The Oil Drum

I think Peter Maass had it right about Saudi thinking on prices in his NY Times article The Breaking Point (published August 2005) and worth another look.

The onset of triple-digit prices might seem a blessing for the Saudis - they would receive greater amounts of money for their increasingly scarce oil. But one popular misunderstanding about the Saudis - and about OPEC in general - is that high prices, no matter how high, are to their benefit.

Although oil costing more than $60 a barrel hasn't caused a global recession, that could still happen: it can take a while for high prices to have their ruinous impact. And the higher above $60 that prices rise, the more likely a recession will become. High oil prices are inflationary; they raise the cost of virtually everything - from gasoline to jet fuel to plastics and fertilizers - and that means people buy less and travel less, which means a drop-off in economic activity. So after a brief windfall for producers, oil prices would slide as recession sets in and once-voracious economies slow down, using less oil. Prices have collapsed before, and not so long ago: in 1998, oil fell to $10 a barrel after an untimely increase in OPEC production and a reduction in demand from Asia, which was suffering through a financial crash. Saudi Arabia and the other members of OPEC entered crisis mode back then; adjusted for inflation, oil was at its lowest price since the cartel's creation, threatening to feed unrest among the ranks of jobless citizens in OPEC states.

"The Saudis are very happy with oil at $55 per barrel, but they're also nervous," a Western diplomat in Riyadh told me in May, referring to the price that prevailed then. (Like all the diplomats I spoke to, he insisted on speaking anonymously because of the sensitivities of relations with Saudi Arabia.) "They don't know where this magic line has moved to. Is it now $65? Is it $75? Is it $80? They don't want to find out, because if you did have oil move that far north . . . the chain reaction can come back to a price collapse again."

So, they believe there is a magic price above which recession and dropping demand cause prices to fall. We know for sure in May 2006 that $70/barrel is not high enough. Personally, I believe a price collapse of the magnitude they are worried about is impossible. And of course the ongoing irony--the Saudis were very happy when oil was at $55/barrel, a price I think the world will never see again.