Published November 12, 2007 in the Financial Times
From Mr Warren Mosler.
Sir, As crude oil prices continue to rise, the media continue to assume that competitive market forces are behind the increase, including political tensions, weather, supply disruptions and demand pressures. Completely overlooked, however, is the fact that the Saudis post their offered prices for the oil they sell to their refiners, and let the quantity they deliver vary with demand. It is a simple case of monopoly price-setting. The Saudis are acting as ÃƒÂ¢Ã¢â€šÂ¬Ã…â€œswing producerÃƒÂ¢Ã¢â€šÂ¬Ã‚Â and setting the world price.
As a point of logic, the Saudis have no choice but to set the price of oil. At the margin, they are in fact the sole supplier of about 8.5m barrels of crude that the world currently needs from them every day. As all economics students are taught, any sole supplier is necessarily a ÃƒÂ¢Ã¢â€šÂ¬Ã…â€œprice-setterÃƒÂ¢Ã¢â€šÂ¬Ã‚Â.
Of course, the Saudis boldly deny that they set prices. However, they do say they do not sell in the spot markets, but that they do (publicly) post their desired prices to the refiners who buy their oil.
The Saudis will continue as price-setter until net world supply increases sufficiently to cause Saudi sales to fall and production to drop to unsustainably low levels. This is what happened in the early 1980s and persisted until the last several years when a decrease in net available world supply put the Saudis back in the driver’s seat.
Additionally, President Vladimir Putin seems to have gained control over pricing of Russian oil, making him a world ÃƒÂ¢Ã¢â€šÂ¬Ã…â€œprice-setterÃƒÂ¢Ã¢â€šÂ¬Ã‚Â as well. This means that either the Saudis or the Russians can raise prices at will, and the rest of the market automatically follows.
The bottom line is that the price of oil will rise to the higher of any price Russia or the Saudis desire, with no relief unless there is a drop in net world demand that reduces the demand for both Saudi and Russian output to unsustainably low levels.
St Croix, USVI 00820
(Senior Associate Fellow, Cambridge Centre for Economic and Public Policy, University of Cambridge, UK)
Copyright The Financial Times Limited 2007