Thursday, 25 December 2014

Saudi Arabia's Brilliant New Oil Policy, and why $60 Brent Crude is Here to Stay


On Nov 27th meeting of OPEC, the oil producers' cartel agreed to keep production levels unchanged, knowing full well that that decision will send the prices even further down, and indeed, Brent Crude benchmark fell from $80 per barrel to $60 by the end of December. Sparking much controversy and speculation about OPEC's end game, as most countries in OPEC have fiscal break even points for oil way above $60 per barrel, and keeping the production, and therefore prices, at the current levels would cause fiscal deficits for all these countries. Even though OPECs official statement was that this decision was based purely on business considerations, some people suspected political motives.

The first suspect was Russia, Vladimir Putin did not rule out that the current pricing policy is an American-Saudi conspiracy against Russia. It is true that Russia is very vulnerable to oil prices, with the US Energy Information Administration (EIA) reporting that oil and gas made up as much as 68% of Russia's export revenue in 2013. While the US is seen to profit marginally from lower oil prices. And indeed, during the month of December, the effects of the declining oil prices started to show, the ruble plunged to it's lowest point in 16 years by losing 37% of its value this year. In a poll by Reuters, economists forecast that Russia will fall deep into recession next year with the GDP to shrink by 3.6% in 2015, and face a double digit inflation in the same year.

Other people said that Iran was the target, which requires $131 per barrel to balance their budget due to the sanctions imposed on the country. Iran announced a much tighter budget for 2015, and they already unable to continue support for Basshar Alassad in the shadow war in Syria. Others also suspected that ISIS is the target, reducing their revenues from the black market oil they sell throughout Iraq and Syria.

Aside from the political consequences of oil prices. Yesterday, Saudi Arabia announced it's budget for 2015. And despite the low oil prices, and the fact that the budget was made based on an assumed average oil price of $60 per barrel in 2015, they increased expenditure by 0.6% from 2014, with an expected deficit of $39 billion, which would be covered by their foreign currency reserves. The reserves which stand currently at $736 billion can cover such a deficit for more than 18 years!

The assumption that the Saudi deficit would remain constant is based on the scenario of oil prices stabilizing around 60$ per barrel and production levels remain the same, which would result in constant oil revenues, and the fast growing non-oil sector would cover the extra expenditure, projected at a growth rate of an impressive 6.7% in 2015. But sustained oil prices of $60 per barrel will bring a lot of Shale Oil producers out of business, and with declining Shale production growth, and increased global oil demand, the prices might actually start increasing, at which point OPEC can increase production, bringing down the prices back to $60. This way, Saudi Arabia will manage to increase oil revenue and market share while still keeping oil prices low enough for many shale producers operations to be uneconomical.