The ‘Super Spike’ in Oil Prices – Implications for the U.S. and Saudi Arabia

The recent spike in prices at the pump has been "shock and awe" for the American driver – a situation occupying the front pages of major dailies and many minutes of airtime on television news programs. In one year, the price of oil has risen by 52 percent. Drivers who paid $25 to fill their tanks a year ago now pay $50 and more. No relief is in sight. OPEC members (Oil Producing and Exporting Countries) are already producing at full capacity, and OPEC's figures show that the 10 member countries, excluding Iraq, are currently producing 30,255 million barrels of crude oil daily. [1] With the exception of Saudi Arabia, none of the cartel members currently has surplus capacity. [2]

Given that global oil demand is projected to rise by 1.5 million b/d in the next two years, oil producers –both OPEC and non-OPEC members – will be hard pressed to meet the challenge. Meanwhile, neither the U.S. nor China, the two largest consumers of crude oil, is showing a diminishing need for this commodity.

Since the December 1998 collapse to under $10 per barrel – the lowest oil price since before the 1973 Arab oil embargo – oil prices have rebounded strongly. The OPEC "basket" price (a weighted average of Algerian Saharan Blend, Indonesia's Minas, Nigeria's Bonny Light, Saudi Arabia's Arabian Light, Dubai's Fateh, Venezuela's Tia Juana, and Mexico's Isthmus) averaged about $36 per barrel during 2004, nearly triple its 1998 level. [3]

More than half the world's oil reserves are in Saudi Arabia, Iran, Iraq, Kuwait and the United Arab Emirates. It is possible that Iraq has crude oil reserves equal to or higher than those of Saudi Arabia, but the Iraqi oil reserves have not been fully explored.

Price Projections – "Super Spike" in Oil Prices

Goldman Sachs, one of the major financial traders in the commodities sector, issued a research report on March 31, 2005 that warned that oil markets have entered a "super spike" period that could see 1970s-style price surges as high as $105 a barrel. For the immediate term, the research note raised the 2005 and 2006 New York Mercantile Exchange crude oil forecasts to $50 and $55 respectively, from $41 and $40. [4] Goldman Sachs analyst Arjun Murti added that the "super spike" will result in "a multi-year trading band of oil prices high enough to meaningfully reduce energy consumption and recreate a spare capacity cushion only after which will lower prices return." An official in the Arab Company for Petroleum Investments, a company jointly owned by 10 members of OPEC, has suggested that the price of crude oil in the next five years will be in the range of $45 and $50 per barrel. [5]

In a follow-up issued on August 18, Goldman Sachs stated its expectation that U.S. benchmark (West Texas Intermediate or WTI) oil prices will remain above $60 a barrel for the rest of the decade – a figure $15 higher than its previous estimate, set earlier this year. [6] It is significant that the commodity markets are also expecting the price to remain high. For example, WTI futures contracts are priced above $60 until June 2008. [7] Clearly, even the smallest interruption in the flow of oil in any of the oil producing countries, and especially in Saudi Arabia, could send shock waves into the oil market that would result in Goldman Sachs's forecast of a $105-per-barrel nightmare becoming reality. Indeed, interruption of supplies from any of the other major suppliers of crude oil to the United States – e.g., Mexico, Venezuela, Nigeria, United Arab Emirates or Angola – could have similar effects.

OPEC Oil Revenues

The Energy Information Agency of the U.S. Department of Energy estimates net oil export revenues for 2004 at $338 billion, up 39% from 2003 levels. For 2005 and 2006, OPEC net oil export revenues are forecast at $430 billion and $447 billion, respectively. But these figures reflect a price of oil at about $40 per barrel. If the recent spike in oil prices persists in a band of $50-$65 per barrel, OPEC revenues are likely to be much higher.

Implications for Saudi Arabia

For Saudi Arabia, the largest producer/exporter of crude oil, even as small a fluctuation in oil prices as one dollar per barrel translates into billions of dollars gained or lost. With exports approaching 9.4 million b/d, a one-dollar increase in price would translate into annualized revenue of $3.4 billion. For the U.S., which imports 10.5 million b/d, a one-dollar increase translates into $3,832 billion on an annualized basis.

To highlight the contrast, we have constructed the following table with two columns. The first column offers the projected range of oil revenues for Saudi Arabia between a low figure of $30 per barrel and a high of $70 per barrel, using a $5 price interval and assuming an export of 9.0 million b/d. The second column uses the same price forecasts for crude oil to calculate the cost for the U.S., based on current import of approximately 10.5 million b/d, a figure that suggests a stagnant level of import because of slower economic activities and/or conservation. Of course, these figures could change if Saudi Arabia exports more or less oil and if, in the unlikely event that the price of oil declines below $30 per barrel.

Table 1: Annual Oil Revenue Forecast for Saudi Arabia and Oil Cost Forecast for the U.S. (US$ billion)

OPEC estimates Saudi Arabia's net oil export revenue for 2004 at $115.6 billion, and the forecast is for export revenues of $154.3 billion for 2005. Given the recent spike in oil prices, the total revenues are likely to be much higher. According to statistics from the Energy Information Agency (EIA), U.S. net oil import costs reached $94 billion in both 2001 and 2002, and $122 billion in 2003. For 2004, U.S. costs reached $166 billion, nearly four times 1998 levels. There are no available statistics for 2005, but the import costs in the U.S. will likely increase sizably over the 2004 figures.

Obviously, the net costs of crude oil imports reflect the sharp rise of crude oil prices. For the years 2002, 2003, and 2004, and for April 2005, the average cost of a barrel of crude oil imported from OPEC countries was $22.18, $25.36, $33.96 and $44.32, respectively. [8] Certainly, the cost for the first two months of the third quarter of 2005, namely July and August, is much higher, though numbers are not currently available.

To mitigate these numbers, the EIA maintains that in inflation-adjusted per-capita terms, the OPEC oil export revenues are below the peaks reached in the late 1970s and early 1980s. Accordingly, the per-capita oil revenues for all OPEC members are projected at $770 in 2005, or only about 43% of the $1,804 that was achieved, in real terms, in 1980. In other words, the price at the pump is lower in 2005 than it was in 1980.

This argument can be questioned on two grounds: First, it does not take into account the considerable population growth in the OPEC countries; in most, the population has doubled in the last 25 years, and oil export revenues on a per capita basis that does not account for this growth can be misleading. Second, the revenue estimates upon which the per capita income was calculated were based on lower crude oil prices; the increase in revenue will bring about a corresponding increase in the per capita income. Of course, the EIA's argument cannot take into account the psychological response of the consumer, who must, in a few months, adjust to a sharp increase in prices that had been stagnant or in a downward bias for 25 years.

The Implications for the U.S.

The U.S. imports approximately 10.5 million b/d. A fluctuation in oil price of one dollar translates into a little over $4 billion on an annualized basis. A spike of $30 per barrel, as has occurred during the past year, translates into $120 billion charged against the country's current accounts.

As an illustration of the enormity of the U.S.'s oil bill, U.S. agricultural exports to the entire world totaled about $61 billion for each of the two last full calendar years, 2003-2004. [9] In other words, the total proceeds from U.S. agricultural exports would cover just about 25% of the total cost of crude oil imports at the present rate of $60-65 a barrel.

To be fair, Saudi Arabia, or OPEC, cannot be held fully responsible for the "super spike" in the price of crude oil. As already stated, both OPEC and non-OPEC members are producing as much oil as is technically feasible. Even if more oil were available, there is no capacity to refine it. Refineries in the U. S. are operating at 98% capacity to meet demand; not a single new refinery has been constructed in the last 20 years.

Supply is not the only problem. Most experts would argue that the issue of oil price rests as much with the demand side of the equation as with the supply side. In the absence of a rational transportation policy that would divert resources from roads to mass transit systems on a grand scale and of appropriate fiscal measures that would curb the wasteful use of energy, an oil crunch crisis may not be long in coming.

Saudi Arabia accounts for the highest share of OPEC oil export revenues – 34% in 2004. OPEC estimates that the Saudi share of oil export revenue will likely increase to 35% in 2006. [10]

The recent Saudi oil revenue bonanza is a double-edged sword. On the one hand, it will help reduce the Saudi national debt, estimated at $175 billion. On the other hand, in a context in which there is a rapidly growing young population that suffers a high unemployment rate of anywhere between 13% and 20% – a rate which would be even higher if women were allowed to join the labor market – the revenue bonanza is likely to raise expectations for jobs and social services. Should these expectations not be met, these young people could become a destabilizing force in the Kingdom, which could drive oil prices even higher.

Rather than introduce a well-designed plan for creating new sources of employment, King Abdallah has announced that the salaries of all civilian employees, military personnel, and retirees will be increased by 15%, effective the coming month of Ramadan (October). [11] In the absence of proper budgetary procedures, it is not possible to determine the financial implications of these increases. Nor is it possible to assess how these increases would resolve the chronic unemployment problem.

In the meantime, the riches of the Saudi princes continue to grow. Precisely what percentage of oil revenues lines their pockets, however, remains one of the best kept secrets in the kingdom.

* Dr. Nimrod Raphaeli is Senior Analyst of MEMRI's Middle East Economic Studies Program