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Grant McDermott

Assistant Professor
Dept. of Economics
University of Oregon

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Two interesting takes on Saudi oil production amidst all this trouble in North Africa and the current oil price spike.

1) Interfluidity ponders what the private cost of keeping oil in the ground is to the House of Saud. In other words, with all this unrest in the MENA region, can we see any signs that the Saudi Royal Family plans to ramp up production just in case it isn't left in power when the time comes to cash in on future oil prices? I was especially struck by this paragraph:
One might even argue that current circumstances amount to a natural experiment by which we might test the question of whether Saudi Arabia in fact has 3.5M barrels a day of spare capacity they can easily bring on line, or whether they’ve basically been running full tilt already. As the probability of revolution — or else a permanent increase in wealth-sharing to forestall revolution — increases, the private value of oil in the ground falls. If flows don’t increase, that could be taken as evidence that the Saudi Arabia is pumping at capacity.
Personally, I don't think that there are any significant risks of coup taking place in Saudi. Still,  an interesting theory no doubt. There's also no hiding the fact that many analysts are now openly questioning Saudi Arabia's ability to pick up the slack if, say, Libyan production does grind to a halt.[*] Speaking of which...

2) James Hamilton compares past Saudi responses to global oil supply shocks over the last two decades (most notably the first and second Persian Gulf Wars). Using some simple charts, he shows how Saudi Arabia has acted as a very important stabilizing force by promptly making up the shortfall in supply elsewhere. However, he is less confident that they'll be capable of doing so going forward:
But Saudi oil production looks quite different over the last few years[...]. The kingdom's production actually declined between 2005 and 2007. Although it subsequently increased, at the peak of oil prices in July of 2008 Saudi production was essentially only back to where it had been in 2005. The failure of Saudi production to increase between 2005 and 2008 in the face of booming demand for oil from the newly industrialized economies was in my opinion a key reason for the dramatic increase in oil prices over that period. 


An increase of a million barrels per day in Saudi production relative to reported November levels, some of which may have in fact already been implemented, would put them back up to where they were in July of 2008. If all of Libyan production gets knocked out, we'd need 1.8 mb/d to replace it. If the Saudis weren't able or willing to go above those production levels in 2008 when oil was selling for over $140 a barrel, why would you expect them to do so now with West Texas only at $106? 

My answer is, I don't.
Somewhat depressing, but much food for thought here. More twists in the "call in OPEC" tale, you could say. There will, of course, be responses to such negative outlooks on the oil production side, but I'll say it again... Though the current spike is (hopefully) short-lived, we have moved into an era of higher oil prices. Anyone who is forecasting a return to the glory days of (inflation adjusted) $20-$30/bbl circa the 1990s is dreaming IMHO.

(HT: Mark Thoma and Paul Krugman)

[*] Of course, the world is much better prepared for a unexpected slump in production having learnt the hard way during the 1973 oil embargo. That's why, for example, the OECD countries have, on average, two months' worth of inventories as back-up.