Saudi price setting

Saudi Oil Minister: There’s No Shortage of Supply

By Amena Bakr

March 1 (Reuters) — Top oil exporter Saudi Arabia sought to soothe fears about high oil prices, saying on Tuesday world supplies were well in excess of demand and that $125-a-barrel crude prices were not justified given the anemic state of the world economy.

Cleverly trying disguise their role as swing producer/price setter.

Saudi Oil Minister Ali al-Naimi said the kingdom had satisfied all of its customers’ requests for oil and stood ready to raise output to full capacity of 12.5 million barrels per day (bpd), if needed.

Yes, at their posted prices. That’s how monopoly works. The monopolist sets price and lets quantity demanded adjust.

“I want to assure you that there is no shortage of supply in the market,” Naimi told reporters at a press briefing in Doha, Qatar. “We are ready and willing to put more oil on the market, but you need a buyer.”

As the only nation with said excess capacity, they are necessarily swing producer/price setter.

Oil is trading above $123, just $24 short of an all-time high, as tighter Western sanctions on Iran threaten to slow the country’s exports.

“Oil prices today are unjustifiable on a supply and demand basis,” said Naimi. “We really don’t understand why the prices are behaving the way they are.”

Oh really? How about because that’s where you are setting your prices?

Try lowering your prices by $10 and see what happens?

He said supply of oil was now out-pacing demand by more than 1 million bpd and that customers were not asking for extra crude.

Right, at their posted prices.

“From our point of view, we have had no customer not satisfied. We have satisfied every request for every customer that has come asking,” said Naimi. “We ask the customers, ‘Do you need more?’ and invariably the answer is ‘No thank you.'”

Yes, that’s how monopoly works.

Riyadh is now pumping 9.9 million bpd – the highest in decades – and is willing to produce at full capacity of 12.5 million bpd immediately, should demand warrant, Naimi said. He said he expected output next month to stay at 9.9 million bpd.

Saudi spare production capacity now stands at 2.5 million bpd, he said.

And no one else has any spare capacity to speak of.

“We spent a lot of money building that capacity. We finished building it in 2009, and it is there to be used,” said Naimi.

Yes, they would like more demand at their posted prices.

How hard is this to understand?

The risk now is that WTI converges to Brent when the new pipeline out of Cushing starts flowing, which will be June 1 last I heard.

Storage inside the kingdom was full and Riyadh was holding about 10 million barrels outside of Saudi Arabia in Rotterdam, Sidi Kerir and Okinawa, he said.

“Our inventories both in Saudi Arabia and worldwide are full.”

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55 Responses to Saudi price setting

  1. scarmani says:

    The End of the Saudi Oil Reserve Margin
    Riyadh is less and less able to cushion supply shocks as it consumes more and more of its own oil.

    http://online.wsj.com/article/SB10001424052702303816504577319571732227492.html

    “For the first time, Saudi Arabia’s vaunted spare capacity appears insufficient to cover the loss of a major exporter.”

    Reply

    WARREN MOSLER Reply:

    always a risk.

    Reply

  2. scarmani says:

    http://www.ergo.net/ErgoSpecialReport_Saudi_Oil_Feb2012.pdf

    Is the Saudi Era drawing to a close?
    Since the 1970s, Saudi Arabia has stood as the oil producing nation with the greatest influence on global petroleum markets. With the largest proven reserves, highest exports, and most spare capacity of any country in the world, Saudi Arabia’s sway over oil supply and prices has been unchallenged.

    But events last year—including disruptions in Libyan production, a fractious June OPEC meeting, and increasing domestic political tensions—have laid bare some serious challenges to Saudi Arabia’s ability to maintain its position of power in the medium and long term.

    In this unique study Ergo investigates the pillars of Saudi Arabia’s past and present oil power, and enlists a group of thought leaders to analyze several key threats to Saudi Arabia’s future as the world’s oil hegemon.

    KEY FINDINGS //

    Last year Goldman Sachs concluded that Saudi Arabia was producing more oil than it had been reporting, and that therefore the country had less spare capacity than previously thought. The Goldman study focused on the short-term response to halted Libyan production, but several other critical trends that have long been gathering momentum are impinging upon the Kingdom’s ability to act as the world’s central bank of oil in the long term.

    • Growing Domestic Demands
    » Increasing domestic consumption is the most critical concern for Saudi Arabia’s oil dominance. Saudi Arabia’s quickly growing population of 28 million is increasingly consuming electricity, housing, cars — and ultimately the oil that makes them all possible. Increasing domestic demand for petroleum products has begun to affect Saudi Arabia’s ability to produce for external markets, and Ergo’s threat analysis suggests that it will continue to do so in the future.

    • Constrained Resource Base
    » Saudi Arabia’s oil fields are maturing, and the easy oil has been extracted. Maintaining reserves and production — much less increasing them — will require more advanced and expensive technologies. Although Saudi Aramco has proven itself adept at exploiting the Kingdom’s oil resources, the need for higher capital expenditures to maintain oil production will require higher oil revenues, hence reducing Saudi leverage to stabilize or bring down prices by flooding the market.

    Reply

  3. Walid M says:

    Saudis aside. Oil has become an asset class and is also subject to investment demand . Randy Wray did a great piece last year on commodities showing how investment demand help explains the performance of commodities.
    One cannot deny how closely correlated the price of oil is to the sp 500 . If you want oil down then a market sell off could and has always led to lower oil prices ….. (that does not exclude higher prices being the catalyst for a Lower market which if true means that the sp is itself becoming a commodity )

    Reply

    WARREN MOSLER Reply:

    yes, and the saudis can lose control of price on the downside in the face of a massive liquidation sell off, like the great mike masters sell off in 2008 as explained at the time.

    Reply

  4. pebird says:

    @WARREN MOSLER, But Warren, oil is a strange monopoly, there are dozens of suppliers, not a single (or the more common three) supplier. And one supplier becomes the price setter because they have excess capacity? Maybe I am confusing stocks and flows, but next month other countries are going to sell oil. What does excess capacity mean in this context?

    Reply

    WARREN MOSLER Reply:

    if another nation tries to raise it’s price, and the saudis don’t raise theirs, the buyers will go to the saudis for what they need at the lower saudi price. it’s only if the saudis don’t have enough to fill the demand at their price do they lose control of prices on the upside.

    but if the saudis raise price, and no one else has excess capacity, and the world needs 9.9 million bpd of saudi crude, the buyers have to pay the higher price or shut the lights off

    Reply

    MRW Reply:

    @WARREN MOSLER,

    Does anyone know the actual Saudi price because it isn’t the $125/barrel we hear. That’s the distributor price after other costs are added. What is supplier price/cost? My father was in the oil business peripherally and one day spent an hour explaining what happened from the moment oil was still in the ground until it showed up at the local gas station. I wish l’d paid attention. But I remember him mocking the largely held idea that the Saudis, Canadians, and Venezuelans set the stated price of oil as if only the drillers matter, and those who touch it subsequently get zip. He maintained that the price of oil has been set in The City of London since the mid-70s, separate and apart from national price considerations, a consequence of the 1973 ‘oil crisis’.

    So, was he wrong?

    Reply

    WARREN MOSLER Reply:

    looks like you could subscribe to this:

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    WARREN MOSLER Reply:

    here’s more from the internet, land of eternal frauds, of course, but anyway:

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  5. john newman says:

    This is off the subject, but I thought you would be amused by what Krugman just posted:
    http://krugman.blogs.nytimes.com/2012/03/30/banking-mysticism-continued/

    Reply

    SteveK9 Reply:

    @john newman, Could he talk to a banker and find out who is right here?

    Reply

    wh10 Reply:

    @john newman,

    Krugman really done did it with that one. He’s going down that one, but will rise back up again like a phoenix :).

    Reply

    WARREN MOSLER Reply:

    :(

    Reply

    ESM Reply:

    @john newman,

    Krugman: “First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand. I hope this isn’t controversial, although given what usually happens when we discuss banks, I assume that even this proposition will spur outrage.”

    LOL. What a maroon…

    Reply

    WARREN MOSLER Reply:

    When i worked at banker’s trust in the 70’s loans were approved first, then funded as needed in the CD market, and the fed funds trader was the lowest paid guy on the desk.

    Reply

  6. scarmani says:

    This post is a goad. Saudi Arabia has little or no effective spare capacity remaining. It either can’t or won’t produce much more than it is producing now – and if it did, it would not have customers to buy the additional oil other than to put it back into storage. Therefore, Saudi Arabia has once again lost its role as swing producer / monopolist / price setter.

    It is clear that Saudi’s effective maximum production capacity in 2007 and 2008 was 9.5 mbpd. Saudi was incapable or unwilling to produce more than 9.5 mbpd in 2007/2008, despite prices wildly exceeding those it wished to see.

    Since 2007, Saudi completed several large projects such as Khurais, Manifa and Khursaniya to nominally boost its output capacity by about 2.5 mbpd, but this has been partially offset by continual depletion of existing fields of at least 0.2 mbpd / year.

    Saudi Arabia’s rapidly increasing domestic oil consumption and depleting fields combine to ensure that Saudi Arabia will never again have as much oil production available for export to the rest of the world as it did in 2004 and 2005. Looking forward, their net crude oil export potential has a downslope, and begins to decline markedly after 2015. Markets are forward looking and will increasingly begin to take this reality into account and discount future structural scarcity into present day prices, whatever Saudi says or does on a temporary basis.

    Most realistic estimates put Saudi Arabia’s true usable spare capacity (sustainable >90 days) at 10.5 – 11 mbpd. But Saudi Arabia appears highly reluctant to produce substantially more than 10 mbpd for any steady-state period of time. While technically capable of doing so, producing this much on more than a very temporary basis risks permanent harm to the long term production rate potential of its fields, adds nothing to the current net revenues that Saudi would earn (price decreases and investment costs offset production increases), and the type of extra oil produced, heavy and sour, would not be sought after by existing refineries. Incremental oil beyond 10 mbpd kept in the ground now is more valuable to Saudi Arabia than the additional currency (if any) it would receive for producing it, even factoring in the risk of demand destruction.

    Indeed, this has been more or less explicitly stated in the past. In 2008, “Saudi Arabia’s King Abdullah said he had ordered some new oil discoveries left untapped to preserve oil wealth in the world’s top exporter for future generations, the official Saudi Press Agency (SPA) reported.

    “I keep no secret from you that when there were some new finds, I told them, ‘no, leave it in the ground, with grace from god, our children need it’,” King Abdullah said in remarks made late on Saturday, SPA said.” http://uk.reuters.com/article/2008/04/13/saudi-oil-idUKL139687720080413

    Saudi has already been incented by deeply held security interests to drive prices down in an effort to topple the Iranian regime. The fact that it has not done so in conjunction with tightening sanctions further strengthens the case that it cannot. Only a production-affecting war in the Middle East would lead to maximum Saudi production; but pricing under that scenario would be on a different and much higher basis.

    The incentive for Saudi Arabia to keep some oil in reserve also applies to consumer countries like China. Hoarding behavior is not exclusive to individuals in crowds http://www.businessweek.com/ap/2012-03/D9TQ7HR02.htm. Countries with thin strategic inventories and large trade surpluses will feel the need to build emergency supplies, and this too will affect the supply demand balance.

    For all of the above reasons, it is no longer accurate to say that Saudi Arabia has ample spare capacity of fungible oil and is the swing producer / price setter. Market prices will not be set based on 12 mbpd of Saudi production capacity. For all practical purposes, Saudi Arabia is within 0.5 mbpd of being maxed out.

    Mr. Naimi’s words and actions are mirroring his words and actions during the run-up of oil prices in 2007 and 2008. His denials now echo almost verbatim his denials then. All that remains for the next 12-24 months are shell games shifting oil reserves between less visible and more visible above-ground inventories. The prospect of a second internationally coordinated strategic petroleum reserve release underlines the impotence of Saudi to control market prices by verbally asserting its role as a swing producer. The market knows Saudi will neither set its prices lower nor produce more.

    If the world economy attempts ongoing real economic growth of more than about 1-2% in 2012 and 2013, then there will be an unavoidable replay of 2007-2008 – energy prices spiking out of control, followed by a drastic financial crisis.

    -=-

    http://blogs.wsj.com/overheard/2012/03/29/saudi-arabia-paper-tiger/

    “The question is whether Mr. Naimi’s article will be taken by the market as a warning or a cry for help. On one hand, when the minister controlling most of the world’s spare oil producing capacity says he wants lower prices, those betting on further price increases should be worried. If Saudi Arabia boosts production, fears of oil shortages could dissipate quickly, causing prices to slide.

    But while Brent is down about 1% today, Mr. Naimi’s words have hardly caused a panic. One reason could be the fact that he took such an unusual step in the first place. After all, if Saudi Arabia really can increase production so quickly to deal with any disruption that might arise, why does it feel the need to shout about it? Why not just do it? The very act of advertising one’s claimed strengths can be the surest way to raise questions about their credibility.”

    -=-

    http://ftalphaville.ft.com/blog/2012/03/29/942361/saudi-arabia-resorts-to-jedi-mindtricks/

    “But what does resorting to an op-ed in the Financial Times actually tell us about the kingdom’s position?

    Could it be that the Saudis have taken a leaf out of the Fed’s book, an institution also known to have lost firepower, and resorted to communications as a policy instrument in its own right? That is, when all else fails, resort to Jedi mindtricks: “This is not the supply shortage you’re looking for”.

    Olivier Jakob at Petromatrix has had some thoughts on the matter. As he wrote on Thursday:

    ‘It used to be that Saudi Arabia produced more oil when it wanted lower oil prices. Today, when Saudi Arabia wants lower prices it produces an op-ed in the Financial Times… Writing an op-ed is nice but it also shows that you either do not want [to] or can’t produce more.'”

    -=-

    http://www.ft.com/intl/cms/s/0/d50b7efa-6e9a-11e1-a82d-00144feab49a.html

    “A report by think tank Chatham House [[ http://www.chathamhouse.org/sites/default/files/public/Research/Energy,%20Environment%20and%20Development/1211pr_lahn_stevens.pdf ]] had a stark message. “The world’s largest exporter of oil is consuming so much energy at home that its ability to play a stabilising role in world oil markets is at stake,” it said.”

    -=-

    http://www.reuters.com/article/2012/03/28/column-oil-naimi-idUSL6E8ESAK720120328

    “GROUNDHOG DAY

    We have been here before. Naimi’s argument is precisely the same Saudi officials have made many times before – including when prices were surging in the first half of 2008, again when prices broke OPEC’s presumed price band of $70-80 in late 2010, and when the Libyan civil war sent Brent soaring in 2011.

    In each case, jawboning by the kingdom proved to a substitute rather than a prelude to action, or action only came much later.

    The problem for the Saudis, however, is that it is not obvious that there is much they can do. “Saudi Arabia does not control the price; it sells its crude oil according to international prices,” as Naimi reminded his readers.

    He is perhaps too modest about Riyadh’s influence. But there are real constraints on what the kingdom can do.

    If the kingdom boosted exports, for example by cutting its official selling prices and offering a significant discounts to encourage buyers to take more barrels, it could raise global inventories.

    Oil bears could point to rising output and stocks. But bulls would simply switch the focus to the shrinking margin of spare capacity. Every barrel of increased output reduces Saudi Arabia’s spare capacity by an equivalent amount.

    Prices are driven by expectations, which may or may not be fully rational, depending on whether you believe fundamentalist or behaviouralist theories of commodity pricing, or some blend of the two.

    Saudi Arabia can control actual barrels, but its grip on perceptions is much shakier.

    If Saudi oil officials sometimes sound irritated when asked about the kingdom’s strategy on prices, especially when prices are rising and consumer countries are under pressure, it is because they are being asked to take responsibility for something they do not fully control.”

    -=-

    Reply

    WARREN MOSLER Reply:

    yes, with no excess capacity they can lose control of prices to the upside if net demand grows.

    but they still have control on the downside.

    Reply

    SteveK9 Reply:

    @scarmani, Note: Saudi Arabia has announced plans to commission the construction of 16 large nuclear reactors. The purpose is to free up oil for export. They currently burn oil for electricity, which no one else does because of the world price. That could keep their export game going. And, they won’t take 10 years to build each one, this isn’t the US.

    Reply

    MamMoTh Reply:

    @SteveK9, some other countries also burn oil to produce electricity, which has to come from some source of energy.

    Reply

    scarmani Reply:

    @SteveK9, Yes, Saudi aims to go nuclear, although their motives for doing so may extend beyond electrical needs. They also talk about becoming the Saudi Arabia of Solar PV, and producing more natural gas for domestic use.

    All these fine sentiments are belied in the near term by the fact that they are bidding for / in the process of constructing another 11 GW worth of oil fired power plants:
    http://arabnews.com/economy/article583664.ece

    At 560 barrels per GWh and 40% efficiency, that’s nearly another 0.4 mbpd up the smokestack.

    I agree with Mr. Mosler, they have (constrained) ability to set prices on the upside. But, whatever spare capacity they have left as a producer nation is more than offset by unmet desire to store away oil on the part of developing consumer nations. If they dropped their posted prices, no more net oil would reach the market; the geopolitical risk premium and the lack-of-spare-capacity premium would ensure that there was no meaningful decline in spot prices. If they produced faster, they would simply harm their fields and spend more money trying to run in place. They have no more usable spare capacity, no swing-producer / monopolist status, and consequently no ability to set prices lower.

    Reply

    scarmani Reply:

    @SteveK9, their desalination plants too are oil fueled. Having recently been built at the cost of billions, they are unlikely to be discarded any time soon.

    Also, not all the oil is for water and air conditioning. The more oil revenue the Saudi royals earn, the more they must throw at their unrelentingly swelling populace to keep things from boiling over. More and more Saudis are becoming drivers. The price of gasoline in Riyadh is less than a dollar per gallon. The bottom line is that as long Saudi remains a totalitarian welfare state and preserves oil subsidies that divorce the cost of waste from the world market, Saudi domestic oil consumption will be POSITIVELY, not negatively correlated to the world oil price. Which, in a world with only a few large exporters, is a recipe for a dangerous positive feedback loop.

    Reply

  7. MamMoTh says:

    Unrelated to this post, but here’s Dean Baker’s recent take on tax-backed bonds:

    Can Ireland Outsmart the European Central Bank? http://bit.ly/HtS02O

    Would Saudis accept them for their oil? ;)

    Reply

    SteveK9 Reply:

    @MamMoTh, Refers directly to Mosler.

    Reply

    MamMoTh Reply:

    @SteveK9, of course.

    Reply

    wh10 Reply:

    @MamMoTh,

    Great publicity!! This is exciting! Go Team Mosler!

    Reply

    WARREN MOSLER Reply:

    glad dean likes the idea though he has a few bits sort of confused.

    the saudis accept pretty much anything. the question is what currency they ‘save’ as fx reserves

    Reply

  8. Broll The American says:

    But Al Naimi also says, “Saudi Arabia does not control the price; it sells its crude oil according to international prices.” Aren’t we going to take his word for it?

    Reply

    Jim Thomson Reply:

    @Broll The American, Indeed, same as we believe all statements of all upstanding totalitarian governments. How can you tell if a politician is lying?

    Reply

    ESM Reply:

    @Broll The American,

    Are you going to take Warren’s word for it? Warren’s been pounding this idea for years that the Saudis post a price and sell as much as or as little as the world wants at that price. Yet somehow he’s never provided any evidence for his claim.

    I just spent 15 minutes digging around, and here’s what I came up with:

    I gathered Saudi monthly avg daily crude production from jodidata.org for the Nov 2010 – Jan 2012 period. I gathered the front month closing price for the WTI crude oil future on the NYMEX for the Oct 2010 – Feb 2012 period.

    Then I very simply calculated the correlation between Saudi production and oil price, for monthly data, using no lag, a 1 mth lag on price and a 1mth lag on production. The correlations are 0.014, -0.121, and 0.244. That is, there is virtually no correlation for the same month, there is a slight negative correlation between Saudi production in one month and the price the next month, and there is a more significant positive correlation between the price in one month and the Saudi production in the next month.

    This is obviously a small set of data and covers only recent history (although it does include oil prices varying from 79 to 114), but it leads me to believe that Saudi production responds to price and not the other way around. Of course, what the Saudis actually sell, as opposed to produce, is more important for testing Warren’s claim, and since the Saudis presumably have a big storage capacity, there could be very little correlation between what they produce and what they sell (or at least a highly lagged correlation). If we had that data, then we could really learn something. If Warren is right, then I would expect to see a negative correlation between price and the volume of Saudi oil sales with no lag. If there is no correlation or a positive correlation, then I don’t see how the Saudis could be setting the price.

    Reply

    Adam (ak) Reply:

    @ESM,

    This is interesting. I absolutely don’t have time to play with the data or to get any deeper as I am doing some interesting computer programming stuff at the moment, but:

    Please consider how a Zener diode regulator works.
    http://en.wikipedia.org/wiki/Zener_diode

    The diode is a highly non-linear element which can be linearised in the breakdown voltage region with the introduction of the Zener resistance parameter Rz.

    i(t) = (u(t) – Uz)/Rz for u > Uz, for the range 0<u<Uz i=0
    where Uz is the Zener voltage. For u < 0 the usual exponential characteristic of a diode applies (we have reversed the polarity of the diode in our notation)

    To build a model of the oil price(volume) regulator a buffering component may need to be introduced as the Saudis do not respond immediately to random changes in prices. This would be the time lag component.

    As long as they increase their production as a response to an increase in the prices they do behave like a Zener diode in the interesting range:

    volume(t) = (price(t-t0) – price0) * sensitivity_coefficient

    We would be able to build a non-stationary stochastic model characterised which can be characterised by the correlation parameter which you derived from your analysis of the empirical data.

    Looking at this analogy you have shown that there is a positive correlation between lagged price (voltage) and the volume (current) . This is exactly how a Zener regulator works – in the end it regulates the voltage by the means of passing higher current. You have actually given arguments strongly supporting Warren's hypothesis that the Saudis regulate global prices by producing more oil if the market price rises above the level they want to maintain (or are told to maintain by their American friends).

    Reply

    ESM Reply:

    @Adam (ak),

    What I’ve shown some evidence for is that the Saudis respond to higher prices with higher production, and that the price does tend to respond to the higher production by falling (although one must be careful about the difference between correlation and causation). There is no doubt that the Saudis, with their excess capacity, can influence (or perhaps even regulate) the world oil price to some extent. However, Warren is arguing something more – that the Saudis are directly setting the price. This means that if the Saudis decided on a whim to raise the price, the price would go higher, but they would sell less oil. If they decided on a whim to lower the price, the price would go lower, and they would sell more oil. This does not appear to me to be what is happening. I see the price go up, and then this incentivizes the Saudis to produce more oil. The extra production then slightly brings down prices in response. All pretty basic. The oil market works just like every other one, and the Saudis act like any normal producer which is not running balls to the wall all the time.

    Warren is claiming (I think) that if the Saudis decided Monday morning to sell oil at $90/barrel, the world oil price (with appropriate basis adjustments) would go there immediately. Similarly, if the Saudis told people their price was $115/barrel, the world oil price would go there immediately. I think this is completely wrong. In fact, not even the price of Saudi oil would go to their posted price immediately, since there would be plenty of Saudi oil in storage outside of Saudi Arabia or in transit which could be resold or withheld as the owners decided.

    WARREN MOSLER Reply:

    the saudi policy can only be that of price setter, whether it knows it or not.

    it doesn’t have the option to just sell it’s potential current output at the market without driving price way down.
    so it sets price and watches how much is demanded at that price, and a lot of other things, and acts accordingly

    and that does not mean that in the near term if they raise prices they will sell less, as they probably will sell the same.
    demand doesn’t change that fast, apart from demand to alter quantities in storage.

    And I’m not saying saudi price changes would simultaneously change everyone else’s price, it might take a few weeks for all the adjustments.

    WARREN MOSLER Reply:

    as a point of logic, what else can they do apart from post prices and wait for the phone to ring?

    the key is they have excess capacity. this means they aren’t selling their entire output at ‘market prices’ like the other producers are, who, because of their policies, don’t have excess capacity, and just sell what they can produce at the best price they can negotiate.

    I don’t see why this is so hard to understand, though obviously it is

    Reply

    ESM Reply:

    @WARREN MOSLER,

    This is a funny argument coming from somebody who in the past has essentially said that the US should leave its oil in the ground because it will have much more value in 30 years than it does today.

    There are a whole host of reasons why a producer wouldn’t want to sell 100% of its potential output. For example, it could have a view that oil prices are going higher. Or it could be the case that the marginal cost of producing oil increases rapidly as the producer approaches maximum capacity. Or perhaps even the marginal value of the extra revenues would be lower because it is having difficulty wisely investing the pile of dollars it has already accumulated (this is somewhat related to the 1st example because, the producer is implicitly investing in oil by leaving it in the ground).

    I mean presumably somebody like you could work harder and make more money. So what’s keeping you from selling 100% of your labor capacity? Are you a hedge fund labor monopolist because you’re withholding some of your capacity from the market?

    WARREN MOSLER Reply:

    yes, there are lots of reason not to sell your available output.

    but the point is that if the saudis hike price, the price has to go up because buyers either have to pay the higher price or shut the lights off as there’s no where else to buy those 9.9 million bpd.

    and if the saudis cut price the price will go down as anyone not lowering his price will lose sales to the saudis for as long as they have the excess capacity to support their actions.

    Zaid Reply:

    @ESM,

    I’ve been testing this hypothesis for quite some time. I just modified ESM’s approach by changing WTI to Spot Brent and testing for correlation against premiums/discounts set by ARAMCO for different grades for European delivery (as opposed to production levels). The reason I avoid WTI is because very little oil is actually shipped to the US from Saudi, and WTI is distorted because of the glut in Oklahoma (we know the story: Seaway pipeline, Canadian oil flows, etc). Production in this case is meaningless because what is produced may not be sold, and we’re trying to test whether Saudi’s price setting follows the price moves or vice versa.

    The results? Well, I found significant correlation (P-Value 0.0011 and correlation of 0.32) between the change in the spot price of brent in one month and the change in premiums/discounts set by Saudi Aramco for delivery in the next month for the light crude grade (using 1 month lag). Mosler may be right that the Saudis “can” set prices if they wish, but the correlation significance test is evidence that they are in fact responding to the market price action by lowering premiums when the price jumps too high and hiking them when the price is too low. They are reacting to the prices rather than causing them because when I tested for the other scenario, I found near zero correlation. Because they are setting premiums/discounts to a market-traded price (i.e. “our price is X + spot brent), the effect on price is not as absolute as if they were to come out and say: “our price is X.”

    Reply

    Zaid Reply:

    @Zaid,

    For those with Bloomberg, use the BOIL function, go to option “15) Iran/Saudi Arabia” to see the latest monthly ritual of Saudi price setting for different grades for delivery to different regions around the world. The premiums/discounts are set once every month for near-month delivery, and they reference different benchmarks depending on the region (for Europe it is in reference to Brent).

    ESM Reply:

    @Zaid,

    Nice analysis. Unfortunately, I can’t use BOIL without paying for a commodity package license.

    I realized afterwards that it was silly for me to use WTI prices, but in any event, using the Saudi premium/discount prices is better than using production numbers. The premium/discount prices are telling us how much the Saudis are incentivized to sell. Your calculation indicates that they want to sell more when prices are high and less when prices are low. Hardly surprising behavior.

    WARREN MOSLER Reply:

    it’s an iteration of ‘bufferstock’/price setter

    walter Reply:

    @Broll The American, On several occasions CEOs of the Big Oil companies have said they are not going to try to forecast the oil price anymore. I have heard this for sure from Peter Voser, CEO of Royal Dutch Shell.
    I think that this price unpredictability is in line with Warren’s claim that a swing producer is de facto monopolist and can set the price how he wants.
    As Warren suggested in earlier posts they easily can regularly set it higher or lower while having taken positions in private to benefit from such moves. In such a way they could easily transfer wealth from State companies to their private accounts.
    And the whole world puzzling why it goes up or down.

    Reply

    WARREN MOSLER Reply:

    sorry to ever have doubted that statement.
    ;)

    Reply

  9. Paul says:

    Warren,

    What new pipeline are you referring to?

    Reply

    Ryan Reply:

    @Paul, The Keystone XL southern extension construction and the Seaway pipeline reversal is also happening.

    Increasing prices of domestically produced oil probably does less damage than with imported oil.

    Reply

    WARREN MOSLER Reply:

    thanks, and yes, though the psychological effect/political fallout of wti at 125 could be substantial

    Reply

  10. Tom says:

    Warren,

    Ive always been a bit confiused about this since Im sort of new at all of this…

    If the price of oil in the commodities markets is ~$125 a barrel, is that the price the saudis are posting? Or is it their price plus adding the price of market forces?

    Im a bit confused on how it all works.

    Reply

    Carlos Reply:

    @Tom,

    Yes, I’m in the same boat. Warren, I think we could use a “7 Deadly Economic Myths about Oil.” How do you arrive at the insight that they control price and so few experts don’t seem to get it? Also, is it possible that the US is a victim of this or is there collusion somewhere. I always thought it was a case of US-Saudi Aramco as somehow controlling the Mideast oil supply.

    Reply

    WARREN MOSLER Reply:

    for some reason the mainstream press and economics profession has a problem analyzing monopoly, which ironically is the easiest of all cases to analyze.

    might be because the ‘believe in free markets’ whatever that means.

    yet they recognize the need for anti trust and anti monopoly law

    Reply

    Neil Wilson Reply:

    @WARREN MOSLER,

    They might recognise the need for anti-trust and anti-monopoly laws, but they seem to have spent the last few decades weakening them to the point of uselessness.

    WARREN MOSLER Reply:

    they post various prices for the different grades they might be selling, and the brent price of about 125 reflects relative value.

    Reply

  11. Neil Wilson says:

    What’s the assembled view on this latest video by David McWilliams – about the commodity bubble.

    Normally he’s pretty good, but it looks like he’s gone all neo-classical on this one.

    Reply

    Paul Krueger Reply:

    @Neil Wilson,
    I don’t have a definitive answer, but I like the question very much.

    I think there is an element of truth underlying worries about increased commodity speculation, but I don’t have a handle on what exactly the magnitude of the speculation is, who is doing it (either directly or via investment funds), and how much debt they are accumulating to do so. McWilliams seems to suggest that much of the money being pumped into banks by central bank lending is going towards the purchase of commodities. Does anyone know to what degree that is true? McWilliams worries about the inflation that will result and the Fed’s attempt to curb it with interest rate hikes, but I worry that the inevitable collapse of the asset price bubble and subsequent defaults by investors may pose an even bigger risk if it once again threatens the solvency of major financial institutions. If McWilliams is correct and interest rates were high at the time, it seems like that would accelerate the collapse. In other words is there a growing “commodity bubble” that is anything like the stock market bubble of the 1920’s or the pre-2007 housing bubble? Or could it be something slightly more benign like the dot-com bubble? Or is there little or no risk at all?

    Reply

    WARREN MOSLER Reply:

    have you been through the ‘mandatory readings’ on this website?

    Reply

    Paul Krueger Reply:

    @WARREN MOSLER,
    Yes, actually I’ve read everything a few times, but obviously I’ve missed something significant to get this comment. So please help me understand what that is. I’m guessing that it has something to do with the relationship between the Fed and other banks. There has been a lot made of the large amount of low rate discount window lending being done by the Fed (Randy Wray et al) which has allowed banks to borrow and reinvest to make significant profits. I was wondering if that was fueling any sort of commodity bubble. Did I misunderstand all of that somehow?

    My questions were/are:
    Is there a significant commodity bubble occurring?
    Since bubbles are typically driven by debt, is there evidence of that sort of debt build-up and if so whose debt is it and who is the debt owed to?

    WARREN MOSLER Reply:

    all the fed has been doing is supply liquidity at it’s target interest rate, it’s instrument of monetary policy, and the banks’ cost of funds.

    it’s what it always does, how banking works. i have no issue with the fed in this regard

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