In-depth analysis of the oil world mechanisms: factors that regulate the price of this crucial product.
Article written by Francesco Belluomo for The Young Economist.
Among the many events that are creating a sensation during the last few days, is the visit of US President Joe Biden to Saudi Arabian - one of the country members of the OPEC - Organization of the Petroleum Exporting Countries, a cartel that manages world oil production to regulate its price -. The "handshake" between him and the crown prince, Mohammed bin Salman, who welcomed the American President since he holds the position of Deputy Prime Minister of Saudi, attracted the attention of everyone, perhaps it was the only event that the overwhelming majority of the population, including the media, perceived from the visit.
The reason for this sensation is connected to the fact that, according to what is claimed by American intelligence, Prince bin Salman is believed to be the instigator of the murder of the journalist Khashoggi, a critic of bin Salman, which took place inside the consulate of Saudi Arabian in Istanbul in 2018. Biden, after taking what claims by 007 to be true and publicly calling the crown prince responsible for the murder of the journalist, had been immortalized while "punching" the crown prince in greeting.
I do not want to dwell more on this detail; almost every newspaper is talking about it. This article aims to offer a different point of view. It is important to explain why Biden is not inconsistent with what he said about bin Salman, but he still had to compromise with him. The reasons for all this are linked to an economic choice; an inevitable choice to face the geopolitical scenario we are experiencing. Before moving the focus on the real protagonist of this meeting, the oil, it is necessary to take a few steps back.
Due to the invasion of Ukraine by Russia in February, the Western world did not stand by. Over the last months, the EU has decided to enact numerous sanctions, including one in particular that regulates the import of Russian oil into European countries. In May, the green light was given to the "ban on oil imports from Russia by sea”, starting from 2023; moreover, the French president announced that this ban "will also be integrated as soon as possible with the block of the imports of crude oil from pipelines".
This decision, combined with those already taken by other member states of the European Union, will have a measurable effect in the current year already, with a 92% forecast reduction in the import of crude oil from Moscow by December. This provision, even though it may seem fundamentally fair and ethically correct, has had a huge impact globally and the consequences have been not so positive.
Because of the decrement in the quantity of oil present in the new and old continent, on equal demand, the price has skyrocketed. The progressive embargo by the EU has caused the price of a barrel to fly above 120 dollars. Thi event has rocked the economies all around the world and it is in this scenario that we have to come back to Joe Biden in Saudi Arabian. To better understand the reasons for this meeting and to understand its outcome, it has to be introduced the main factors that influence the price of liquid gold.
They can be summarized in four elements.
The first is certainly the supply of oil, in terms of production. The leading role is played by the countries members of the OPEC, followed by a few states with smaller deposits.
The second element is the supply expectations for the future. To analyze this aspect, it is necessary to refer to the political-economic situation - present and in the near future - and the available reserves; take a look at how much oil is available in refineries and its, so-called, strategic reserves.
The third element is the oil demand, especially from the major consumer countries of this good (such as the United States). Depending on the period of the year to be analyzed, various factors are taken into consideration to estimate this demand. For instance, in summer, attention is paid to motorway traffic data, trying to determine the potential use of gasoline, while in winter, weather forecasts are the main focus to predict the intensity of the use of oil-powered domestic heating systems.
The last principal element is what is called "sentiment", or the now notorious "self-fulfilling prophecy": the belief that the price of oil will increase or decrease induces economic agents to adopt behaviors that start what allows their prediction to become true. Like almost all the items on the market, crude oil is subject to psychological factors.
After this not short premise, we can return to the core of the article. Biden went to Saudi Arabia to lower the price of oil. How can this country satisfy his request?
Here we reconnect to the elements mentioned above. Saudi is the only OPEC member capable of increasing oil production - the first element -, given that all the other member states are operating at full capacity. Another factor that makes this state unique in the liquid gold market is its large reserve capacity; this characteristic allows Saudi to easily increase the quantity of oil on the market - the second element -. Knowing that it is understandable the reasons that have brought the president of the United States of America to the Middle East.
Joe Biden left the meeting with his goal achieved: the commitment by Saudi Arabia to increase oil production by 50%, thus favoring the lowering of its price. Although the media has moved the attention from the true result of this event, we can say that, despite the countless tragedies that have been marking our civilization in recent months, it is a positive sign.
A breath of fresh air on a topic that affects us all in our daily lives, but, like other economic phenomena, we have to wait before seeing the real effects produced.