This article is written in response to a link posted by @TimPollard entitled Here’s the Real Story Why Oil Prices will Spike. All of the points in Tim’s linked article have been made and discussed on #Oilpro.com already, but the refutation of the author’s point follows.
The reason boils down to the classic game theory example called The Prisoner’s Dilemma. In this theory, two rational individuals may not act rationally. The basic premise is that there are two accused individuals:
If they both deny everything, they will both get very light sentences.
If they both betray one-another, they will both get moderate-to-harsh sentences.
If one betrays, but one does not, the one who does the betrayal will get off without any penalty, but the other will get a harsh sentence.
Rational people will see that working together is best for both of them; however, with no mutual trust, then the likelihood is that both will betray the other, hoping for the best individual outcome. This course insures that both suffer more than is necessary.
This is where we sit with oil production today. Rational producers would moderately cut back production to maintain the price at a sustainable level so that all producers benefit; however, if one producer moderates production, other producers can increase production to take advantage of the higher price.
It is the prisoner’s dilemma for KSA:
If all producers throttle back their production, then prices will rise, and all producers will benefit.
If all producers ramp up production as quickly and as much as they are able, then oil prices will plummet and all producers will be struggling to maintain operations.
If KSA throttles back production and US shale, Iraq, or Iran ramp up production, then oil prices will rise even more, and US, Iraq, or Iran will benefit at KSA’s expense.
What we now have is position 2. KSA is tired of losing sales to others when they are capable of producing more oil, more cheaply. If KSA were to go back to position 3 and cut back, they will just watch their competitors destroy their good intentions.
What has happened in the world, as well, is that position 1 is no longer just two or three major operators. Iraq, Iran, Russia, Venezuela, US shale, and KSA are all capable of ramping up production almost single-handedly, assuming that each can get their acts together enough to exploit their resources. Imagine if all of the producers enumerated in this paragraph were to put politics and personal gain aside and just concentrate on increasing oil production. We would see such a glut that the old bumper stickers would come back: “The Last One to Leave Houston, Please Turn Off the Lights.”
Demand is coming back up, but it is only marginally above the “make up point” from last year’s decrease in demand growth. Note that this is not to say that demand went down last year; demand rose, but the rate of rise was about half of the typical growth rate. With oil prices off 60%, it will take another million BPD consumption growth to have an impact. Once oil prices go back up, so will production, and that’s why @TimPollard’s article author has it wrong. The article’s author ignores the fact that people will do what they see as best in their personal interests, regardless of the situation the industry is in at the present time.
Maybe we should call it “The Oil Producer’s Dilemma” instead. Once oil prices go up, will producers be able to maintain a sustainable production rate so that all producers see some benefit, or will one (or more) of the players ramp up production even more to take advantage of the higher price?
With 2000 US Shale DUCs, Iraq on a production growth curve similar to the last few years of US Shale, and Iran about to come back online, I know what I believe will happen.