference in Qatar.

That’s why he paired talk with action—or at least with talk of the actions that the Saudi’s had taken. Saudi Arabia had an extra 2.5 million barrels a day of production capacity that it could bring on line; Saudi oil storage reserves around the world were full; and a newly hired fleet of super tankers were on their way to the United States.

But Ali al-Naimi must have been disappointed in the market’s reaction to this salvo. On the day the price of Brent crude, the European benchmark, fell just $1.59 a barrel, or 1.3%, to close at $124.12. Brent crude is up, as of the close on March 20, by 15% in 2012.

One day’s battle doesn’t decide a war, certainly, but the Saudis have pulled out their big guns and they didn’t make much of an impression.

Is there anything Saudi Arabia, or the governments of Europe and the United States, can do to stop oil from moving higher? Or have the speculators won a free hand to drive up oil prices—and the price of gasoline--until the day they decide to take their profits?

Let’s start by looking at what the Saudis did and why those actions didn’t impress the global oil market.

First, al-Naimi talked up Saudi Arabia’s ability to raise production. In November the Saudis increased production to 10.05 million barrels a day. That was the highest level of production in more than 30 years. The country will pump about 9.9 million barrels a day in March and April and has the capacity to produce as much as 12.5 million barrels a day, the Saudis say. That would be more than enough to make up for the 1 million barrels a day from Iran that would be lost from global supplies if the United States, Europe, Japan and other countries stop buying Iranian oil as a part of a program of sanctions designed to end that country’s efforts to build a nuclear weapon.

Second, al-Naimi ridiculed the idea that the Iranians could cause a global oil crisis by shutting the narrow Gulf of Hormuz. “If you believe Hormuz will close, I will sell you the Egyptian pyramids. (Who knew there was a Saudi equivalent of the Brooklyn cry of “Hey, Mister, do you want to buy a bridge?)

Besides scoffing at the Iranian ability to close the gulf, which handles 30% of the world’s seaborne trade in oil, al-Naimi pointed out that his country had filled its storage facilities in Rotterdam, Sidi Kerir (Egypt) and Okinawa. Those storage sites hold about 10 million barrels of oil, he noted.

And third, Vela, the shipping arm of government-owned oil producer Saudi Aramco, has started up an oil express headed for the U.S. In 2011 Vela hired one very large crude oil carrier, a BIG oil tanker capable of carrying two million barrels of oil, every other month to ship oil to the U.S. Now Vela has stepped up its hiring rate—this month--to 11 very large crude carriers. The message is clear, the Saudi’s hope: U.S. refineries will have all the oil they need no matter what happens with Iran, the sanctions, and the Strait of Hormuz. (U.S. oil refineries are key to the global prices of refined oil products since the U.S. is a major exporter of refined petroleum products.)

All in all, that’s a pretty impressive line up of action. So why didn’t it knock more off the price of oil than a meager 1.3%?

A big part of the market’s decision to shrug off the Saudi oil minister was a sense that there wasn’t really anything new in al-Naimi’s action plan. Traders who have bid up the price of oil already had these moves figured into their scenario.

So, for example, any speculation on the rising price of oil knows the Saudi numbers by heart—and doubts that the math works out the way al-Naimi believes it does. The Saudi oil minister dismissed fears of production shortfalls from the Sudan and Yemen; forecast that Libya’s oil production would rapidly recover from the country’s civil war; and looked forward to increased production from Iraq. If you’re speculating that oil prices will rise, you’re operating on a very different assessment of production from these four countries.

And speculators also don’t believe the Saudi estimate for how much additional oil the country could pump. In February the International Energy Agency reduced its estimate of the maximum output from Saudi wells to 11.88 million barrels a day from its previous estimate of 12 million barrels a day. That puts the agency ‘s estimate more than 600,000 barrels a day below al-Naimi’s figures for maximum Saudi production.

There’s also the little matter of how much of that spare capacity is actually spare. Domestic demand for oil in Saudi Arabia is at a seasonal low point now and will rise once summer arrives and plunges the country into peak air conditioning season.

It didn’t hurt the speculators’ case either when on March 21 the U.S. Energy Information Administration said that U.S. inventories of crude fell by 1.2 million barrels to 346 million barrels in the week ended on March 16. Analysts had been expecting an increase of about 2.2 million barrels. Gasoline inventories dropped as well by 1.2 million barrels. This is supposed to be the seasonal shoulder period when demand is low and inventories build in advance of the summer driving season.

What everyone knows of the government budgets in the big oil producing countries of Saudi Arabia and Russia certainly makes the speculative trade on higher oil prices more attractive too. Russia and Saudi Arabia need $100 a barrel oil to bring their national budgets into balance. If you’re a trader in oil that means you’ve got a floor to the downside. When the Saudis and the other members of the Organization of Petroleum Exporting Countries say that $100 a barrel is about right for the global price of oil, they mean it. Even oil producers such as the Saudis that want to avoid an oil price shock that would slow the global economy aren’t looking to cut the cash payments and subsidies that they’ve promised and risk domestic upheaval. For an oil speculator that means there’s a solid floor on oil prices to the downside that limits risk if you’re wrong.

But oil speculators feel even more comfortable keeping with their bets on higher oil prices because it’s very hard to see what more the Saudis or the Americans or the Europeans can do. If al-Naimi’s list of the Saudi response to high oil prices is the best that they can do, well, the traders long oil have taken that best shot and are still standing.

Speculators don’t seem in much fear of another release from world’s strategic oil reserves. Rumors that the United States and the United Kingdom had decided on a coordinated release sent the price of Brent crude down just $2 a barrel—the same size drop generated by al-Naimi’s remarks—on March 15.

The very subdued reaction to that rumor is a result, I think, of traders’ experience with the June 2011 release of 30 million barrels by the United States and another 30 million barrels by other members of the International Energy Agency. That took prices modestly lower—well, something did—for three months. But this time countries that include Germany and Italy have said they won’t participate and any release would be a smaller move by just the United States and the United Kingdom in all likelihood. And speculators are also betting—bless their cynical hearts—that if President Barack Obama does authorize a release, he’ll do it closer to summer driving season and closer to the November election.

As I survey the landscape, I have to admit that I end up agreeing with the speculators—I don’t see much on the near horizon that would make me take off my bet on higher oil prices.

Oh, go out six months to a year and Saudi plans to take old fields, such as the Damman field (taken out of production in 1980), out of mothballs will boost production. And Saudi Aramco is spending money to get the new Manifa oil field into production sooner than expected—but expected was originally 2013 and it’s not clear how much time extra money will cut out of that schedule. Saudi Aramco has also boosted the number of drilling rigs at work in the country to 77 in January, Baker Hughes (BHI) estimates, from 59 at the trough for drilling activity in 2011. But again that’s not production that will come on line soon enough to change the thinking on what are, remember, short-term bets on the direction of oil prices.

Really the only thing that speculators betting on higher oil prices have to fear right now is an economic slowdown that would cut demand for oil. (Which is, of course, exactly what the Saudi’s fear.) You can see what fears of economic slowing can do to oil prices by looking at what happened yesterday when bad news from Europe and China took Brent crude down to $123.14 a barrel.

On recent evidence even fears of a slowdown—without an actual slowdown itself--might be enough to smack oil prices over the head and hard. Worries in the early part of this week that growth in China might be slowing more than expected was enough to send oil prices lower, taking the prices of shares of oil producers and oil service companies lower.

I’d be willing to bet dollars to doughnuts (which used to be a riskier bet when doughnuts didn’t sell for 99 cents at Dunkin Donuts (DNKN)) that the country oil speculators are watching most closely right now isn’t Saudi Arabia or the United States, but China. News that real estate prices have tumbled further or that China has cut back on its imports of copper would stall the increase in oil prices. News that industrial production had taken another downward turn or that China’s imports were down again might well be enough to cap this upward move in oil prices. After all, oil speculators have made good profits. No use putting them at risk if the odds that have made this trade so profitable start to get worse.

So, if you’re wishing for lower gasoline prices, maybe, the thing to wish for is bad news on economic growth from China. Of course, you know what they say about being careful what you wish for. That news might be exactly enough to put an end to the current rally in stocks and to slow economic growth in the United States. Seems a lot to pay for lower gas prices in July.

And if you’re an oil trader, I know what speculation is likely to be attractive in say six to 12 months when the extra capacity that the Saudis are working to accelerate now actually comes on line. Think, then, it might be profitable to bet on falling oil prices?

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any company mentioned in this post as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at
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