THE BLOG
09/21/2006 12:30 am ET | Updated May 25, 2011

Saudi Arabia/OPEC Establish A "Reasonable" Price For Oil

Oil has retreated nearly $18 a barrel from its July record high
of $78.40/bbl in its steepest dollar decline in 15 years.

On Tuesday, according to Reuters, we were instructed by the Saudi Oil Minister Ali al-Naimi,
describing oil prices as reasonable for the first time since the market scaled record highs.
"The oil industry is convinced that the price of oil is reasonable", Naimi, the erstwhile
President of OPEC told reporters in Riyadh.

After having conditioned the consuming public to view $60/bbl oil
as reasonable rather than an aberration, al- Naimi's comments begin
to take on a patina of statesmanship.

But wait, if I can interject an element of incredulousness. Perhaps
Minister al-Naimi has forgotten, but back in November 1999 in a
speech at the Houston Forum, he pegged his country's cost of production
at less than $1.50 a barrel. As for discovering new reserves he boasted that
Saudi Arabia spent less than 10 cents per barrel.

That was seven years ago. Let's be very conservative and suppose that
today's cost of production for the Saudis has doubled over that period and is now
$3.00 per barrel (I would be willing to bet al-Naimi a case of lemonade that it's
actually less than $1.00/bbl today).

Keeping to the basis of $3.00/barrel, and with a market selling price of $60/bbl today, we are at what the Saudis perceive as "reasonable" with a markup multiplier of 2000 percent.

What would that mean to a company like Ford, whose difficulties and job layoffs have made poignant headlines this past week? What if they were able to price their 'Taurus' cars as "reasonably" as Saudi Arabia prices its oil.

The following calculation would hold true. We can safely assume it costs Ford at least some $12,000 to manufacture each 'Taurus' car, give or take. With a markup of 2000 percent the sales price would then evolve to be some $240,000 per vehicle.

Result: Were Ford able to pass those margins along there would be an immediate
recall of all those termination notices. Question: Why is it the Saudi's are so smart?