Saudi price setting

Yes, they use the specs for cover and get away with it

They announce their posted prices will be a spread off of ‘market prices’
And then raise their posted prices lock step with higher prices from specs.

If instead the simply left their posted prices alone the price would quickly come back to their posted prices.

It seems to me impossible they don’t know this and are playing us for complete fools

WikiLeaks: Saudis often warned U.S. about oil speculators

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23 Responses to Saudi price setting

  1. Elv says:

    So basically speculators are doing saudis a favor?





  2. Ken says:

    Still don’t see how futures market speculators can drive the spot price of physical oil, given that hardly anybody takes delivery on futures contracts and storage is scarce/expensive, as pointed out by another commenter above.

    If the Saudis are setting the real price based on the forward price, and then saying the forward price is just speculation and doesn’t reflect anything about the real world …. that’s just inconsistent and incoherent. Nobody’s forcing them to use that price.

    If that is indeed what’s going on, it can only happen if the Saudis are indeed monopoly price setters …. otherwise other producers would drop this charade and undercut them in the market.

    To further confuse things …. Krugman pointed out during the 08 runnup that the forward price actually **lagged** the spot price, not the other way around.

    So what am I missing?




    right, no one’s forcing the saudis to use ‘market’ prices as a guide. but the fact remains they can set the prices they post to their refiners at any level they want, it’s a political choice.

    other producers can undercut them, but that doesn’t alter how much the saudis will pump at their posted prices, unless other producers have and use excess capacity, which they don’t, for all practical purposes.


    Ken Reply:

    Thanks …. so does that mean you agree that this whole “futures speculators are driving the price of oil” meme is fallacious? Because I usually get bewildered looks when I suggest that it may be wrong.



    they are driving things in that the saudis use them for cover

  3. macrosam says:

    Don’t disagree but why would they do this? If there are buyers tripping overthemselves more than willing to pay current and higher prices, why would they lower their posted prices? The onus is on the bids being lowered, not the offer, no?


    roger erickson Reply:

    because the Saudis are juggling greed, royal families and lower classes, while worrying about sustainability of their regime, not just spot pricing.

    I’d trust people who have lived there. The Saudis are survivors, not a culture of dynamic speculators.

    You can draw different projection tables based on the alternatives that they’re a) conservative, or b) risk takers.

    They don’t have a population big enough to take many risks. There’s no one to back ‘em up if some fail.



    there are always buyers tripping over themselves to buy at whatever price they charge, up to the point where price actually changes demand, ‘that day’

    the fact that they are the only ones with excess capacity necessarily makes them ‘price setter’

    if they didn’t have excess capacity they would be a ‘price taker’


    macrosam Reply:


    Completely agree but again, excess capacity to a certain degree for what we all seem to acknowledge is a finite resource on perhaps an even more finite demand timeline. And the difference between the Saudis and the Fed as price setter/monopolist supplier is that the Fed doesn’t need to obtain US Dollars while the Saudis do. Why would they reduce their real terms of trade without coercion?

    I understand that they could set the price lower. Just don’t understand why they would unlesss forced to, or why anyone would sell for less than they could unless forced to.

    Roger, not calling them speculators or risk-takers at all, and the US has a geopolitcal interest in maintaining the Saudi regime with its geographical placement and bordering of the Persian Gulf. Part of the US’s grand military strategy seems to be committed to preventing the formation of a caliphate state that extends to both oceans, as the US extends to both oceans. I don’t think they’d bail on the Saudis, though they will pressure them.


    ESM Reply:


    Once again I think your obsession with the Saudi’s oil pricing power is very silly and inconsistent with the rest of your market philosophy.

    “…up to the point where price actually changes demand…”

    Ummm. Changes in price always change demand. As Scarmani pointed out the price elasticity of crude oil is not zero. In fact, it is about -0.4, meaning the demand drops 0.4% in response to a rise in price of 1%.

    “the fact that they are the only ones with excess capacity necessarily makes them ‘price setter’”

    How do you know they’re the only ones with excess capacity. In fact, I’m quite sure they’re not. The US, in fact, has excess capacity but our bumbling president won’t let us tap it. Does that make Barack Obama a “price setter”, or merely a spiteful jerk?


    roger erickson Reply:

    I thought Warren’s point is that there’s no way to empirically find out, so far. That translates into considerable uncertainty, not just risk.

    One can’t be criticized just for being suspicious.

    “No matter how cynical you become, it’s never enough to keep up.” Lily Tomlin


    my arguments are points of logic

    ESM Reply:


    actually @Warren

    “my arguments are points of logic”

    No, they’re not. Even if the Saudis have spare capacity, which is not obvious (and there are perfectly rational reasons for not using spare capacity other than trying to squeeze the maximum amount of revenue possible in the short-term), and even if none of their competitors have spare capacity, which is also not obvious (and I have already given you one good example of a country which has spare capacity but is not using it for reasons having little to do with the price of oil), the Saudis can still only be price-setters within a fairly narrow range.

    The price elasticity of demand for crude oil is approximately -0.4. If the Saudis can increase their daily production by 2MM bpd (which is optimistic), that would increase world production by 2.4%. This should lead to a drop in the price of oil of 2.4%/0.4 = 6%, or about $6 per barrel. This is hardly anything to write home about.

    The following argument is a point of logic:

    If the Saudis have true spare capacity (“true” in the sense that they are truly indifferent towards ramping up production except for the effect on price, i.e. it doesn’t damage fields, equipment, compromise security, cause bottlenecks in shipping, deplete reserves that they expect to sell at a higher price in the future, etc.), and nobody else in the world has true spare capacity, then the Saudis have the ability to set the world price of crude within a narrow range.

    You have been saying something a bit different.


    No, that is what I have been saying

  4. Mario says:

    great article Warren.

    I don’t what you are saying though…who is playing us for fools here? the Saudis? Why? B/c they are speculating as well?

    I would think it’s the US politicians and Wall St. that are playing us all for fools and not addressing these facts that are right before their eyes. Is that what you mean?

    What is the problem with making profits on spreads? You always remind me that it’s okay for banks to do that off the FFR for public loans and public debt consumption…why can’t it be okay to do here as well? Everyone has a business to run, so spreads are okay right?

    Don’t OPEC and the various nationalized Mid-East oil companies function in essentially the same manner regarding oil as the Fed and banks do with capital? OPEC’s set prices would be similar to the Fed setting rates and market prices would be similar to bond prices and everything “follows” from there.

    thanks again for the great article



    yes, it’s like the fed is the monopoly supplier of reserve balances, and therefore is price setter when it comes to fed funds.

    it could pretend otherwise, and say it was letting the market decide rates, and peg the ff rate to, say, the 10 year tsy. so when the specs ran up the yield on the 10 year tsy the fed would hike the ff rate, and vice versa. you can imagine the forces that would set loose and the chaos that would follow?


  5. scarmani says:

    I don’t think the Saudis are playing us for complete fools; I don’t think that speculators are doing anything other than discounting long term supply and demand constraints.

    The remaining spare Saudi production capacity (to the extent it exists) seems to be for heavy sour crude which can only be sold at a heavy discount. All of the crude with desirable characteristics that the Saudis can produce, they appear to be producing.

    If the Saudis dropped their posted prices for physical crude oil shipments with desirable characteristics to $20 / bbl below the current market price, what would happen?

    My guess is that the spot price would quickly fall toward the Saudi posted price, but the term structure of the market would shift to steep contango (long dated futures would remain relatively stable). As a result, speculators would request increased delivery of physical crude oil to store away for risk-free profit, and Saudis would be unable to deliver the incremental barrels.

    Net result, the Saudis would just get less currency for producing the same quantity of oil, and have to turn some customers down – leaving them less able to fund the constantly growing welfare state which they to pacify their oppressed populace, and risking their credibility to boot. The Saudis are not like a Central Bank – they do not have unlimited capacity to create barrels (and in particular, the RATE of production is strongly constrained and path dependent).

    This scenario does depend on the assumption that long-dated futures prices remain anchored in the face of the Saudis pricing their oil below market.

    For long-dated futures prices to fall, the market would have to believe that 1) there was a permanent change in Saudi policy towards pricing their oil below what the market could bear, 2) that the trajectory of demand would not rise in response to such a change in policy, and 3) the global investment in new supply would not fall in response to such a change in policy.

    In response to belief 1) – the populations of Arab countries are growing increasingly restive; King Abdullah bin Abdul-Aziz Al Saud is 88 years old; 70% of the Saudi population is less than 30 years old; 40% of Saudi youth are unemployed; half of those that are employed earn less than USD 1000 / month; whereas thousands of Saudi royals get tens of thousands of dollars per month (sometimes more) in stipends. Some Saudis who do not like a status quo have been known to express their views through violent terrorism. Thus, the Saudi regime will need increasing flows of currency, in order to fund the growing welfare state on which it depends to keep its population at bay. Saudis have already stated they will not be increasing their rate of production above 9 mbpd anytime in the foreseeable future, and further stated that therefore the price of crude will need to increase yearly to cover their budget needs. Conclusion – Saudis will charge all that the market can bear for the crude it produces, risking demand destruction abroad rather than political overthrow at home.

    In response to beliefs 2 and 3, the elasticity of demand for crude oil is very low, but it is not zero. Lower prices will over time result in higher demand and lower supply. The futures market should take this into account and longer-dated futures contracts should remain anchored relative to spot price fluctuations. This was empirically observed in 2007-2009.

    So, it seems very likely that long-dated futures prices would remain anchored even if Saudis could drop spot prices tomorrow. If the Saudis dropped their posted price, spot prices would fall but futures prices remain at high levels. More physical crude would be demanded by speculators seeking to profit from the arbitrage opportunity. Saudi would not be able to deliver the extra barrels, thus barrels would be removed from the market and stashed away on tankers etc., and the spot price would increasingly creep back above the Saudis posted price until the arbitrage was exploited.

    Net maximum crude oil production capacity will (at best) be increasing less than 1% per annum between now and 2015, and the economic growth that everyone seems to be counting on will imply crude oil demand rising more than 1% per annum. Given the current thin margin of spare capacity, this implies either a preemptive soft landing (lack of economic growth through 2015, engineered by policymakers), or a physical shortage of crude oil resulting in a severe price spike and hard landing (like 2008 but worse).

    The actions of the US and Chinese authorities, who both want to minimize unemployment leading up to the 2013 transitions of power, make the latter course appear more likely.


    Dan F Reply:


    “More physical crude would be demanded by speculators seeking to profit from the arbitrage opportunity.”

    Doesn’t that assume there is 1)speculators want to take physical inventory 2) there is storage space available.

    From what I have read a great deal of speculators never take inventory and the world capacity for storage is maxed out.


    roger erickson Reply:


    Impressive analysis. Yet the omnipresent ignorance of current policy staff seems likely to accelerate all the events you expect. That acceleration will produce it’s own, unpredictable events. The Saudis are caught between a rock-headed system and some hard components.

    The questions are: how intelligent are policymakers, and how complacent are residents? That’s not risk, it’s rank uncertainty.

    re Warren’s message:
    > It seems to me impossible they don’t know this and are
    > playing us for complete fools

    When assessing the “fool-stock” of adversaries, Pogo advised to never discount domestic supply.

    Whenever we wonder how ignorant policy can be, it always seems to surprise on the downside. PT Barnum & Will Rogers echoed this. Seems to be a problem especially of 20th century scale, but has been present since 1776.

    Go long nuclear/other energy alternatives? Or not until the oil lobby destroys pricing once again? In maneuver warfare, timing & coordination is everything.



    if the saudis don’t have any actual excess capacity then they are price takers and not price setters.


    jason m Reply:

    @scarmani, +1
    Good contribution to the discussion.


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