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You have got to love the oil markets. There is always some excitement out there. It seems the media cannot stop talking about it. In the first couple of weeks of the year we suddenly realized that we were brimming with inventories of crude oil and prices tumbled . When viewed in days of demand cover, US inventories can hardly be considered excessive. Attributing the sell off to inventories appears even more ludicrous when one considers the fact that US inventories have declined by about 55 million barrels in just a few weeks. That, in spite of a winter which seemed to be doing a publicity stunt for the DVD release of Al Gore's An Inconvenient Truth. The media as usual have displayed their high single digit IQ by trying to explain every move in oil. The weather, speculators, Saudi comments, Saudi lack of comments, excess inventories and new supply coming online have all been blamed. To illustrate my point I would like to enter into evidence exhibit A. The comment I am referring to is “Oil in a $40 to $50 range suits the Saudis much better than oil at $70.'' I am amazed that such comments as they are so far moved from reality. Saudi cost of oil production is not exactly known but it is not what it used to be. If it was then the oil service companies would not be announcing quarter after quarter of blowout results. I wonder if Mr Brady ever went and told his boss that he would prefer half his normal pay as that would suit him much better. As far as significant supply coming on line, I remain skeptical. Anyone who was blinded by oil's lightning drop over the past few days missed these headlines. Lower production from BP and Chevron, and the most shocking of them all from Norway in which they cut their 2007 production forecast by about 13%. It also said there was a margin of error of 13% in its new forecast. If production were to hit the low end of the range then that would be 700,000 barrels less than expected just a few months back. That is about half the total amount of new production increase that the market expects in 2007. It is indeed alarming how quickly the world's most productive regions are falling. Norway is one of the largest exporters and news like this should double the world's resolve to move rapidly to renewable sources of energy and begin conservation efforts in full earnest. However the recent price action is likely to make the opposite more likely. Getting back to Saudi Arabia. I had earlier written a piece about their spare capacity previously, “Can We Afford Another Saudi Response”. Now with Saudi production falling again, many are suggesting that Saudi Arabia has peaked. Others say that the extraordinarily high spare capacity that has developed in Saudi Arabia has brought prices down. I disagree with both explanations. Saudi Arabia has been leasing almost every available rig on the market for the past 18 months. These rigs are not cheap. If Saudi Arabia is doing it to have millions of barrels of spare capacity available then that is an extraordinarily expensive commitment. I do think that Saudi Arabia has peaked. However I think the latest drop in production is not geological. I think that the only reason that they are cutting back is to rest their tired warhorses. Also using every available land rig they are mobilizing many of their smaller prospects ahead of their official schedule. Is it not amazing that while every oil company announces delays in project completions, Saudi Arabia seems to finish stuff ahead of schedule? They saw this coming way before anyone else and I believe they are working hard on every one of their “200 prospects” which they have often outlined in their long term plans. If push comes to shove I think the Saudi Arabia can mobilize a few hundred thousand barrels from current levels. So where does supply go from here? I think any increase from Russia will be eaten up domestically and hence will not add to world exports. Norway should decline at least 250,000 barrels per day by end of the year. The news out of the UK's North Sea and Mexico's Canterell complex seems to be right out of a Stephen King novel. Finally if the current cold conditions continue it could wipe out the overhang in North American Natural gas inventories and decrease Natural Gas Liquids supply in the US as Natural Gas and Crude oil move to BTU parity. At current prices demand could re accelerate and I suspect before the year is over OPEC will be pumping at maximum and once again blaming the speculators for high prices.
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