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The Price of Gasoline

July 13, 2012

Will the price of oil collapse, and lower the price of gasoline? Or, will the price of oil find a floor?

Before proceeding, the stage must be set.

  • Recent high oil prices were primarily caused by the cut-off of Libyan sweet crude, in conjunction with Mideast instability creating fear in the oil market.

The large difference between Brent and West Texas Intermediate (WTI) prices was partially explained by the Libyan crisis and by the low prices in the US Midwest due to the sudden influx of unconventional crude and a lack of pipelines. The differential has become less in recent weeks.

  • OPEC producing countries have become petro-welfare states that must produce oil income to support their populations.

By one report, Saudi Arabia must sell its oil at $79 per barrel to meet its financial needs. The UAE must get $90 per barrel. Venezuela needs $87 per barrel. Most other OPEC countries are in similar straits. Another report identifies ranges for prices that must be attained.

OPEC countries can’t go back on their commitments to their populations without incurring unrest.

Even Russia, a large oil producing country that is not an OPEC member, needs $115 per barrel to balance its budget. Putin is already clamping down on dissidents, and without high prices he can’t modernize Russia’s oil infrastructure or pursue Arctic oil.

What has precipitated the question of whether oil prices will collapse has been lower demand for oil in OECD countries, especially in the United States, as well as in China.

With WTI hovering around $85 per barrel and Brent around $95 per barrel, OPEC must make a strategic decision.

Do member countries increase output to maintain income at lower prices? Or do OPEC countries cut production, hoping that reduced output will keep prices sufficiently high to maintain income at acceptable levels?

History has shown that increasing output merely leads to lower prices, and a death spiral in terms of prices and national incomes. OPEC countries can’t win a price war.

If OPEC members learn from history, they will attempt to cut output in an effort to maintain prices.

Lurking behind the economic issue is the political issue. Specifically what happens if the governments of Saudi Arabia, Kuwait and the UAE collapse?

It would appear as though Saudi Arabia is the only country with sufficient spread between its income needs and its income at current price levels, and sufficient capacity, to be able to cut output significantly. But, can it cut output enough, with some modest support from other oil producing countries, to hold up world oil prices?

And this, in turn, depends on how quickly the economy’s of the United States and China rebound from current recessionary levels. If their economies improve in 2013, with a concurrent increase in oil prices, OPEC can maintain its present output. But this is a big if, and one must wonder how long OPEC can wait before implementing a strategy for maintaining prices.

The International Energy Agency (IEA) has recently forecast that worldwide demand will increase by 1 million barrels per day in 2013. If correct, it might be enough to maintain prices at current levels.

Like it or not, barring an unforeseen event, it is Saudi Arabia’s call as to whether to cut output.

The worst outcome for the United States is a collapse of the government of Saudi Arabia, which could bring down governments in Qatar, Kuwait and, almost certainly, Bahrain.

While increasing domestic production in the United States could undermine any short-term efforts by Saudi Arabia to maintain oil prices, it’s in America’s best long term interests to become as energy independent as possible.

At some point, the Saudi government will change, and it’s impossible to know what will follow. And there is always Iran, plus the Shia – Sunni animosities.

In the near term, Saudi Arabia will probably cut production enough to hold oil prices above $80 per barrel, but it can’t do this for very long. If the US economy doesn’t quickly rebound, or if China experiences a further significant drop in GDP, demand may not recover quickly enough to prevent a collapse in the price of oil.

Then, Katy bar the door.

The key to the future of the Mideast, for the next year or two, could easily be whether the American economy rebounds quickly.


Data on oil prices are from multiple sources, including the European Energy Review, the Financial Post, Deutsche Bank and Credit Suisse. One source shows a range of estimated oil prices for maintaining income at sufficiently high levels to forestall political unrest. For example, the range for Saudi Arabia was $78 to $90.

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