Monday, May 24, 2004

Saudi Rebels?
It's hard to know what to make of the announcement by Saudi Arabia that it would increase oil production by half a million barrels per day in June, without prior OPEC concurrence. Does this signal a split in OPEC, just when its cohesion has been seemingly most effective at raising prices? Or is it mere theater for our benefit?

The Saudis have been signaling for at least the last month that they see the current price levels as being unsustainably high, in terms of their impact on the global economy and on future demand for oil. At the same time, they have blamed high prices on a number of issues other than the volume of crude being produced by OPEC: tight refinery capacity, conflicting US gasoline specifications, and speculation by hedge funds and others.

The key to all of this is inventories. Even if the extra crude that the Saudis will begin selling in June does not immediately turn into petroleum products, because refineries are full, it will prop up the very lean crude oil inventories that have contributed to the run up in prices. Once the market flattens or actually turns down, the incentive to bet on higher future prices diminishes and speculation should return to normal levels. Speculators that miss that shift will find themselves giving back most of their recent gains.

As others have noted, none of this is likely to make driving any cheaper this summer, but it should ease some concerns about how costly heating oil might be next winter.

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