OPEC lacks sufficient tools to manage oil, but Saudi Arabia could shift from the position of price taker to that of price maker. Saudi Arabia should sell its oil in the same way that Governments sell their bonds, by auction.
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 [2]) .
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.”