Saturday, March 10

Who runs the world? You're about to find out.

The world is run by five clerks who work above a grocery store in Geneva, Switzerland. I am not making this up, except the number could be more than five depending on the amount of square footage above the store.

The clerks work for a company called Petrologistics, which is the world's only source for OPEC oil production numbers that come from outside OPEC. That means Petrologistics is the only definitive source for sets of numbers that underpin the entire global financial sector and thus, Petrologistics keeps modern civilization from falling back into the dark ages.

How did Petrologistics get to be the sole arbiter of the OPEC production figures? Because the cartel members lie to the sky about the size of their country's oil reserves. That's so they can cheat other cartel members by producing oil above the agreed-upon quota, which is based on reserves.

How do we know that Petrologistics figures can be trusted any more than OPEC's? We don't. The company claims to have spies in every port -- presumably to count the oil barrels being loaded and offloaded from container ships. If that doesn't sound like a very reassuring way to collect data, there is no alternative except for the OPEC numbers. So everybody in the oil business, and all the world's currency traders, and international bankers, and governments take the Petrologistics fact sheet as their Bible for oil production numbers.

Next question: How wide is the divergence between the Petrologistics and OPEC numbers? The June 2005 Wall Street Journal article I'm referencing doesn't say, but it reviews a 2005 book, Twilight in the Desert by Matthew R. Simmons, a Texas investment banker with a Harvard Business School degree and 20 years' experience in oil. Simmons claims that the Saudis are considerably overstating the amount of their oil reserves.

"Again, there is no way to validate or dispute Simmons's claim because the Saudi version of the reserves number can't be vetted. In 1982, the Saudi government took complete control of Aramco (Arabian American Oil Company); since then the company has never released field-by-field figures for its oil production. Yet the Saudis claim that, for at least the next 50 years, they could easily double their current output of 10 million barrels a day.

"Simmons took a back door approach in the attempt to get near a realistic production figure. According to the Journal article:

"Simmons became suspicious of Saudi claims after taking a guided tour of Aramco facilities in 2003. To penetrate the veil, he turned to the electronic library of the Society of Petroleum Engineers, which regularly publishes technical papers by field geologists. After downloading and studying more than 200 reports by Aramco personnel, Mr. Simmons came up with his own portrait of Saudi Arabia's oil resources. It is not a pretty picture. [...]

"Simmons doubts that Aramco can increase its output to anywhere near the level it claims. In fact, he believes that Saudi production may have already peaked."

Simmons does have his critics, who argue "that, by relying on technical papers, he has biased his survey, since geologists like to concentrate on problem wells the way that doctors focus on sick patients." But from others who read the tea leaves, the truth is probably somewhere between Simmons's dire projections and the rosy story told by the Saudis. It's really anybody's guess.

So why am I highlighting a speculative report published almost two years ago? Because now Wretched at the Belmont Club blog is concerned about the Saudi oil reserve figures and the implications, if Simmons's projections are correct"

"The Oil Drum is suggesting that Saudi Arabian oil production is now declining due to depletion. It juxtaposes declining Saudi production against its rising recovery effort. They're running harder but they're slowing down. From the data, he reaches the conclusion that yes, the Kingdom is running out of oil. [...] I suggest that this is likely to place severe political strains on Saudi Arabia within a year or two at most.(1)"

I don't know whether the Saudis are running out of oil but I think it's beyond argument that they're running out (or maybe they've already run out) of oil that's cheap to extract, which is the story for many oil-producing regions. Back to the Journal article:

"The six major [Saudi] fields, having all produced at or near capacity for almost 40 years, are showing signs of age. All require extensive water injection to maintain their current flow."

The water injection is very expensive. So, even if dire predictions are wrong about the Saudi oil fields, we're still looking at the prospect of oil that is much more expensive than found today. What's the net result for the US?

To answer the question, visualize the US dollar. The greenback and in particular the petrodollar is America's major export. One of Pundita's earliest posts was to warn about the specter of petrocurrency wars, and periodically I return to the topic.

The use of US currency as the major medium of payment for major commodities, including oil, is a double-edged sword for the American economy. But nobody wants to think of the consequences for the global economy if the US dollar crashes, so it won't happen. The Lords of the Craps Table won't let it happen because The Casino -- the international monetary system -- has to stay standing. However, there is now underway a reasonably orderly progression from the dollar hegemony, which is not a bad thing for the US economy if the progression remains orderly. Russia is already denominating a basket of currencies as payment for their oil.

With those points in mind, tell me what happens when the price of oil goes up? Yes; the dollar gains back value it lost by having to share the stage with other currencies used to purchase oil. The higher the price of oil goes, the greater the dollar export cushion to the US economy. Recall that formula whenever you hear doomsday projections for the US if the Saudi oil fields running out.

All this said, the Saudis are getting off their bums (at least partly due to pressure from WTO, now that Saudi Arabia is a member) and casting about to diversify their economy; this, so they're not entirely dependent on oil revenues. As to how they're going to pay for the water needed for these diversification projects, I dunno, but here's the plan:

(Hat tip for the link to Buddy Larsen via Belmont Club comment section.) From the Financial Times via Wall Street Journal via T. Boone Pickens blog:

"Saudis build for less oil-dependent future
by Andrew England in Cairo, March 1:

“We have always believed in free trade but we needed to open up further,” says Fawaz al-Alamy, Saudi’s chief technical negotiator for World Trade Organisation accession. “We found out after the previous boom and the last decline that oil is a volatile commodity and we cannot keep a country hostage to it.”

"After the Saudi boom of the 1970s and early 1980s, gross domestic product growth in the Gulf’s largest economy dwindled to about 1 per cent annually, while population growth soared to about 4 per cent. During the current boom, its real GDP annual growth bounced back to between 4.2 and 6.4 per cent, with the size of the economy swelling from $188.5bn in 2002 to $348bn last year. Economists say nominal growth, a more accurate indicator, has been double-digit.

"After years of budget deficits, the government is now flush with petrodollars and was able to announce a record budget surplus of $70.7bn last year. Economists expect economic activity to be robust this year, even if real GDP growth slows on a reduction in oil output.

"Yet even with its abundant wealth, the world’s largest oil exporter faces tough challenges as it seeks to expand the private sector and reform the education system and labour market, which will be crucial to ensuring young Saudis find roles outside the public sector.

"The issues confront all Gulf states but in Saudi Arabia they are perhaps more acute as the kingdom is the Gulf’s most populous nation, and reforms could face resistance from the highly influential religious establishment. And, in spite of producing about 9m barrels per day, Saudi Arabia’s oil production per national citizen is lower than four of the other five members of the Gulf Co-operation Council, according to McKinsey and Co, the international consultants.

"Saudi officials say they have already begun the diversification process, citing the kingdom’s accession to the World Trade Organisation in December 2005 and the acceleration of economic liberalisation. Since then, non-oil exports have increased by 13 per cent annually to more than $20bn, while foreign direct investment has increased by 250 per cent to more than $5.6bn, Mr Alamy says.

"Much of the investment still focuses on the oil sector but a key element of the government’s strategy to spread funds wider is the construction of the economic cities, including King Abdullah City, to attract foreign and domestic investment, broaden economic activity throughout the kingdom and create hundreds of thousands of jobs.

"The plan, officials say, is to build on reforms and leverage the state’s competitive advantages – targeting energy-intensive industries, such as aluminium, steel and plastics, and utilising its location on the Red Sea.

"Sagia, the investment authority, is even looking to tap into the kingdom’s role as host of Islam’s two holiest sites. King Abdullah City’s port will be designed to cater for 300,000 Hajj pilgrims, and a new city on the edge of Medina will be seeking to attract Islamic investment, says Fahd al-Rasheed, deputy governor at Sagia.

“It’s based on economic rationale,” he says. “We have 25 per cent of the oil reserves in the world but only 2 per cent of the energy-intensive industries. For example, a major component for producing aluminium is energy and we know that we are 31 per cent cheaper than the US and Europe.” One goal, he says, is to corner 15 per cent of the aluminium market by 2020. Saudi Arabia’s current share is negligible.

"By the time the cities are complete in 10 to 15 years, their combined GDP is targeted at $150bn in today’s terms, with the creation of 1.3m jobs and a total population of 4.5m.

“The cities are designed in a way so that you establish the industries, that brings jobs, they bring families, they start buying real estate, they start requiring restaurants and shopping malls, so there’s a virtuous circle of real estate and job creation,” Mr Rasheed says.

"Some $100bn will be invested in infrastructure alone and the government is seeking private sector investment to finance the projects, with Sagia acting as regulator and promoter. Emaar Properties, the Dubai-based group, is a significant shareholder in Emaar Economic City, which is spearheading the King Abdullah city project.

"The targets are ambitious and some question whether the conservative nature of the state – where women are banned from driving and segregated in most work and social places – will enable it to compete with more liberal Gulf countries in terms of foreign investment.

"Security will be another factor in a country where extremists have attacked foreign workers in recent years. Four Frenchmen were killed this week.

"However, Brad Bourland, chief economist at Samba Financial Group, says the cities concept can work and adds that Saudi business will be a key factor in their potential success.

“There won’t be any big white elephant projects built in the desert,” he says. “The decisions will be driven by businessmen, so I think they are quite viable.”

"He adds that the government is managing its oil wealth well so far, reducing debt and spending cautiously so as not to exceed the state’s absorption capacity.

“Four years into the first oil boom, the country had a current account deficit, so although revenue grew tremendously in the 1970s, imports also shot up,” Mr Bourland says. “It is quite the opposite this time and imports as a percentage of oil revenue have actually declined. There is not a conviction that oil prices will stay high for ever.”

"But he warns it is unrealistic to expect the kingdom to reduce its oil dependency. “Oil is just too big,” he says. “The best you can do is try to smooth it out."



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