Why did the Saudis call on oil producers and consumers to meet in Jeddah to discuss various ways of cooperation to curb the recent run up in oil prices? Why has Saudi Arabia increased its oil production? Why does it plan to announce additional increases, despite objections from other OPEC members? Why did consuming countries and oil companies accept the invitation and agree to participate?
The answer can be summed up in two key words: “moderate” and “stable”. Saudi Arabia is the biggest loser from excessively high and unstable oil prices. Consuming nations are worried that high and unstable oil prices will derail their prospects for steady economic growth. The Jeddah meeting will focus on both moderation and stability.
The Saudi Interest
Current high prices, sharp increases in oil prices, and high price volatility are not in the interest of Saudi Arabia. Saudis who call on the government to ignore the interests of the oil consuming countries and call for lower production in order to keep the oil for future generations ignore the basics of Economics 101.
It best serves future generations in Saudi Arabia to make sure that the demand for oil remains strong for the longest possible time, especially since Saudi Arabia has the largest oil reserves in the world. This objective requires the government of Saudi Arabia to promote moderate and stable oil prices that sustain the demand for oil. Few OPEC members might not have the same goal.
Excessive prices will reduce demand, encourage conservation and substitution, encourage alternative resources, and increase oil production outside Saudi Arabia. Under such a scenario, Saudis will again experience the hardship they suffered in the mid-1980s and in 1998-99.
In short, to keep the oil underground for future generations requires moderate prices. Moderate prices thus become the core of the Saudi oil policy both in the short run, for the current generation, and the long run for future generations.
Some Saudis claim that, unlike the 1970s, high oil prices in the last four years have not led to demand destruction. Instead, the demand for oil continued to grow at high rates along with economic growth. Therefore, they call on the Saudi government to cut production and keep oil prices high.
Those who make these claims ignore several historical facts Generally speaking, the increase in oil prices since 2004 took place in the only period in the history of the oil industry in which oil prices increased along with economic growth, government spending, and military spending and at a time when the value of the dollar and interest rates were declining. The fiscal and monetary stimulus not only compensated for the negative effect of oil prices but also led to strong economic growth that increased the demand for oil.
Now the tide is turning. Economic growth is declining. Inflation and budget deficits in the US could lead to tight fiscal and monetary policies. In such an environment, high oil prices become very destructive. The Saudis are worried about the share of oil in the world energy markets and about their own share in world oil markets. They do not want a repeat of the disastrous experience of the mid-1980s and 1998-99.
The Interests of Oil-Consuming Nations
The objectives of the consuming nations are similar to those of Saudi Arabia: moderate and stable oil prices. Under certain circumstances, high oil prices derail economic growth, increase inflation and unemployment, and increase social and political tension. We are witnessing these conditions now in various consuming nations.
The objective of these nations at this stage is to moderate oil prices. The permanent objective of most consuming nations is price stability. Stable oil prices enable politicians and planers to achieve their goals without the risk of large swings in energy prices, which affect almost everyone in the society in various ways. For example, large price swings in energy prices affect the budgets of schools and police departments. Therefore, they affect education, safety, and security in local communities.
Consuming countries cannot get moderate and stable prices without the help of oil-producing nations. They need to talk with them. The Jeddah meeting will be the platform on which they can discuss “moderation” and “stability.”
The Interests of the IOCs
Even the IOCs want moderate and stable prices. Moderate prices ensure that the demand for oil will continue for the foreseeable future. Stable prices will reduce risk and enable them to invest accordingly. To achieve these “shared” goals, they need to negotiate with producing countries to gain access to reserves or, at the least, to help them produce in a manner that guarantees the longest life for oil reserves. The IOCs also want to persuade the consuming nations to grant them access to markets without heavy government intervention. They want a fair return on their investments.
Excess Capacity vs. Commercial Stocks
Moderate prices result from reserving large amounts of idle excess capacity in the oil producing countries against potential emergencies. Price stability depends on a large number of economic, political, natural, and technical factors, some of which are impossible to predict or avoid.
Cooperation among various parties should focus on the variables that they can control. They cannot achieve goals that require actions that are not under their control. For example, they cannot control investors and futures markets. Producing countries control production levels and excess capacity. The oil companies own commercial stocks. Consuming nations own strategic stocks.
Statistical analysis indicates that the only way we can achieve moderate and stable oil prices is when excess capacity and inventory levels are above certain levels simultaneously. High inventories and low excess capacity will not help.
That means that OPEC cannot adjust its production if inventories are below the optimal level, which is not known to OPEC at this stage. It also means that governments cannot build their strategic stocks if this build up leads to lower commercial stocks.
Once prices are moderate and stable, oil producing countries and oil companies will do what they do best: produce and deliver oil. Policy makers in the oil producing countries will focus on the well-being of their own people rather than worrying about high and unstable energy prices.
Moderate and stable prices are the shared objectives of all stakeholders in the oil industry. The Jeddah meeting will provide the platform to discuss these shared goals and the various ways to achieving them. Regardless, the meeting at the end reflects Saudi Arabia’s own interest. It wants moderate and stable oil prices. It is up to the other parties to decide whether they want to work with Saudi Arabia to achieve these goals. However, I hope that the meeting will not be a platform for finger-pointing and political hype. Blaming speculators will not yield results and will not moderate and stabilize prices. Blaming speculators and increasing production makes sense only if tight supplies are increasing speculation!
Cooperation should focus on what decision makers can control: excess capacity and inventory levels. Once excess capacity and inventories are above certain levels at the same time, oil prices will decline and stabilize. However, this is long term objective. There is nothing can be done in the short run, and thus, the blame game will continue.