I’m going to give you some money. Alright, it’s only notional money, but here it is: you have a product that costs about $20 to produce. You sell it for $50. That’s a nice 30 bucks profit.
Now this is the world’s most popular product and you sell millions of units each day. So you voluntarily decide to stop selling 1 million units per day, giving up 30 million dollars profit per day.
What’s wrong with this picture? No commercial organisation is going to do something so crazy. OK, some of the producers of this material are wholly–owned by their governments, but that just means it’s the government is giving up the moolah.
I’ll tell you what the product is: black gold – oil.
OPEC spokesmen have repeatedly said that they are going to reduce their production (really extraction) of oil, even though demand is at an all-time high. “OPEC decided on its current quota during its December meeting in Cairo, when it agreed to reduce output by one million barrels a day.” (31 January, 2005 Yahoo Business News)
They have also stated repeatedly that they will increase production to lower prices:
"For the longer term, scenarios to raise [Saudi] capacity [from claimed 11 million] to 15 million barrels per day have also been studied and can be set in motion if the global demand requires it," Ali al-Naimi, the Saudi oil minister said at a Conference at Chatham House, London 29 November 2004. Saudi Arabia is the world’s largest oil producer, with the greatest oil reserves, and is thus the lynchpin of OPEC. Historically, as the ‘Swing Producer’, Saudi Arabia has made up shortfalls from other producing countries. OPEC supplies 30 million of the 80+ million barrels the world consumes daily.
So OPEC might reduce or might increase production? It’s certainly confusing, especially as prices have continued to soar. It has been explained away by all sorts of whacky reasons, such as a Texas refinery fire. How can one refinery fire affect the prices of crude oil? Surely the shortage, if any, would be of refined products, gasoline, pesticides, plastics; those would see price rises, not the crude.
I’m no economist but in my simple world of supply and demand, if there’s a product shortage, prices go up.
Adnan Shehab-Eldin, OPEC 's acting secretary-general, also told Kuwait's Al-Qabas newspaper: "I can affirm that the price of a barrel of crude oil rising to 80 dollars in the near future is a weak possibility ... But I cannot rule out [the possibility] of oil prices rising to 80 dollars a barrel within the next two years," he said on 3 March, 2005 to Yahoo Business News.
But we can test this, can’t we? Just check up how much OPEC is producing and whether the numbers of barrels are going up or down. Are the Saudis producing 11 million barrels as they say, or the 9 million Al-Jazeera suggests?
Er, no. OPEC doesn’t produce anything that you can independently check. All the oil figures you see bandied about – including in this article - are guesstimates. Even the respected USGS or the BP Statistical Review take the announced OPEC figures on face value. There is no independent regulator in the way that banks, investment companies, and insurers come under independent scrutiny in most countries. Internationally, there are organisations that check whether cocoa, or coffee, or uranium is being transparently produced. No such deal for oil.
“A lack of transparency in oil markets and poor quality information contributes to volatility and uncertainties. There must be renewed co-operation between oil producers, consumers and market participants to ensure oil market decisions are based on timely, reliable and transparent information.” (UK Chancellor Gordon Brown, IMF statement to G7 finance ministers October 2, 2004)
However, there is a simple explanation for the steady rise of oil prices and the curious obfuscations of OPEC spokesmen. We are nearing the phenomenon of global Peak Oil. We’re probably not there yet, just bumping along near the top of the Hubbert Curve. OPEC has only a limited capacity to pump any more oil. ”One does not have to be a convert to the “Peak Oil” concept to be aware that outside the FSU [Former Soviet Union] oil production appears to be very near peaking, with output from new discoveries just barely offsetting depletion in mature producing conventional oilfields.” (7 February, 2005 Herman Franssen, The End of Cheap Oil: Cyclical Or Structural Change in the Global Oil Market?)
High technology extraction is dangerous: if you extract oil from a field too fast, you damage it, causing dramatic declines such as seen recently in the North Sea (up to 9% per year instead of the expected 3% norm). Energy Banker Matthew Simmons stated: "The faster you pull a reservoir, the faster you pull out all of the easy-to-produce oil. What happens is that you lose massive amounts of what the oil industry calls ‘oil-left-behind’ still inside the field." (20 February, 2005)
If this is so, why don’t they say so? Probably because they are unstable régimes with booming populations, like Saudi Arabia, and fear that if they told the truth the US might invade them to grab the remaining oil. Or their people might revolt if they found out that their already declining standard of living was about to drop further.
If we have hit the structural production peak of oil worldwide, then the trajectory of prices will be relentlessly upward, with only temporary respites. The spokesmen will blather on about ‘terrorism’ or ‘refinery fires’, but the prices will tell the real story. If the increasing prices start a recession that reduces demand, there will be another temporary ‘respite’ as production continues a relentless decline after we have gone over the peak.
“Oil prices will rise through 2008 and stay high thereafter as demand increases and concern mounts that global production is nearing its peak,” according to analysts at Lehman Brothers Holdings Inc. (March 8, 2005)
When Lehman Brothers admits oil is peaking on Bloomberg, its time to fasten your seatbelts. The ride is going to be rocky.