Saudi Arabia s comments halt oil price rally post QE3

In our note published last week and entitled “Oil consumption – China vs The Untied States”, we suspected the Brent crude rally would hit some hurdles as key swing producers, like Saudi Arabia, voice their ability to ramp up production into the market. We wrote “the short term vocal response from these key Middle Eastern suppliers is more important to monitor when prices rise too rapidly, rather than fears around supply constraints. The Middle Eastern suppliers all know very well that an unsustainably high oil price is not in the best interest of their customer base, when they have the ability to ramp up supply and pull back prices. Brent could trend back below US$110 per barrel in the coming weeks, should this pan out.”

It only took a report in the Financial Times, quoting a Gulf based oil official, saying the crude price was too high to send prices downwards overnight. Brent last traded at US$108 per barrel. The Gulf official was further quoted as saying the Saudi Kingdom “would like to see oil prices back to US$100 a barrel”. When the Saudis talk, the market listens and for very good reason, its oil production numbers grew by 12.7% last year even though it is already the world’s largest single producer. Again, a lot of factual information around 2011 oil statistics is contained in our prior note and for those who have missed it, we recommend giving it a quick read.

Looking forward, the temporary pullback might be short lived. Since publishing our last note, something else has emerged which has caught our attention. Iran’s nuclear chief on Monday escalated his attack on the IAEA following an earlier admission that power lines leading into Iran’s uranium enrichment plants were bombed by unknown saboteurs. The claims are difficult to verify, but Iran is adamant the explosions were aimed at infrastructure leading into the enrichment facility at Fordo. Iran is unlikely to disrupt its supplies, having recently found convenient ways to bypass very strict sanctions as expressed in our previous note. This view however, is based on the status quo holding, something which could change.

If there is a covert international operation against Iran and one which is ramping up, the regime might be forced into actioning orders to exert its position. It’s a big “IF” but an important one, so we continue to monitor the situation very closely and plan to update our views which tend to lie outside of the normal news cycle. The recent explosions follow on from prior assassinations of nuclear scientists, airplanes carrying scientists linked to Iran’s nuclear program crashing and reports of cyber attacks – so the recent string of explosions around electricity to centrifuges is nothing completely new.

Iran’s leverage lies not in its own supplies, which at a best case scenario produces around 4.3m barrels per day, around a third of what the Saudis produce but its ability to disrupt is of greater influence. The Strait of Hormuz sees around 35% of total seaborne trade going through it. Blocking the Strait of Hormuz is an option of last resort, an option of desperation. Iran is not in such a desperate position at the moment, but its comments against the IAEA and admission of internal sabotage are important to monitor.

In the short term, we think Brent at US$100 per barrel is unlikely to be achieved, despite the Saudi comments making reference to the level. The purpose of pushing down the price temporarily has been achieved and an elevation in price post QE3 towards the US$115 level will meet similar statements. We see the price ranging between the mid US$105’s per barrel to an upward limit of around US$114 per barrel over the next few weeks should the status quo hold, but if it does not there could be a very low probability awkward upward shock.