Dec

19

I would like to draw your attention to this post from MoslerEconomics (the web site of Warren Mosler), this guy seems to know what he is talking about:

Crude pricing

The Saudis are the ‘supplier of last resort’/swing producer. Every day the world buys all the crude the other producers sell to the highest bidder and then go to the Saudis for the last 9-10 million barrels that are getting consumed. They either pay the Saudis price or shut the lights off, rendering the Saudis price setter/swing producer.

Specifically, the Saudis don’t sell at spot price in the market place, but instead simply post prices for their customers/refiners and let them buy all they want at those prices.

And most recently the prices they have posted have been fixed spreads from various benchmarks, like Brent.

Saudi spread pricing works like this: Assume, for purposes of illustration, Saudi crude would sell at a discount of $1 vs Brent (due to higher refining costs etc.) if they let ‘the market’ decide the spread by selling a specific quantity at ‘market prices’/to the highest bidder. Instead, however, they announce they will sell at a $2 discount to Brent and let the refiners buy all they want.

So what happens? The answer first- this sets a downward price spiral in motion. Refiners see the lower price available from the Saudis and lower the price they are willing to pay everyone else. And everyone else is a ‘price taker’ selling to the highest bidder, which is now $1 lower than ‘indifference levels’. When the other suppliers sell $1 lower than before the Saudi price cut/larger discount of $1, the Brent price drops by $1. Saudi crude is then available for $1 less than before, as the $2 discount remains in place. Etc. etc. with no end until either:
1) The Saudis change the discount/raise their price
2) Physical demand goes up beyond the Saudis capacity to increase production

And setting the spread north of ‘neutral’ causes prices to rise, etc.

Bottom line is the Saudis set price, and have engineered the latest decline. There was no shift in net global supply/demand as evidenced by Saudi output remaining relatively stable throughout.


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