Brad Setser

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If OPEC’s unofficial price floor for oil is now $50

by Brad Setser
May 27, 2006

If oil producers intend to cut production to keep prices above $50, why are so many oil producers budgeting for oil at $30?

And in the process creating a government savings glut?   The growing deposits of the government of the oil producers at their own central banks are absolutely stunning.

The Saudis will add over $100b to their reserves this way this year.   That is enough to write a check of $20,000 to each of Saudi Arabia’s roughly 5 million households.

Just saying.

Incidentally, I also should give credit where credit is due.  In the past, I have criticized the IMF for its silence on the GCC countries’ dollar pegs.   The most recent regional outlook isn’t guilty on that front.  It clearly notes the contribution dollar pegs and conservative fiscal policy have made to the region’s large current account surplus, and makes the case that real exchange rate adjustment is needed.


  • Posted by psh

    ‘why are so many oil producers budgeting for oil at $30?’

    Because they can recall how well their cartel worked in ’98?

  • Posted by Guest

    Does anyone seriously think we will every see $50 oil–let alone $30–again?

  • Posted by Iasius

    $50 oil? Probably, unless the extreme peak oilers are right and we’re falling off a cliff next year.
    $30 oil? We won’t enjoy getting there if we do.

  • Posted by Anonymous

    psh is on the right track but needs to remember that it is not just a cartel but a cartel combined with an oligopoly. Sure, vertically integrated majors lost some power for a period but in this business, accomodations – masked to a degree by nominal competition – seem to always be arrived at.

    Oversimplifying, I would guess that the $50 vs $30 has to do with different analyses of present and future supply (developing glut, glut) on one hand, i.e. OPEC considering reduced production volume in an effort to mitigate this typical cycle, while on the other hand, the planning horizon – which is *much* longer term than most in today’s short-term world – must also attempt to take probable multi-decade price into account, must be relatively conservative. Oilcos know very well that ‘permanent boom’ is mythology — that today’s expansion becomes tomorrow’s contraction.

    When considering price, it is well worth keeping in mind something that Matt Simmons noted in a 1998 paper considering changes in the structure of crude oil pricing:
    “For all those that fervently believe price movement always reflects fundamental changes in physical markets, the discussion in this paper bears careful reading. Our work strongly suggests that large swings in the funds’ net position in oil contracts on the NYMEX have driven virtually every significant movement of crude oil since the MG position was unwound in early 1994. The single exception was a brief period in the fall of 1996 when physical tightness in the market itself set the price of oil.”

    Matt very well identified what seems generally missed, that speculative activity and associated price movement had come to dominate real economy fundamentals, which is also to question the ingrained notion of efficient markets. Too many today fail to grasp that oil price, especially since mid 2003 but starting earlier, is a bubble.

    The question, then, is not whether crude prices will fall – they will – but what, if anything, will offset the decline of petrodollars available for recycle.

  • Posted by dryfly

    The Saudis will add over $100b to their reserves this way this year. That is enough to write a check of $20,000 to each of Saudi Arabia’s roughly 5 million households.

    That could buy one helluva a lot of box cutters. Hint – money can’t buy you ‘love’.

    On the conjecture of whether we will see $30/bbl oil… I’d say ‘yes’ for sure… if it is ‘inflation adjusted’ otherwise ‘no not really’.

    So I guess in some respects the better question to ask is ‘what will a barrel of oil buy’ in dollar denominated products & services?

  • Posted by smekhovo

    There’s no glut of oil, nor will there be, unless many of us die of bird flu.

  • Posted by Sunlight

    Brad, I agree with the thrust of your comment but I think it would have been more precise of you to identify, exactly “which” price of oil has a $50 floor. OPEC manages the price of a basket that blends 11 grades of oil. When most people think of “the price of oil” they refer to the price of Arab Light Crude, 29 degrees API gravity, as traded on the NYMEX. Since the OPEC basket contains some heavy and sour grades in addition to the more desirable, light, sweet grades, the average basket price appears to have traded, as a rough guess, about $5/bbl lower than the NYMEX price during the last year or two. A $50 OPEC price floor then translates to a NYMEX price floor in the mid-50s.

  • Posted by Derkar

    Don’t be obsessed with oil-rich countries. Yes, their wealth comes from oil and gas that command high market prices. Due to the rise of China and India as economic powers, world demand for energy resources has permanently shifted upward and with more demand comes a higher price. But, on the supply side, things do not look simple. To maintain supplies, new oil and gas fields need to be developed and those are mainly offshore. Bringing oil and gas on-stream from deep offshore zones has a huge cost which definitely affects profitability of energy companies. Take Russian Gazprom that has long-term commitments to supply natural gas to EU and China. Clearly, in Russia gas is gradually getting expensive to produce and high energy prices will hardly leave Gazprom with any better profitability indicators. Unless sufficient funds are invested in development, the company may face falling production (in volume terms). There might be a scenario under which production would fall to the point where the decrease in dollar revenues (due to the negative volume change) would not be offset by rising energy prices. That’s why the company borrows heavily. And what we have already started to observe in Russia is a rise in non-public external debt representing potential drains on a country’s foreign currency assets.

  • Posted by Guest

    So markets and participants have evolved since 1998. Would be interesting to see something which interprets Matt’s perspective in 2006 terms. Not difficult to imagine a short term collapse in the price of oil, no matter what the supply situation. Aren’t these moves frequently about profit taking and asset reallocation? My guess is any possible price collapse would be followed by a faster rebound, but not without a rearrangement of the current natural order. Whether strategic or chaotic, perhaps the oil-producers are anticipating an adjustment. Behind the fear and greed, lots of cold, hard logic at work.

    One of John Dizard’s FT columns in April reminded us that the stuff in the ground is not worth much without the capacity to get it to market.

  • Posted by gillies

    oil prices will very probably collapse. if there is some fundamental preventing them from collapsing from this level – don’t worry. one-way-bet speculation will drive them to a level where they a r e capable of collapsing.
    as for fundamentals driving the market – chart the last thirty years of total known oil reserves against the oil price and there seems to be no connection.

  • Posted by gillies

    “Due to the rise of China and India as economic powers, world demand for energy resources has permanently shifted upward and with more demand comes a higher price.”

    o yes ? so does economic activity drive the flow of oil and gas – or is it the flow of oil and gas which powers economic activity ? taking the growing economic activity of china and india as a fundamental, leads to unfounded conclusions.

  • Posted by bsetser

    Sunlight — fair point, I don’t think the quotes from OPEC were precise about what they intend to target, only that they have no desire to see oil back in the 30s (and perhaps not the 40s).

    psh — fair point. I too remember the dynamics of 98. and krugman’s argument that the supply response to falling prices can be procyclical, as producers pump more to defend their budgets. that said, cartel reduces to the saudis right now, and i suspect that at some point, they are willing to take 1 mbd off the market. they don’t need the cash.

    bigger issue though is “is there a better way for producers to manage volatility other than conservative budgets for oil and massive government deposits at the central bank” — the scale of those deposits for Russia/ Saudi Arabia is ridiculous. Long-term oil funds for already rich countries, i see. but presumably there are better uses of Russian/ Saudi funds than just bank deposits/ short-term treasuries …

  • Posted by Steve Kyle

    Yes, oil prices will almost certainly collapse at some point. From where is hard to say since in the meantime they could well spike due to some unforeseen event like some nutcase bombing a tanker or perhaps Iran. But the price increases of the past year or two have generated massive drilling in hitherto “uneconomic” places like ultra deep water. New supplies will therefore start reaching the market in a couple of years. On the demand side there is bound to be a business cycle downturn in the near future since the current expansion is getting long in the tooth. So even if the long run projection is for higher prices there is still a high probability of lower prices in the medium term.

    Besides, there is the fundamental truth of all economic time series – Nothing ever happens in a straight line.

  • Posted by Charlie

    Oil will once again be nominally priced under $30. Hybrid technologies will enable this. The world is very close to having usable cars that use batteries that can be recharged overnight. Our cars will be dependant on coal and nuclear fuel instead of oil. My hunch is oil companies and oil producing nations will fight this, but, in the end, they’ll lose out. The Japanese are leading the way.

  • Posted by Guest

    i was just wondering if anyone could point me in the right direction about the consequences of imposing a price floor on the foreign exchange market