Why Saudi Arabia Favors Increasing OPEC's Output

Why Saudi Arabia Favors Increasing OPEC's Output...Officially
September 10, 2007 11:20:AM ET
By Tom Waterman
http://www.oilintel.com/

There's an increasing buzz surrounding the OPEC meeting in Vienna tomorrow that Saudi Arabia -- easily the most influential of cartel members, will make a pitch to increase output in the fourth quarter.

Practically every other cartel member, addicted to the petro-dollars now flowing through its coffers, does not agree. They all point out that crude oil supplies are growing and that any increase in OPEC output would collapse prices.

It's all a mirage anyway as crude supplies are building and OPEC is selling beyond output quotas, by anywhere from 650,000 to 850,000 barrels per day. So what's all the fuss?

We need to go back 10 years or so when OPEC looked at the commodities markets as just another financial instrument that would bow to its will. They never imagined that the price of oil would be set daily in New York or London, instead of Riyadh or Tehran.

Saudi Arabia understands that the explosion in electronic trading, particularly ICE in London, where regulations and oversight are virtually non-existent, speculators can control the price of oil. All it takes is enough money to force a position, and the staying power to see it through, and influence the rest of the speculative community.

There are rumors that some OPEC members, through third party agents, are in fact participating in the London Brent futures market. The suspects are Iran, Venezuela and perhaps Nigeria. What better way to push markets in a favorable direction, using the petro-dollars consumers pay.

It's not clear if Saudi Arabia participates, but it would not be surprising if all OPEC members have a role in conjunction with huge banking firms in manipulating oil prices. The financial ability of OPEC members cannot be underestimated. It would explain how prices can remain artificially high for such an extended period of time.

It also makes sense from the fundamental side. OPEC's power to influence oil prices relies on a joint commitment to restrict supplies in order to prop up prices. The problem with this method is the cartel itself. They simply cannot present a unified front when cutting production. Simply put, they cheat. Some more than others, but every OPEC member will not turn away buyers, especially with prices as high as they have been for the past two years.

There are many reasons the Saudis would favor an increase in output, not the least of which is a means to protect market-share as glut conditions approach. Saudi Arabia is concerned that it is losing ground in some of its Asian markets, and it wants to protect its current U.S. market-share, among other markets.

Through the first six months of 2007, Saudi Arabia supplied 10.7 percent of U.S. imported crude oil. They would prefer to supply about 11.5 percent, a share achieved just once in 2007, in January. In May and June, Saudi Arabia supplied 11.4 percent of U.S. imported oil -- acceptable levels.

However, two countries currently exempt from output restrictions are Iraq and OPEC's newest member -- Angola. Iraq will not have a quota until it can sustain production levels at predictable rates, which might not be for another 5 years. Nevertheless, Iraq is gradually increasing production and its share of the U.S. import market is growing. In May, Iraq supplied the U.S. with 10.6 million barrels of crude oil, or 2.4 percent of total imports. In June, Iraq supplied the U.S. with 17.2 million barrels, or 4.2 percent of total U.S. imports.

Saudi Arabia, while sustaining an 11.4 percent of the U.S. market in May and June, it supplied 4 million less barrels of crude in June than in May.

Angola, the other OPEC member that has no output quota, has been erratic in its supplies to the U.S. The range has been a low of 12.9 million barrels in February (3.8 percent) to a high of 21.4 million barrels in May, or 4.9 percent of the U.S. import market. Angola has also competed successfully for some of Saudi Arabia's Asian customer base.

This is the main reason that Sheik Ahmed Fahd Al Ahmed Al Sabah, who is also Kuwait's oil minister, had talks with Angolan officials about how they will be assigned a quota in the near future. Just as they are ready to bring new production online in early 2008, Angola does not like the timing of being assigned a quota. It seems that the prestige of becoming an OPEC member might not be worth the potential financial sacrifice.

We expect that a quota will be postponed until the second quarter of 2008, after new deepwater production is flowing and its levels have risen.

But there is another reason that Saudi Arabia might favor increasing production in the fourth quarter. Prices are too high. The Saudis always look beyond today and tomorrow. They realize that prices approaching $80 per barrel, while offering tremendous profits, also carry a risk. The risk is a weak U.S. economy that seems to heading toward a possible recession, which will mean a broad worldwide economic slowdown. Perhaps even more important than the Federal Reserve reducing interest rates by a half point would be oil prices that fall to the low $60s.

Saudi Arabia understands that current prices are artificially high, and simply making statements that there is plenty of crude oil available is not enough to overcome the powerful spec money that controls the price of oil. Something else must be done to curb the speculative direction oil is tracking.

There are other reasons to bring prices down. The political battle of wills between Iran and Saudi Arabia as each country tries to influence policies in Iraq should not be underestimated. Iran needs money as it pours support into Shiite dominated Iraq. Saudi Arabia provides cash for the Sunni contingent, trying to carve out its slice of Iraq. The Saudi vault is virtually limitless while Iran works paycheck to paycheck. Every petro-dollar Iran can grab, a certain percentage will work to extend its influence.

As Iran's influence in the region grows, it undermines the Saudi royal family, and beyond all other factors, the royal family wants to remain in power.

This is why I suspect that Saudi Arabia will try to impose its will on the OPEC meeting tomorrow. It's not clear if the Saudis have the will to demand a direction against price hawks like Iran, Venezuela, Libya and Nigeria, but the signals are that the Saudis will either nudge the cartel to announce increases in the fourth quarter. The alternative is that Saudi Arabia could open the spigots and single handedly increase worldwide supplies.

In a dangerous time, Saudi Arabia seeks to limit Iran's influence, and now may be the moment to do so.