Last month, the European Union agreed to stop buying oil from Iran, after Saudi Arabia promised the world to increase its production to make sure European countries will not see an oil shortage due to sanctions against Iran. While oil prices moved up to levels as high as $102 a barrel, they did not spike up as much as they would have if Saudi Arabia did not promise to make up for the shortage of oil. But, can Saudi Arabia actually deliver on its promise?
Iran produces 2.2 million barrels of oil per day, addressing 2.24% of the daily oil consumption in the world. About one fifth of Iranian oil goes to European countries and the rest of the shipments go to Asian countries with very high demand on energy such as India and China. Iranian oil is considered to be important not only for its quantity, but also for its quality.
Saudi Arabia currently produces around 10 million barrels of oil per day. All in all, 90% of all Saudi Imports and 75% of all revenues of Saudi government come from oil. In december, the country's oil production was actually down to 9.81 million barrels a day compared to 10.05 barrels per day in November. The country uses about 1.7 million barrels of oil per day, and exports the remaining oil.
Saudi Arabia has a spare capacity of 2.15 barrels of oil per day. The country can definitely increase its oil production; however, there are a few issues to consider.
- Saudi Arabia's spare capacity is not expected to be of very high quality. While it may replace Iranian oil in quantity, it might not do the same job in quality.
- Saudis know that if they increase daily oil production, this will keep oil prices from going north. Considering 90% of the country's exports are oil, why would the country want oil prices to come down? The country could produce less oil and make more money due to oil prices.
- Saudi government owns all the oil operations in the country. Many people do not trust their numbers, just like they don't trust Chinese financial numbers. Saudi's "proven oil reserves" are not confirmed by independent sources. If the country has less oil reserves than once thought, then it will not want to waste its resources to help drop oil prices.
At the same time, Saudi Arabia has one main motivation to increase its oil production, and this is not economical. Saudis want to hurt Iranians at all costs. There has been a cold war between these two countries for decades, the main culprits of which are religion and ethnicity. When it comes to hate-hate relationships, all reasoning is thrown out the window.
I believe that Saudi Arabia will at least attempt to make up for the oil shortage in Europe due to Iranian sanctions. This should keep the oil prices below $100 in the next year or so. Oil traders and those that trade oil companies, such as Exxon Mobil (XOM), BP (BP) and Chevron (CVX), should not count on a spike in oil prices anytime soon; however, oil prices aren't likely to go down by much either.
Disclosure: I am long XOM, CVX.
