OPEC last week underlined that Asia’s continued strong economic growth would account for virtually all the growth in demand for oil this year. Saudi Aramco added that China and India will drive oil demand growth of more than 2 million barrels per day (bpd) in the period. Just prior to these two comments, Saudi Arabia’s energy minister Prince Abdulaziz bin Salman said that OPEC and its allies are in “a state of readiness” amid a divergence between the physical and futures oil markets. These actions, he added, would be “precautionary […,] part and parcel of what we call being proactive and pre-emptive.” For oil trading insiders what these comments add up to is OPEC, and its de facto leader Saudi Arabia, setting the stage for further major ad hoc cuts in their oil production aimed at pushing oil prices much higher. The traders didn’t have to wait long. Saudi Arabia, on Monday morning, announced that it was extending its voluntary 1 million bpd production cut through August, sending oil prices rising by 1%.
Taking a look at the longer term, the demand question comes first: someone somewhere in Saudi Arabia, Saudi Aramco and/or OPEC must know full well that the scale and scope of growth this year in the powerhouse Asian economy of China is extremely uncertain. As highlighted in several previous articles by me in OilPrice.com, a cyclical recovery in China for the first time will be led by household consumption, mainly services, as there is a great deal of pent-up demand and savings - about 4 percent of GDP - following three years of intermittent mobility restrictions. For oil prices, as TS Lombard’s chief China economist, Rory Green, has repeatedly stressed, it is apposite to note that transportation accounts for just 54 percent of China’s oil consumption, compared to 72 percent in the U.S. and 68 percent in the European Union. This all leads to the situation in which China now finds itself, of patchy growth and major drags remaining in the economy. In oil market terms, what this means is a rise in net import volumes certainly, but one which is unlikely to cause oil prices to surge, especially as China is buying oil at a discount from Russia, Iran, and Iraq, among others. Broadly the same economic and oil demand dynamics are also in play, mainly for the same post-COVID-19 reasons, in the other great Asian economy of India.
Consequently, by predicating the argument that global oil demand will be driven by these countries, and others with similar economic profiles in Asia, OPEC and Saudi Arabia are preparing the ground for future oil price-supportive cuts in production when this supposedly expected demand does not fully materialise but oil supply needs to be supported for sudden rises in demand. The method of such cuts has already been laid out (“precautionary […,] part and parcel of what we call being proactive and pre-emptive”), and the rationale has been expounded several times before by OPEC and Saudi Arabia (because they are dealing with “uncertainties and sentiment” that are “working against” the alliance). These comments by Prince Abdulaziz bin Salman build on his earlier statements that the global oil market must be supported through higher pricing in order that it can cater for future demand spikes and not find itself short of supplies as the world transitions to cleaner energy.
What all these comments amount to is that OPEC and Saudi Arabia want oil prices much higher than they are now but know that the U.S. and its key allies in the West and the East want the opposite and are working busily to keep them lower. In theory, Saudi Arabia has a fiscal breakeven oil price of US$78 pb of Brent in 2023. In practice, though, 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 budget, Saudi Arabia’s true fiscal breakeven oil price is a lot higher than that. It is true that the average cost of extracting one barrel of oil in Saudi Arabia (and in Iran and Iraq too) is just US$1-2. With genuine capital expenditure added in then, this per barrel lifting cost is around US$6-8. However, it is also true that there is a huge difference between this actual cost and the official Saudi Arabian fiscal breakeven oil price and that this difference is accounted for by Saudi’s real-world spending. And this spending can vary wildly from one month to the next based solely on a passing whim.
This was one of the key reasons why the initial public offering of Saudi Aramco failed to attract any notable buyers from the West, as analysed in full in my new book on the new global oil market order. Examples of unappealing Saudi socio-economic projects at that time included developing a US$5 billion ship repair and building complex on the east coast, working with General Electric on a US$400 million forging and casting venture, and even creating the King Abdullah University of Science and Technology. At the same time, a new extravagant vanity project was in the offing in the shape of the then-costed US$500 billion Neom project. According to its own advertisements, Neom would be ‘An Accelerator of Human Progress’ that may include such features as an artificial moon, glow-in-the-dark beaches, flying drone-powered taxis, robotic butlers to clean the homes of residents and a Jurassic Park-style attraction featuring ‘animatronic’ lizards. Predictably, this idea was not well-received by would-be international investors in the US or UK.
On the other hand, the U.S. and its main allies in the West and the East are broadly net importers of oil and gas, so sustained oil prices above US$80 pb of Brent, and corollary rising gas prices, mean that inflation will remain higher for longer, which will keep interest rates higher for longer, which will increase the economic damage done to them. For the U.S., 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.
These are the reasons why the U.S. has long sought to rigorously enforce a price range for the Brent crude oil benchmark 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 rigorous enforcement saw its apotheosis under former President Donald Trump, as also analysed in my new book on the new global oil market order. When Saudi Arabia (with the help of Russia) was pushing oil prices up over the US$80 pb of Brent level in the second half of 2018, Trump sent a clear warning to Riyadh to stop doing this. In a speech before the United Nations General Assembly, the then-President said: “We defend many of these nations for nothing, and then they take advantage of us by giving us high oil prices. Not good. We want them to stop raising prices. We want them to start lowering prices, and they must contribute substantially to military protection from now on.” In short, during Trump’s entire presidency, the ‘U.S./Trump Oil Price Range’ was breached only once for a period of around three weeks (toward the end of September 2018 to the middle of that October).
Right now, these are also the key reasons why the U.S. has not been too perturbed about Russia undercutting its supposed ‘OPEC+’ brothers to sell as much oil as it can, including to China and India. Legal or illegal, such supplies have the net effect of bringing global oil prices down. The same rationale applies to the U.S.’s view of oil sales from Iran directly to China, or of Iranian oil sold to multiple other countries through its willing conduit Iraq. The details of such sales and the methodology that facilitates them is also analysed in full in my new book on the new global oil market order.
By Simon Watkins for Oilprice.com
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