Tuesday, January 13, 2015

The oil price collapse: did the Saudis make a smart move?

Saudi Arabia's data on oil production (all liquids). Data from EIA

Arthur Berman recently wrote this on the oil price collapse:

As far as Saudi Arabia and its motives, that is very simple also. The Saudis are good at money and arithmetic. Faced with the painful choice of losing money maintaining current production at $60/barrel or taking 2 million barrels per day off the market and losing much more money—it’s an easy choice: take the path that is less painful. If there are secondary reasons like hurting U.S. tight oil producers or hurting Iran and Russia, that’s great, but it’s really just about the money.

I think that Berman may very well be right; the Saudi really reasoned in these terms. They wanted to reduce their losses and keep their market share.

But think about that for a moment: was it really a smart move for the Saudis?

Saudi Arabia produces little in addition to oil; its economy is heavily based on oil. And even for food, Saudi Arabia must rely on revenues from oil in order to import food. And even for the mighty Saudi Arabia, oil resources are not infinite.

So, assume you have the power to regulate oil production in Saudi Arabia, what would you do? Logically, you would think that it is silly to keep pumping oil at full speed when it has become so cheap. You would reason that it is a good idea to keep as much as possible of it underground, to use when it will be really rare and expensive. In addition, your competitors will run out of oil when you still have plenty of it; wouldn't that be nice?

Logic? Sure, but only if you think long term. If you think only of the near term profit, then it makes sense to sell all what you have, when you have it. And the future? Well, that will be someone else's problem.

Unfortunately, it is not just in Saudi Arabia that they think in this way.


  1. We have done exactly the some thing with the North Sea oil. We pumped the best half of it in the 20 years of the historical minimum of the price. Congratulations!

  2. Logically, resource scarcity should create higher prices, and therefore it would be logical to leave it in the ground until it is more expensive and reap higher profits. See Ecological Economics (Daly and Farley), p. 188, figure 11.3. For some reason, it doesn't always work that way. EE comments (p. 194-195) on this suggesting that (1) prices reflect scarcity very poorly because no one knows how much oil is really left, (2) in the future demand may fall off because of substitutes, new discoveries, new technology, or a collapsing economy, so future price may NOT be higher despite scarcity. The Saudis may not believe the peak oil forecasts and be more worried that really effective future treaties might limit fossil fuels before they run out. -- Keith Akers

  3. I think Keith's last sentence nails it - much of that oil may never be procured if the world's governments choose to get serious about limiting greenhouse gas emissions. One wonders what the loss of this revenue stream might mean to the people and politics of the region. - corey todnem

  4. Honestly, I doubt it. I think it is more that they don't want to think to the future - they fear it so much that they behave as if there were none

  5. If the Saudis are not thinking of the future, then they are not thinking about their children. I don't care what sect of Islam they belong to in that region, there is no way that abandoning or neglecting children would be acceptable under Islamic law. Maybe the Saudi leadership is stupid? That stretches the limits of credibility. So many of my facebook friends and educated professionals have weighed in on this matter, but nobody seems to be quite sure of the reason. Gail Tverberg's explanation is mechanistic, using financial issues, the inevitable and irreversible decline of industrial civilization and Peak Oil as guides. All I can do is to scratch my head and wait until it's really clear what's going on. The Seneca cliff awaits us all no matter what in any case.

  6. The problem here is, that down the line you probably cannot sell the oil at ANY price, in any currency that holds any worth.

    The House of Saud is doing a Final Liquidation Sale, getting rid of as much inventory as possible here selling into a market that is rapidly dwindling of customers to buy the oil.

    The Oil only holds value as long as the industrial machinery that uses it keeps running, which requires customers with enough purchasing power to buy the products of that industry.

    The issue here is that credit is not being issued out globally to customers to buy the oil, because it's not being paid back, it is in fact all defaulting. The Saudis need to get rid of as much of this as they can before the credit system collapses. Once this occurs, the Saudis probably will still have some Oil left in the ground, but it won't do much good for anybody including them.

    So, if I was a Saudi Prince, I would do precisely what they are doing, which is to liquidate as fast as possible.


  7. "The Saudis are good at money and arithmetic". By now they probably are but when I worked in Saudi Arabia between 1978 and 1981 on something then called "Saudization" of the professional-technical workforce of a big (and I mean BIG) project, they didn't seem to be all that good. But their British and American advisors were already quite good even then. Now they are probably all even better. As far as the future, as long as the U.S. and Israel keep wanting to do their thing in the so called "Middle East" the petrodollar Saudis (the "third pillar") will be fine geopolitically. Geo-economically it is likely to be a different matter and I agree that they probably don't really want to think too much about the future. And when they do they are probably dreaming that at least the royal family and its multitude of friends and good buddies one or two echelons down can all still move to London and enjoy the nice parks, the greenery and the comfortable huge West -end properties they have all bought and maybe rub shoulders with the Tories at their country estates (if those humble western Lords are worthy enough of "their excellencies") or send their wives to Harrods. (they prefer not to think about the climate change in London that their oil in good part caused and will continue to cause) As far as "average Saudis" to the extent there are any, they matter about as much to the Saudi ruling elite as average Americans matter to Lloyd Blankfein and Jamie Diamond. In any case if the clever hare-brained scheme (and whether the rabbits were Saudi or American) was intended to hurt the Russians the Bakken drillers will go bankrupt well before Gazprom or any of the Russian oil companies do. Or maybe they want to produce all of their oil ASAP simply because they are convinced that it could soon become a "stranded asset" after Saudi Arabia fully and meticulously subscribes to the latest climate change accords to come out of Paris?

  8. My guess is that oil companies, specially Saud family, really think in the long term, four or five decades. After all, oil companies hired M. K. Hubbert. Read Jared Diamond book Guns, germs and steel, and Colapse, and you can read it from second hand.

    No, Saud masters know very well what is going on. 200$/barrel is totally unsustainable. Economy can't afford it. And having it when prices are high, is a call to the war mongers for resources. If we atted that Ghawar is close to EOL due depletion, then the picture comes more clear.

    Even at 100$/barrel, economy didn't work, it required high amounts of QE to hold finance and economy working, but this is also unsustainable.

    All this leads to some financial and economical downturn that will have major political implications also. Seneca cliff is close, every day closer...


  9. I trust in our government to make the right decision when it comes to where the oil is sourced from. I just hope it remains stable in the future or we find alternative means to fuel our needs. The electrical capabilities of hardware is forever increasing so maybe they will come up with a good battery soon. Thank you again.

    Abraham Yates @ Apache Oil Company



Ugo Bardi is a member of the Club of Rome and the author of "Extracted: how the quest for mineral resources is plundering the Planet" (Chelsea Green 2014). His most recent book is "The Seneca Effect" (Springer 2017)