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OPEC Lifts Production in February

At What Level Will Saudi Arabia And Russia Stop Pushing Oil Prices Higher?

The decisions last week by Saudi Arabia to continue its 1 million barrel per day (bpd) production cut to the end of this year and by Russia to extend its 300,000 barrels per day export cut for the same period conspired to push oil prices to their highest level since last November. This in turn has added to the inflationary pressure threatening the economic health of the U.S. and many countries allied to it. The question for these net oil importers (and gas importers too, given that historically 70 percent of gas prices have been comprised of the price of oil) is at what level the two leaders of OPEC+ will halt their efforts to keep pushing prices higher?  The first part of this equation revolves around the necessity or not of higher prices to keep these two economies afloat, or whether it is simply greed at work, or a geopolitical power play, or any combination thereof. It is a common conception that Saudi Arabia's economy is a powerhouse, fuelled by vast revenues from oil. The latter part has some truth to it, helped by having (along with Iran and Iraq) the lowest lifting cost per barrel of oil in the world, at just US$1-2. This said, much of these revenues are deducted almost at source, through the massive dividend repayment obligations that must be made every quarter by Saudi Aramco. Even with Brent oil price averaging around US$80 pb in Q2, 65 percent of its net income went on this debt payment to shareholders. If its net income stayed the same in Q3, this debt payment would rise to 98 percent. What is left after these deductions is the foundation stone of all Saudi Arabia's spending, which includes not just the basic functions of state - such as health, education, and defence - but vast socioeconomic and vanity projects as well, as analysed in depth in my new book on the new global oil market order. In theory, then, Saudi Arabia's fiscal breakeven oil price is US$78 pb of Brent. In practice, however - as the fiscal breakeven oil price is the minimum price per barrel that an oil-exporting country needs to meet its expected spending needs while balancing its official budget - its true fiscal breakeven oil price has no set limit. The same applies to Russia. For around 20 years, it had a fiscal breakeven oil price of around US$40 pb. Following its invasion of Ukraine on 24 February 2022, though, officially this has jumped to US$115 pb. Unofficially, as wars do not adhere to easily quantifiable and strictly adhered to budgets, the unofficial fiscal breakeven oil price is whatever President Vladimir Putin thinks it should be at any given moment. 

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The first part of the equation, then, is that both Saudi Arabia and Russia absolutely need to keep pushing oil prices higher, which moves the equation into its second part - at what level will they face overwhelming pressure from their customers to stop doing so? The first group of customers are the U.S. and its core allies, in which ever-increasing oil and gas prices have caused dramatic spikes in inflation and the interest rates required to combat it, which in turn make economic recessions more likely. For the U.S. itself, these fears have very specific ramifications: one economic and one political, as also analysed in my new book on the new global oil market order. The economic one is that historically every US$10 pb change in the price of crude oil results in a 25-30 cent change in the price of a gallon of gasoline. For every 1 cent that the average price per gallon of gasoline rises, more than US$1 billion per year in consumer spending is lost, and the U.S. economy suffers. The political one is that, according to statistics from the U.S.'s National Bureau of Economic Research, since the end of World War I in 2018, the sitting U.S. president has won re-election 11 times out of 11 if the U.S. economy was not in recession within two years of an upcoming election. However, sitting U.S. presidents who went into a re-election campaign with the economy in recession won only one time out of seven. This is not a position sitting President Joe Biden, or the Democratic Party, wants to be in one year out from the next U.S. election.

Russia has increasingly less to do with these countries than Saudi Arabia, given the ongoing escalation of sanctions against its energy exports to them. Saudi Arabia has moved so far into China's sphere of influence now that it appears not to care at all what the U.S. wants in any respect. This was perhaps most personally and palpably underlined when Saudi Crown Prince Mohammed bin Salman refused even to take a telephone call from U.S. President Joe Biden just after Russia's invasion of Ukraine in which he wanted to ask Saudi Arabia for help to bring down economically-crippling energy prices. However, this does not mean that the U.S. is powerless to cause Saudi Arabia to change its mind. The mechanism to cut off much of its oil revenues by effectively destroying Saudi Aramco is already in place in the U.S, in the form of the 'No Oil Producing and Exporting Cartels' (NOPEC) bill, as also analysed in depth in my new book. This legislation would open the way for sovereign governments to be sued for predatory pricing and any failure to comply with the U.S.'s antitrust laws. OPEC is a de facto cartel, Saudi Arabia is its de facto leader, and Saudi Aramco is Saudi Arabia's key oil company. The enactment of NOPEC would mean that trading in all Saudi Aramco's products - including oil - would be subject to the antitrust legislation, meaning the prohibition of sales in U.S. dollars. It would also mean the eventual break-up of Aramco into smaller constituent companies that are not capable of influencing the oil price. 

This leaves the big Asian customers, especially China and India. China can purchase oil from several major sources - including Iran, Iraq, Russia, and even Saudi Arabia itself, among many others - at discounts of anywhere from 25 to 45 percent, according to several sources exclusively spoken to by in the past few weeks. However, China's willingness to tacitly encourage escalating oil and gas prices is likely to be outweighed over time by the indirect impact of that on its economy. Specifically, it is still highly dependent on exports to the U.S. and its allies, so as rising oil and gas prices hit these economies further, China's economy will slip further into the mire. As has been seen since the end of 2022, the country's economic bounce back after three years of very-tightly managed Covid has been less than assured, and could be seen as being at a dangerous tipping point for President Xi Jinping's government. Its decision on 15 August to stop publishing youth unemployment data after it hit a record 21.3 percent in June will not change the growing discontent in that section of its society. And the government knows that just before the series of violent uprisings in 2010 that marked the onset of the Arab Spring, average youth unemployment across those countries was 23.4 percent. So, either China does not influence Saudi Arabia and Russia towards moderating oil and gas price rises, which will reduce major demand for its exports, which will weigh further on its economy, which will reduce oil and gas demand, which will serve to dampen prices. Or it does, and prices fall by dint of that.

Given this range of factors, the short-term steady equilibrium price for Brent looks to be around US$80-85 pb, with a ceiling of around US$95 pb. Longer-term, these factors should result in a reversion back down to the longstanding 'Trump Range' of oil pricing, as also analysed in depth in my new book. The range comprised a Brent price of US$40-45 pb on the floor (the price at which U.S. shale oil producers can survive and make decent profits) to US$75-80 pb on the ceiling (the price after which economic threat becomes apparent to the U.S. and its allies, and political threat looms for sitting U.S. presidents). This range was rigorously enforced under former President Donald Trump's administration, to the degree that during his entire presidency it was breached only once - for a period of around three weeks (toward the end of September 2018 to the middle of that October).

By Simon Watkins for

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Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for… More