The oil price weapon

Thomas Lifson
Numbers of leftists predicted with certainty that following the November elections oil prices would rebound. Their conspiracy theory had it that Bushalliburton was conspiring with its flunkies to dupe the ignorant masses into voting Republican. Once the elections were over, the sheep would once again be sheared by the oil patch gang.

Exactly the contrary has happened. Oil prices are going down. Warm weather in the eastern United States helped, as did a slowing of our economy. There hasn't yet been and won't be a chorus of apologies, or even demands from the right for a reckoning. Such foolishness speaks for itself.

Only one actor has the ability to substantially influence oil prices at the margin: Saudi Arabia. The reason is simple. Only Saudi Arabia has substantial unused production capacity. Because it can raise or lower its own production by roughly 3 million barrels a day, Saudi has an oil weapon to use. The major use for the weapon has been to enforce some discipline on OPEC. Saudi does not want sustained high prices (above $50-60 a barrel, roughly) because at that level it becomes economical to develop tar sands, oil shale, and other substitutes. It wants the maximum price that prevents development of new resources outside of its control.

Commentators are beginning to notice that Saudi is pushing prices down, and the reason seems to be more than economic. Iran needs every penny it can get from oil. High prices have funded the mullahs' nuclear development plan, and helped keep a lid on civil discontent.

Pinchas Landau in the Jerusalem Post writes:
Saudi has always been an OPEC "dove," preferring lower and more stable prices to higher and more volatile ones. Its perennial rivals regarding OPEC policy have been Iran, Venezuela and Algeria. The fact that Saudi and Kuwait are American allies while Iran and Venezuela are stridently anti-American is part of this, but the underlying rationale is commercial logic: the Saudis have traditionally acted as OPEC's swing producer, by using their massive production capacity as a valve to turn higher or lower, as market conditions required. When OPEC makes cuts, other members cut output slightly while Saudi makes the big moves.

On the margin, therefore, Saudi Arabia controls the oil market, at least within certain parameters.

Saudi Arabia is now engaged in the biggest expansion of its oil industry in decades and intends to add some 25% to its existing production capacity by 2010. To sell this additional oil, it needs prices to remain at levels that don't choke off demand on the one hand or spur huge investments in additional global production on the other.

But Saudi has another, even more pressing, agenda. It is no less concerned about Iran's aggressiveness and nuclear ambitions than Israel - and for the same reason: the Shi'ite fundamentalist regime in Tehran is an existential threat to the Wahhabi Sunni kingdom. But it is the oil price boom that is driving Iran's rise. Prices in the $40s would seriously incommode Iran and the resultant social and economic stress may help undermine the regime. In other words, whether the market is "in a very healthy state" as prices fall through $50 depends on which side of the Persian/ Arab Gulf you sit on.
Ed Morrissey of Captain's Quarters asks if Saudi has declared economic war on Iran and notes:
It also frees the Western nations sanctioning Iran to conduct an agressive pressure campaign. The Iranians thought that they had more leverage than the West as a major oil producer, although Iranian exports only account for a small percentage of global commodity trading (around 5%) -- and that share gets smaller and smaller. The Iranians have had to use more of their shrinking production for domestic purposes, meaning that the lower prices have an exponentially crippling effect on their economy.

Put this another way; the Iranians contribute around 2.5 million bbls/day, that's less than the Saudi spare capacity. The Saudis have basically pledged to make an Iranian shutdown irrelevant in the short to medium term, taking away one of the Iranian trump cards in their standoff with the West.
Hat tip: Ed Lasky
Numbers of leftists predicted with certainty that following the November elections oil prices would rebound. Their conspiracy theory had it that Bushalliburton was conspiring with its flunkies to dupe the ignorant masses into voting Republican. Once the elections were over, the sheep would once again be sheared by the oil patch gang.

Exactly the contrary has happened. Oil prices are going down. Warm weather in the eastern United States helped, as did a slowing of our economy. There hasn't yet been and won't be a chorus of apologies, or even demands from the right for a reckoning. Such foolishness speaks for itself.

Only one actor has the ability to substantially influence oil prices at the margin: Saudi Arabia. The reason is simple. Only Saudi Arabia has substantial unused production capacity. Because it can raise or lower its own production by roughly 3 million barrels a day, Saudi has an oil weapon to use. The major use for the weapon has been to enforce some discipline on OPEC. Saudi does not want sustained high prices (above $50-60 a barrel, roughly) because at that level it becomes economical to develop tar sands, oil shale, and other substitutes. It wants the maximum price that prevents development of new resources outside of its control.

Commentators are beginning to notice that Saudi is pushing prices down, and the reason seems to be more than economic. Iran needs every penny it can get from oil. High prices have funded the mullahs' nuclear development plan, and helped keep a lid on civil discontent.

Pinchas Landau in the Jerusalem Post writes:
Saudi has always been an OPEC "dove," preferring lower and more stable prices to higher and more volatile ones. Its perennial rivals regarding OPEC policy have been Iran, Venezuela and Algeria. The fact that Saudi and Kuwait are American allies while Iran and Venezuela are stridently anti-American is part of this, but the underlying rationale is commercial logic: the Saudis have traditionally acted as OPEC's swing producer, by using their massive production capacity as a valve to turn higher or lower, as market conditions required. When OPEC makes cuts, other members cut output slightly while Saudi makes the big moves.

On the margin, therefore, Saudi Arabia controls the oil market, at least within certain parameters.

Saudi Arabia is now engaged in the biggest expansion of its oil industry in decades and intends to add some 25% to its existing production capacity by 2010. To sell this additional oil, it needs prices to remain at levels that don't choke off demand on the one hand or spur huge investments in additional global production on the other.

But Saudi has another, even more pressing, agenda. It is no less concerned about Iran's aggressiveness and nuclear ambitions than Israel - and for the same reason: the Shi'ite fundamentalist regime in Tehran is an existential threat to the Wahhabi Sunni kingdom. But it is the oil price boom that is driving Iran's rise. Prices in the $40s would seriously incommode Iran and the resultant social and economic stress may help undermine the regime. In other words, whether the market is "in a very healthy state" as prices fall through $50 depends on which side of the Persian/ Arab Gulf you sit on.
Ed Morrissey of Captain's Quarters asks if Saudi has declared economic war on Iran and notes:
It also frees the Western nations sanctioning Iran to conduct an agressive pressure campaign. The Iranians thought that they had more leverage than the West as a major oil producer, although Iranian exports only account for a small percentage of global commodity trading (around 5%) -- and that share gets smaller and smaller. The Iranians have had to use more of their shrinking production for domestic purposes, meaning that the lower prices have an exponentially crippling effect on their economy.

Put this another way; the Iranians contribute around 2.5 million bbls/day, that's less than the Saudi spare capacity. The Saudis have basically pledged to make an Iranian shutdown irrelevant in the short to medium term, taking away one of the Iranian trump cards in their standoff with the West.
Hat tip: Ed Lasky