Colin Barry

Saudi Aramco (ENERGY, Tuesday, Week 2)


"Demand destruction:" if oil prices get too high, consuming nations like the US explore alternative fuels (natural gas) and implement policy measures to decrease consumption (emissions standards). These policy measures do not tend to be reversed when oil prices fall. Thus, oil producers have an interest in maintaining a price ceiling.

The Saudis have 18 percent of the world's oil reserves and the lowest marginal cost of production on earth. Their marginal cost to produce oil is estimated at $2-5 per barrel. This puts them in a position to act as an enforcer if other producers (especially in OPEC nations) export too much oil. If the Saudis have excess capacity, they can "turn on the taps" and flood the market, making it unprofitable for every other player to produce oil.

Barring a major global catastrophe, standards of living will rise for a large number of people in developing nations in the next 20 years. Under most reasonable forecasts, demand for oil will skyrocket as automobiles become accessible for the upper class in places like China and India. It is totally conceivable that global appetite for oil will increase from around 80mn barrels/day to 130mn barrels/day by 2030. It is not clear that oil production can match demand.

There is at least circumstantial evidence for a weak "peak oil" hypothesis. Beginning in 2004, the correlation between oil prices and production begins to unravel. Simply put, we would expect oil producers to respond to higher prices by quickly increasing production (and capacity). This has not really happened.