All Tent and No Camel

When Prince Abdullah Ben Abdel Aziz visited President George W. Bush on April 25, 2005, oil prices topped the list of conversation from the American side. Abdullah, eager to renew his country's old ties with the United States, intended to please.

The question is, how realistic is the expectation that Saudi Arabia can save the day?

The price of oil is sensitive to political turbulence, expectations of global demand and the ability of oil producing countries to manipulate those developments. The "oil decades" of the 1970s and the early 1980s have established such a terrible precedent that any shortfalls in supply of oil tend to create dramatic effects leading to a sharp decline in oil supplies in tandem with price volatility.  As one oil analyst recently observed, "Volatility [of oil prices] is based on supply and demand but more on fear of supply disruption." 

Topping the list of potential disruption is the escalated uncertainty and insecurity in Iraq. The Iraqi insurgents' sophisticated attacks on the Iraqi oil infrastructure remain a major source of concern for oil executives as well as speculators who pretty much rule the spot markets. Add to that the fear of terrorist attacks in any oil-producing country of the Middle East--but especially in Saudi Arabia. Intelligence reports confirm that al Qaeda has long targeted the Saudi oil-production facilities, even though it has not yet been successful. However, al Qaeda has to get lucky in that country only once before the oil production there would be seriously disrupted. One can only imagine the implications of such a catastrophic development on global oil prices. 

That's because the Kingdom not only takes seriously its role as a safe channel for the supply of oil to the West, but it also has systematically built surplus capacity to operate as a "swing producer." Saudi Arabia maintains anywhere from 1.5 to 2 million barrels per day of surplus capacity--a strategic asset that has more than once been called on to counteract supply disruptions in various parts of the world. Now the United States, once again, expects the Saudis to pump more and bring prices back down.

But Saudi surplus capacity is not what it used to be. The problem is that global surplus capacity "has eroded from an excess of some 6 million barrels per day [b/d] at the start of 2002 to between 1 million and 1.5 million b/d today, depending on the source of the estimate. This decline, while partially the result of rising global demand and poor non-OPEC investment, also stems from political events" in producing countries. The result is that the global market is so tight that the current surplus capacity of the Saudis is not expected to serve as very much of a cushion against price volatility stemming from one or more global emergencies.

Interestingly, the official Saudi view discounts the idea that increasing Saudi output would have any effect on gasoline prices. A high Saudi official was quoted yesterday saying that the "high price of gasoline in the United States was mostly the result of a lack of refining capacity in this country rather than a global shortage of oil."  According to this explanation, "It will not make a difference if Saudi Arabia ships an extra million or two million barrels of crude oil to the United States. If you cannot refine it, it will not turn into gasoline and that will not turn into lower prices." 

But supply concerns are only half of the picture; global demand is at record levels. Americans consume more than 25 percent of the world's oil. Petroleum demand in the United States "is projected to average 20.9 million barrels per day in 2005, up 1.7 percent from 2004."  Almost all of this increase is in the transportation sector: "Jet fuel demand is up by 4.5 percent from 2004; motor gasoline use, accounting for almost half of total petroleum demand, is expected to increase by 1.6 percent this year. In 2006, U.S. petroleum demand is projected to increase by an additional 1.5 percent, as use of motor gasoline and other transportation fuels continues to increase."  These statistics come from the Energy Information Administration's April 2005 report.