Ape Man

If Stuart Staniford is wrong, he is making one of the most rigorous wrong arguments I have ever seen. He now has a third essay up making the case that Saudi Arabia is facing involuntary cuts in production.

You would think that his last two essays would have covered all there is to cover with currently available data. But in this essay he gets into the issue of water. Specifically, he talks about how much water is being brought up with the oil.

You see, when the pressure gets low in an oil well, a common technique to keep production up is to pump water down into the well. To grossly oversimplify things, the more water you pump down in the well the more water is going to come out with the oil. The higher the water content in your oil, the closer you are to closing up shop.

Anyway, in Stuart Staniford’s latest post, he makes a convincing argument that the water levels in the Saudi oil point to big problems ahead. I think his latest essay is well worth reading as always. But I want to point out that wither you buy his theory is largely irrelevant to whether you should be concerned with the facts he brings up.

It seems to me that if you deny Stanford’s theory, it you must accept that there has been a fundamental shift Saudi policy away from cheap oil. This shift will have much the same implications for Oil consumers as if Stanford’s theory that cuts are involuntary is correct.

First off, let me say that I am constitutionally inclined to doubt any talk of resource scarcity. To my mind, resource problems are usually an indication of the folly of man, and not any natural lack.

In spite of my constitutional make up, I have to confess that sometimes you just don’t get the rain you want. And as a kind of corollary, I have to allow that sometimes you just don’t have the resources you would like. The essays that have been written that set out to debunk Staniford have not been convincing and I am coming to the conclusion that Staniford may well be right.

The reason that I have come to believe Staniford in spite of my constitutional make up has much to do with the weakness in explanations put out by Staniford’s opponents for the Arabian production cut. To believe that Saudi Arabia is cutting production voluntarily, you have to believe a lot of things that I just can’t swallow.

For example, as soon as prices went above 30 dollars a barrel in 2004, Saudi Arabia dramatically kick up its oil production by about 1.5 million barrels of oil per day almost in the blink of an eye. But even though prices kept rising, Saudi Arabia’s production leveled off at around 9.5 million barrels of oil per day. They stayed at the level until sometime in 2006. At which point production started dropping even though the price of oil was above 60 dollars a barrel.

Now those who disagree with Staniford argue that this drop is voluntary. But why did Saudi Arabia think that above 30 was to high in 2004 and above 60 was to low 2006?

Some people try to argue that the Saudis’ cut production with oil above $60 a barrel because they were scared by how high inventories climbed. For a long time I bought that argument myself. In fact, I figured that oil prices just had to drop sharply to rebalance inventories. But if some people have inside information on the state of Saudi oil production, it would make sense that there would be a lot of inventory build up even as prices were rising.

Now we see inventory unwinding and we don’t see prices falling. Makes you think.

What it boils down to is this: Charts showing climbing rig counts and rising water levels are cool and all, but the fundamental thing that sells me on Stanford’s argument is the price vs production chart. To me, all the other things that Staniford brings up are just icing on the cake.

Saudi Arabia’s recent production moves are entirely at odds with their stated policy goals, their past practices, and common sense. If Saudi Arabia’s recent production cuts are truly voluntary, then there has been a momentous policy change in the Kingdom.

One of the main problems with the “Saudi Arabia wants oil price to be high” argument is that in the past (except for the oil embargo) Saudi Arabia has always wanted oil prices to be low. Their stated reason was always that high oil prices encourage investment in alternate forms of energy. Since Saudi Arabia always had lots of oil, they were afraid that if they kept oil prices high enough to encourage alternate investment, they would kill the goose that laid the golden egg.

But now oil prices are high enough to cause a regular boom in investments in alternatives to oil. As long as oil stays above 60 dollars a barrel, that boom looks likely to continue. So if Saudi Arabia has decided to keep oil about 60 dollars a barrel voluntarily, what has suddenly changed to make it so that they are not afraid of killing their golden goose?

Moreover, the ruling house of Saudi has been publicly worrying about the threat posed to their rule by Iran. One of the worst things that could happen to Iran would be for the price of oil to drop. Heck, Iran can’t even afford to pay the Russia’s for help with their nuclear installations even with the currently high oil prices. If the Saudi Arabian princes are truly keeping prices up voluntarily, then they are handing a great gift to their greatest enemy.

To me, simplest explanation for the evidence is that Saudi Arabia can not keep up a production rate of 9.5 million barrels of oil a day. But if you don’t agree, then you should at least accept that Saudi Arabia believes that high oil prices are good thing. In the short term at least, that bodes ill for poor people and poor countries.

This entry was posted on Monday, March 26th, 2007 at 8:30 pm and is filed under Economics, Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.