Articles and Media
Discounted UAE Oil: Deal or No Deal?
Issue: You asked about an offer, possibly from the United Arab Emirates (UAE) through a former KGB official acting as agent, to sell your client 300,000 barrels per day (300MBD) of crude oil at $3 per barrel below world price, for three years.
Background: You know enough about the KGB. The UAE comprises seven Persian Gulf emirates: Abu Dhabi, Dubai, Sharjah, Ajman, Fujairah, Ras al-Khaimah, and Umm al-Qaiwain. Abu Dhabi is the capital and economic power center. UAE Proved Oil Reserves total 98 Billion Barrels (98BB -- 8% of world total), 92BB in Abu Dhabi and 4BB in Dubai. Abu Dhabi and Dubai provide 80% of UAE income; non-oil (aluminum, tourism, re-exporting, etc.) income accounts for 70% of total UAE GDP though oil was the beginning. UAE crude is light (simpler to process; higher priced).
Proved Reserves reflects highest certainty about quantities of in-ground oil or natural gas, based on wells drilled, production history, field pressure and data from developed fields and reservoirs. Probable Reserves are estimates based on undeveloped, but discovered resources; Possible Reserves, or Undiscovered Resources are estimates based on geological, geophysical, geochemical studies, probabilities and black magic.
Abu Dhabi is an OPEC member; Dubai is not (Dubai exported oil before the UAE was formed, never joined OPEC, has a declining production rate and does not feel bound by OPEC quotas). Abu Dhabi and Dubai both continue to explore and find additional oil. Dubai’s production could be viewed as quota cheating but is generally ignored by OPEC.
The UAE (with Dubai) quota is 2.44 Million Barrels Per Day (2.44MMBD); 2005 production was 2.80 MMBD, after Abu Dhabi and Dubai completed $300MM in projects to raise production capacity. World demand in 2006 meant that quotas were largely irrelevant - until this autumn. Any production cuts may not even return to quota levels.
Recommendation: NO DEAL - in fact -- RUN! Here’s why:
First, such "deals" are rife when prices are high (1973-74 Arab Embargo, 1979-1980 Iran crisis, etc.). No deal was real; there was no reason for one, since the oil could be sold into a ready market. Buyers were and are ready; why should a seller make such a "deal?"
Second, oil is fungible at world prices with corrections for quality and gravity. It sells as it comes out of the ground and is pipelined or shipped anywhere in the world. Cargoes are often sold or traded several times en route to their final destination, increasing market efficiency and helping with contingencies. There is no reason to sell below world prices.
Third, buyers or sellers with no "wet" barrels can use the futures markets to move oil at agreed prices months in advance, without ever owning the oil. Thus dry barrels and wet ones on the world market all depend upon delivery at world oil prices; none need be sold at discounts since the badly handled UN Oil for Food Program. Futures market speculation was one key to the price run-up this summer.
Fourth, you opined that the 300MBD may be "outside of OPEC quotas" to sell "extra" production. Quota cheating has always been, but Saudi excess production capacity is nearly 2MMBD and the Saudis do not cheat; Abu Dhabi’s is second at perhaps 10MBD; no one else has any. An OPEC production cut of 1MMBD would provide some excess, mostly in Saudi Arabia. No one else could have enough to meet the offered deal. Dubai may not consider itself part of OPEC, but Dubai is unlikely to sell at a discount - ever -- and its production is declining - exactly the wrong time to sell at a discount.
Note: in 1985 the Saudis had shut in about 6MMBD to make up for OPEC cheating (world demand was 60MMBD). After repeatedly warning their OPEC colleagues, they opened all their capacity, flooded the market, drove prices from $30+ per barrel to about $9, and held them there for more than a year. High-cost production (all non- Saudi) was shut in around the world. The Saudis continue to oppose cheating; the UAE has no need to cheat; and no one else can -- not to the amount of 300MBD.
Fifth, if an OPEC nation had excess production capacity and wanted to cheat - or if a non-OPEC nation wants to sell more oil and can produce it - they need not discount to sell at today’s market price, nor for a long term. 300MBD, out of 82MMBD of total demand, would not drive the world price down by $3 per barrel. It doesn’t make sense.
Sixth, are you suspicious that a former KGB official is the middle man in the offer? Why would he sell for less than the going price? Demand sets the price; the Saudis and OPEC aimed for years to keep a price band of about $22-$28 per barrel then raised it several years ago to center about $35. The summer’s $70 price was not good for OPEC or anyone else, but I believe that $45-$55 could hold because of booming Chinese and Indian demand, growing demand in the US and Europe and concern about future production from Iraq and elsewhere. Why would anyone sell it for $3 less?
Finally, "If it sounds too good to be true, it is too good to be true."
Stay away from it. Tell any who is interested that they’d have a better investment in Nigerian or Ugandan bonds or secret treasure.
