There has been ample speculation on whether the Saudis are truly close to tapped out as far as current oil production is concerned. The overwhelming majority believes that declining production is due to falling yields from their biggest oilfield, Gwahar, which has not been fully compensated for by increased output from other fields. A minority argues that the issue isn’t the sheikdom’s absolute capability; that may or may not be close to its limits, but the oils from current fields is sour crude, when for environmental reasons (and a mis-match of refining capacity) demand has shifted to sweeter crude. This cohort argues the Saudis aren’t making it up when they say they don’t see unsatisfied demand for their product and are correctly reluctant to increase supplies.
An even smaller group contends that Riyadh plays its cards very close to its vest and may quite deliberately be sending false signals. Yes, the Saudis have added more wells, which would be consistent with declining productivity of their developed oilfields. But they could also be seeking to maximize returns by choosing to lower output by taking high productivity wells out of the equation for now and relying on more small wells that would allow them to more finely tune output. Consider: if advanced economies are seriously considering carbon taxes and cap and trade regimes, why should OPEC let charges and schemes increase the real cost of its product and let governments and intermediaries reap the windfall? You might as well run the price up yourself and get as much benefit as you can under the circumstances.
The adherents to that view might argue that the current spike reflects a misjudgment of the supply situation: the continued disruption was not anticipated, nor was the failure of Iraqi production to return to close to its pre-invasion levels. But the Saudis need to look as if their hands are tied, even if the situation hasn’t worked out as planned.
Or has it? Consider this item I stumbled across from a post in June 2007, when I noted a complete absence of reporting in the US of an item picked up by the Financial Times:
As the Financial Times called it, OPEC issued a direct threat against the West. The story, the lead article on page one, titled “Drive on biofuels risks oil price surge,” said that if advanced countries make greater use of biofuels (and therefore reduce their oil dependence), OPEC will punish them by cutting production and producing a price surge:
Opec on Tuesday warned western countries that their efforts to develop biofuels as an alternative energy source to combat climate change risked driving the price of oil “through the roof”.
Abdalla El-Badri, secretary-general of the Organisation of the Petroleum Exporting Countries, said the powerful cartel was considering cutting its investment in new oil production in response to moves by the developed world to use more biofuels.
In case you think this might be a wee bit of overstatement on the FT’s part, keep in mind that OPEC has a proud history of disciplining the US through price moves or threat of production cuts. For example, the International Herald Tribune reported in 2003:
OPEC members, joined for the first time by a delegation from post-Saddam Hussein Iraq, unexpectedly agreed Wednesday to cut oil production by 3.5 percent, driving oil prices sharply higher….
“This was a message to Washington,” said Mehdi Varzi, a private energy consultant in London. “You can send a delegation to OPEC, but we control the oil price.”
In fairness, it’s not clear that OPEC could deliver on its threat, since protracted production cuts in the past have lead to cheating by members. Moreover, a sharply higher oil price would make biofuels and alternative energy more attractive. If OPEC really wanted to discourage the development of new fuel sources, it should engineer volatile oil prices. But it is obviously hoping that its threat will be sufficient (and while it may not affect private sector measures, it could deter government support for alternative energy).
The situation certainly has played out according to script. Whether this outcome was by design or luck is anyone’s guess.