Why Saudi Arabia is Trying to Talk Down Oil Prices

By Dan Denning • April 3rd, 2012 

Why in the world is Saudi oil minister Ali Naimi talking down oil prices? If the Saudis wanted lower oil prices, wouldn't they just pump more oil instead of writing op-eds? Yet Naimi took the op-ed page of the Financial Times last week and wrote:

It is clear that sustained high prices are starting to take their toll on European economic growth targets...The bottom line is that Saudi Arabia would like to see a lower price. It would like to see a fair and reasonable price that will not hurt the global economic recovery, especially in emerging and developing countries, that will generate a good return for producing nations, and that will attract greater investment in the oil industry.

It's not clear at all that Europe's record-high unemployment has anything all to do with oil prices. Europe can't grow because its leaders are heavily invested in prolonging the life of its current debt-based system, which mostly benefits bankers and bureaucrats. Oil prices don't have anything to do with it, although refinery capacity may have something to do with it.

The Saudis claim to have about 2.5 million barrels of spare daily capacity. But to increase production from 10mbpd to 12.5mbpd, the Kingdom would have to pump out mostly heavy sour crudes. Those heavier crudes (as opposed to the light, sweet stuff) require refineries that can "crack" the extra carbon atoms out of the oil to produce refined fuels.

Investing in refineries is not really at the top of the Welfare State's list of priorities. It doesn't exactly win votes. But the lack of refinery capacity for sour crudes clearly DOES have something to do with high prices for refined fuels in Europe, and in Australia for that matter. We'll come back to that in a moment.

For the Saudis, a high oil price supports social spending too. So why would Ali Naimi be trying to talk down oil prices? Is he really worried that high oil prices are destroying demand for oil? If that were the case, wouldn't we have already seen a big drop off in consumption?

We haven't seen that drop off, of course. Oil demand has probably been held up by the giant debt hangover that began ailing the world in 2007. But still, our sense is that the Saudis are worried about the persistently high oil price because it's a function of limited supply. If and when demand DOES rise, it will be revealed that the oil producers can't quickly increase supply.

The sooner energy consumers realise that the oil reserves are a scarce and depleting resource being carefully managed by producers like Saudi Arabia, the sooner energy consumers will look for different sources of energy. THAT is probably what Ali Naimi is worried about. The Saudis don't want oil users looking for other suppliers. They think talking down the price will prevent oil consumers from thinking about alternatives.

For investors, though, now is a very good time to think about who is going to provide the world with the energy it needs over the next 50 years. Not just the developed world in Europe and North America, either. We're talking about the WHOLE world, including China and India. The energy they require will have to come from multiple sources. That's a clear opportunity for investors.

In the meantime, the image below shows that Australia has a grand total of seven oil refineries. You had better expect higher fuel prices, dear reader, unless Australia consciously develops its natural gas industry and produces more refined products. The Australian Institute of Petroleum reports that, "Australia has seven refineries that were generally constructed in the 1950s and 1960s, although they have been extensively upgraded since then, particularly during 2005 and 2006. These refineries are relatively small, with the largest having a capacity of 8300 mega litres per year (ML pa), compared with the four largest Asian refineries which produce between 30 000 ML pa and 70 000 ML pa."

The AIP continues, "Australian refineries must price their output to be competitive with imports (i.e. import parity) from the Asia-Pacific region. There is no tariff protection and all seaboard capitals have product import facilities. Profitability of the Australian refining industry is therefore largely determined by product prices in Asia, and its viability depends on our competitiveness against imports from Asian refiners. In future, the growth in demand in Australia will continue to be largely met by imports, further strengthening the price relationship with Asian product prices."

Source: Australian Institute of Petroleum

Regards,

Dan Denning
for The Daily Reckoning Australia