Ladies and Gentlemen:
It is good to be with you here in New York at this prestigious gathering. I thank the chairman and the board of directors of the NYMEX, for inviting me to be with all of you and I would like to express my gratitude for the wonderful honor they have bestowed upon me tonight.
During my long career in the oil industry, I have witnessed many changes that have shaped the industry as we know it today. Among these changes, were the formation of OPEC in the 1960s, and the eventual shift in control over production, pricing and distribution of world oil from the majors to the producing countries.
The 1970s saw a divide develop between producing and consuming countries as producers exercised their sovereign right to control their petroleum resources. The International Energy Agency was established, as major consuming nations banded together as a perceived counterweight to OPEC. This was also a time when the “common wisdom” – from the Club of Rome and other like-minded groups -- was that the world was running out of oil. However, price increases of the 1970s provided a strong incentive for the petroleum industry to undertake a massive effort to find and develop new reserves, principally in non-OPEC countries. Its success was evidenced by the sharp increase in non-OPEC supplies in the 1980s and 1990s.
The end of the 1970s and the early 1980s witnessed the Iranian revolution and the Iran-Iraq conflict, events that created temporary shortages of oil. During this period oil became a significant source of revenue not only for producing governments, but for many consuming governments as well, with the latter levying heavy taxes on petroleum products, in order to generate revenue to finance government activities.
In some countries, particularly in Europe, consuming governments have gone to extremes, with taxes on petroleum products far exceeding the prices of the crude oil from which they are made. In some countries, government taxes now account for over 70% of the price consumers pay for a petroleum product.
By the 1980s the system of fixed prices that had been in effect since the early 1950s proved unworkable. The system of fixed or posted prices was established by the majors in the early 1950s and later adopted and modified by OPEC in the mid-1970s. But the cost of defending fixed prices in the increasingly competitive oil markets of the 1980s – a burden that fell primarily on OPEC, and Saudi Arabia in particular -- became too great. Market realities demanded that producers adopt “market-based” ways to price crude oil that would provide transparency and more adequately reflect underlying demand and supply fundamentals. The transition was not easy, witness the price collapse of 1986 that was so devastating to the economies of oil producing nations and the oil industry.
In the 1990s there was the Gulf War. Saudi Arabia and a limited number of other key oil producers with spare capacity were called upon once again to maintain market stability by increasing output to compensate for lost production from Kuwait and Iraq.
Finally, the passage of the U.S. Clean Air Act Amendments of 1990 and the subsequent growth of the environmental movement here, and around the world, profoundly changed the nature of our business, presenting us with perhaps our greatest challenge yet – producing high-quality petroleum products to meet the needs of growing economies while reducing their impact on the environment.
The introduction of a viable futures contract, the NYMEX light crude contract, in the early 1980s was another milestone, certainly no less important than other major developments of the past 50 years. The NYMEX crude futures contract, and its cousin at the IPE, provided the industry with a valuable tool for increasing price transparency and managing risk. While not perfect, these futures contracts serve as useful benchmarks, formulated in highly liquid markets where the market-clearing price is freely accessible to anyone. Contrast this with the old system of posted prices, where the majors established pricing benchmarks, and knowledge about prices was generally limited to the direct participants involved in a particular transaction. Information was segmented, not global.
An initially wary oil industry has come to embrace the NYMEX crude contract and it has grown into an indispensable tool, facilitating the day-to-day operations of the oil industry. It, along with the IPE Brent
contract, is the major barometer of price pressures in world oil markets. According to the NYMEX’s own statistics, approximately 148,000 contracts were traded on average each day last year. That amounts to 148 million barrels, a sum approximately twice as large as total daily global demand, quite an impressive figure.
Two major features of the NYMEX futures contract, risk reduction and increased price transparency, are important goals for Saudi Arabia, and, dare I say, for all oil producers. All of us in the oil industry seek to reduce our risk. As producers, we can best reduce risk for the oil industry by promoting price stability.
Consumers also benefit, and want price stability. While each person may have his or her own view of the “right” price for oil, we all benefit from price stability. In a free market, many factors and players influence the price of oil and volatility is the norm, not the exception. Nevertheless, we should work to narrow the band of fluctuations. Stable oil prices that offer a fair return are crucial to the economy of Saudi Arabia and to the world economy. Oil market developments of the past two years have provided invaluable lessons. The oil price collapse in 1998, in the wake of the Asian economic crisis, not only highlighted the strong link between world oil demand and economic growth, but also affirmed the necessity of a stable oil market, where supply and demand are in equilibrium. This experience reaffirmed what we have known all along -- to maintain a healthy global economy, we must work hard to ensure the availability of adequate oil supplies to balance growing demand.
These goals have directed our efforts in OPEC since inception. For example, over the past three years, we successfully, in concert with other producers, reduced production in 1998 and increased output in 2000, to balance the market. The production decreases adopted early this year fall within this marketbalancing endeavor in an ever-changing world economic environment.
We believe that the less favorable U.S. and world economic outlook for this year, and the changing inventory behavior of the industry, warrant caution and continued vigilance to keep the market stable for the sustained growth of the world’s economies and the health of the industry. Our aim, as always, is to keep the market well supplied and prices at the desired average of $25/barrel for the OPEC basket, which equates to about $28 for West Texas Intermediate. As an aside, I would like to clear up a common misconception that the NYMEX WTI price represents the price Saudi Arabia receives for its crude oil sales or what oil refiners pay. It is not. The DOE’s Energy Information Administration’s latest figures show that, in general, U.S. refiners’ per barrel crude costs in January 2001 were about $4.00 less than the WTI price. The composite amount Saudi Arabia received for its crude oil sales to the U.S. in January 2001 was substantially lower: about $7 below the WTI price, due to differences in both quality and transportation. What this means is that when WTI sells for $28 on the NYMEX, our crude sells in the U.S. for only $19-$22/barrel, depending on the grade of crude.
Let me expand further on the importance of price transparency for oil producers like Saudi Arabia, and our
efforts to balance world oil markets and to reduce risks by maintaining price stability. For any producer supplying goods to a market, balancing supply with demand is not an easy task that can be executed precisely. This task can be made all the more difficult by lack of price transparency. The inaccurate and untimely data on economic activity, as well as, on oil demand, supply and stocks aggravate the situation.
These shortcomings mean that decisions taken by market participants may be based on information that does not accurately reflect underlying economic conditions, or the relationship between oil demand and supply. The important determinants of price are often flawed, and this is the reality in which we must operate in the oil industry.
Earlier, I said that the NYMEX and the IPE crude contracts, while increasing market transparency and providing a tool for managing risk, were not perfect. I would like to speak to this point. First, while they are the most liquid and most visible crude markets in the world, movements in the NYMEX and IPE futures prices are often influenced by factors other than the underlying global supply and demand fundamentals. The NYMEX and IPE crude contracts are both based on regional markets – the West Texas Intermediate market in the case of the NYMEX, and the Brent market in the case of the IPE – heavily influenced by “local” economic conditions and industry fundamentals. At any time, regional factors in the U.S. Mid-Continent or Northwest Europe may be more influential in setting prices than global demand, supply and inventory.
Second, futures prices can be unduly influenced by attempts to “squeeze” or manipulate the underlying
physical WTI and Brent markets. Since most of the world’s crudes are priced relative to these two benchmarks, such attempts can distort price relationships in world markets.
Third, crude futures prices are influenced by large funds that switch between oil and non-oil trading. To these funds, oil is just another asset in a diversified portfolio of assets. Decisions to buy or sell depend on the relative prices of other non-oil assets, not on underlying oil market conditions of demand, supply and inventories. In addition, oil is bought and sold by technical traders who analyze charts and chart patterns
and not barrels of oil produced.
Crude futures prices are subject to “mass psychology” that is moved more by the latest news story than by
fundamentals. This characteristic diminishes the usefulness to producers of price signals generated in these markets as they attempt to assess underlying fundamentals and the need to make supply adjustments.
Fourth, and finally, we are watching with great interest attempts to expand the use of the Internet for oil trading. While we are intrigued by the potential of the Internet to bring buyers and sellers together in an
efficient manner, we need to carefully watch its development. Three questions come to mind: what risks are posed by these developing “electronic markets,” how will they affect price volatility, and what safeguards will protect buyers and sellers who may have no prior relationship?
Any pricing system has its limitations, given the nature of world oil markets. Nevertheless, the NYMEX crude contract was a major step forward, providing oil markets with much needed price transparency to the benefit of both producers and consumers.
Ladies and Gentlemen,
Saudi Arabia is proud of its record as a reliable supplier of crude oil to meet the world’s growing energy needs. We will continue to work for a balanced and price stable oil market. Saudi Arabia continues to maintain excess capacity for moderating price spikes whenever disruption to supplies occur, as we did after the invasion of Kuwait. For the foreseeable future, crude oil will continue as the principal fuel for economic development and we all have a vested interest in its price stability. We believe that a continuing dialogue between producers and consumers is crucial to achieving the goal of price stability. To this end, His Royal Highness the Crown Prince of the Kingdom of Saudi Arabia proposed establishing a permanent Secretariat for the International Energy Forum to foster discussion and cooperation among energy producers and consumers on issues of common concern, including economic growth, energy, and the environment. While all
participants would still have their differing self-interests, developing a fuller awareness of each other’s focus could lead to more efficient markets and to more effective solutions to some of the issues that separates them.
In closing, I would like to thank our hosts for this prestigious award and for giving me the opportunity to address such a distinguished audience.