Saudi Arabia and the World’s Biggest Poker Game

Since 2004, at least 20 books have written on the subject of Peak Oil.

The debate centers on the idea that the world...and particularly Saudi Arabia, is running out of oil. Matthew Simmons wrote an entire book about the decline of Saudi Arabian oil fields. He supports his theories with lots of calculations based on water cuts and production volumes...

But if you listen closely, you can hear the hiss of the air coming out of that theory. According to Rigzone, Saudi Arabia will add 1.5 million barrels of crude production per day in 2010-2011, in order to, “mitigate potential supply disruptions and meet growing global demand...”

I think the Saudis can pull off this big output increase. But the truth is, nobody – including myself and Simmons - knows how much oil Saudi Arabia has left... and that’s just how the Saudis like it.

It’s in their interest to be opaque about their reserves. If folks think the world’s number one oil producer is past its prime, they’re more likely to pay top dollar for the black stuff. And sure enough, the price of oil has doubled in the past three years.

In other words, the Saudis are keeping their cards close to the vest in the world’s biggest poker game. But pulling off a production hike like the one I just described tells us a little more about their hand.

Is Saudi Arabia doing this for the good of the world? I don’t think so. According to a Riyadh-based consulting report, the world will “need” that oil.

What a crock.

I say this is a simple matter of economics. Saudi Arabia will increase production because the price is right... to the tune of an additional $27 billion per year in revenues, assuming oil is at $50 a barrel (if you assume $75 a barrel, the number gets crazier - $41 billion).

I dare say that Saudi Arabia isn’t increasing its production for the good of all mankind. Rather, it is forecasting a strong oil price in the near future. It sees this as the ideal time to increase production and reap a windfall.

So much for Twilight in the Desert, Mr. Simmons.

I never believed that Saudi Arabia would show all its cards. In fact, Mr. Simmons was the perfect foil for them to claim far less oil than they actually had without coming right out and declaring it. Let’s face it, when we thought the world is running out of oil, the price skyrocketed. I hope Mr. Simmons gets a finders fee.

In fact, the Saudi decision to bring on new production is the same argument I use to support investing in several of the best Big Oil companies. They are telling us that they think oil prices will remain high.

Good investing,

Matt Badiali