The  economic  situation is  getting worse, and everybody expects high or rising  prices for both energy and food, a double  hit for a still weak world economy , a shock whose political repercussions may be quite unsettling. Moreover,  the Middle East is in a phase of political change.  There is no surprise , therefore, that the crucial problem  of the crude oil price is discussed again  in depth, and  that  time honoured  set ups  are  challenged.  Among the various pious declarations of good will,  a proposal has been advanced  which is sufficiently developed on the technical level  to be taken seriously , and  at least able to create  a useful discussion. It has been presented by Giacomo Luciani,  an Italian economist with a long  experience of the Middle East , and of the oil business ("From Price Taker to Price Maker? Saudi Arabia and the World Oil Market"  http://relooney.info/0_New_9627.pdf) . 

The proposal is quite simple in its general outline, and does not require the agreement of all the world on some objectively difficult , if not impossible, general agreement.  The country with more reserves and more production should  sell its oil directly,  in such a way as to make the real price of oil as free as possible  from the influence of financial speculation.  The proposal starts with a  short , but deep  anaisys of the present situation, which is dominated by the high volatility of the crude oil prices, which is due to a number of reasons.

 First, OPEC has never adopted  a long term  strategy  for pricing oil, and it has fallen back to a reference price system . That  means  that OPEC oil is not available for trading  ( when bought, it cannot be resold) and must therefore  be sold  on the basis of quotations of tradable oil,  Brent and West Texas Intermediate , neither of which is produced in serious volumes. That created  the futures market , whose speculative nature  is often considered  the basic reason for the volatility.

 Second, the present market   produces only slow and often weak answer of both demand and supply  to prices  changes.  Volatility ensues, which means that there is no discernable price trend , and that forecasts are  practically impossible . The impossibility of predicting future prices , in its turn,  frustrates rational investment decisions.

To day, after the shocks of 2007-2009 there is a political consensus  on the need to dampen volatility , and  on the necessity to agree on prices  that may be acceptable to all sides. Prime Ministers and Presidents spoke about  a proposal for an international committee  which would decide on a price band, which presumably would requite  active market intervention. ENI also advanced a similar proposal. 

The objective , as Luciani points out, is not simple:  it requires “devising a set of institutions ( exchanges regulators,  storage facilities,  trading rules) that are sufficiently responsive  to changing markets circumstances , and at the same time  do not generate wide fluctuations , but smooth progressive price changes  more in line with the fundamental equilibrium of demand and supply”. Notwithstanding  the large number of producers that are OPEC members, OPEC has to day no instruments to control the crude oil  market. It would have them if  OPEC Countries would sell  and buy “paper barrels”  every time they saw  a price movement that they would rather correct.

 It would however be quite  paradoxical, the major producer of oil trying to  control the market by dealing in Brent and WTI , when it would do more and better by trading its  own oil.   The only instrument OPEC  has ever used  is  the fixing of “OPEC Quotas” that is, allotting a certain volume of production to each of its members. This has been proved insufficient  as the market does not  react to that  as OPEC would like, as  there are  always doubts that such  quotas would not be respected. One way to control the market would be the use of production capacity kept on reserve for emergencies , practically all sited in Saudi Arabia.  These reserves were used in 1980-81 , when Iraq attacked Iran,   and in 1990-91 when Iraq attacked Kuwait, that is, to quieten the market   during a  war.

OPEC lacks sufficient tools to manage  the market in case  it decided   to implement a certain price band. However, the situation could easily be corrected  without  reducing OPEC’s authority by shifting  Saudi Arabia  from the position of price taker  to that of price maker.  That country could take itself, together with its allies, the initiative  in shaping a new global oil market . To do so
Saudi Arabia should sell its oil in the same way that  Governments sell their bonds, by auction.  A market for Saudi Arabian oil may be established  by conducing regular auctions  of Saudi crude oil.   That would develop the important function  of “discovering prices” , which could  influence the secondary market. The Kingdom would have control of its price at which it may sell to other parties . That would require  the creation of  a market structure, and  the increase of available storage, which could be implemented in a short time. In order to compete with Brent and WTI , the contract proposed by Saudi Arabia would be extended sufficiently  in the future  .

The market would be organised to discourage collusion among buyers; moreover,  an  Independent Authority  could  arrange the various offers in a demand curve  which will indicate how many contracts may be sold at each price.   We could envisage  a Gulf Oil Exchange  offering a trading platform for  the various crudes of the Gulf : Arabian Light, Abu Dhabi Murban,  Kuwait Export,  Arabian Heavy, Bashra Light,  each in a different day.

Volatility would be reduced  through  the producers’ control  of prices and volumes, in an auction similar to that held by the Central Banks  operating on currency market , where the Bank’s intervention are not ruled out ,  but are rare and unpredictable. Of course, the proposed  solution may create political problem, given the   traditional preference of Saudi Arabia for maintaining a rather low profile , but , as the  Luciani paper says “ The status  of Saudi Arabia as one of the emerging  world  economic powers  must be related to the management  of the international oil market.”