Considering that Saudi Arabia probably has the capacity to "flood the market" with crude oil, review the possible scenarios: 1) the whole world switches to Saudi crude oil and drops their other suppliers to take advantage of short term low prices, or 2) refiners stay with their traditional sources of crude oil despite the offer of lower prices by Saudi Arabia or 3) a combination occurs -- some refiners choosing to purchase Saudi crude oils at lower prices, but also continue purchases of other crude oils at higher prices.

In a perfect free market, where supply and demand react only to price, the first scenario might occur, leaving many nations dependent on Saudi Arabia.

But there are other factors to consider. First, security of supply is critical. Historically, dependence on mideast oil did not work out real well for the U.S., so keeping alternative supplies viable may be worth spending extra dollars. Second, the major oil companies are vertically integrated, i.e. they own production AND refineries. While their refineries may prefer to run the least expensive crude oil, it is not likely that the parent company will stand idly by while its production is shut in due to low prices. While the U.S. has no control over the price at which crude oils are offered for sale internationally, its refiners can and do select their crude oil supply and can set the price they will pay for the supply. They could continue to buy the crude oils they are currently using.

However, it seems unlikely that every refiner would choose to ignore the lure of lower crude oil prices, so perhaps the third scenario is more likely to occur. Refiners would balance purchases of local and company related crudes with less expensive imports.

On the other hand, "Refiner control" of crude oil prices might be defeated if foreign refiners purchase Saudi crude at very low prices, then market gasoline and distillate to wholesale markets in international markets at prices that local refiners cannot match without buying lower priced crude oil. In this case, independent refiners and marketers will be able to purchase low priced imports to compete directly with local refiners. Vertically integrated companies will be forced to cut their losses by also purchasing the lower priced imported products and concurrently reducing refinery runs to a level that is cost effective, which, of course, would result in a reduction of crude oil imports as well as purchases of crude oil from U.S. independents.

The bottom line is that Saudi Arabia may be able to bring the oil industry to its knees unless there is some sort of political interference or rapid modification in the way the oil industry does business. For years, the U.S. concerned itself with supply security issues. But the issue of facing a flooded market and what to do in such a situation has not ever been the subject of serious study.

Could we now face a decision to limit competition by setting minimum product prices to insure continued viability of our own crude oil fields? Or are we willing to sacrifice U.S. production companies in the interim while we consume resources from other countries and stand behind the concept of a free market world wide?

This year may be the point at which we have to decide how far the U.S. is willing to go to support the emerging world economy and how much we will hold on to in order to insure our own long term security.

In a free market, major oil companies would be forced to streamline and manage their companies in new ways to remain competitive. Some analysts suggest a new wave of mergers may occur. Mergers may make sense. On the other hand, how will the major economies view such mergers in terms of antitrust? Can we view the situation broadly enough to allow the development of international mega-oil companies competing not just for local markets within countries, but possibly competing for whole markets in whole countries?

After giving all of these concerns due consideration, and after seeing data that emerges in December, NOESIS will revise the forecast for the new year.