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Morgan Stanley Sees Oil Prices Dropping to the Mid-$70s Next Year

The June OPEC Meeting May Spring A Nasty Surprise For The Oil Markets

The recent assurance from Russian Deputy Prime Minister and key OPEC+ negotiator Alexander Novak - that he does not expect the group to take any new decisions at their next meeting scheduled for 4 June - should not assure anyone. This is even more the case as it came around the same time as Russia's key partner in OPEC+, and the de facto leader of the 'OPEC' part of it - Saudi Arabia - warned speculators who have been selling oil to "watch out". Even more specifically, Saudi Arabia's Energy Minister, Prince Abdulaziz bin Salman, said: "I keep advising them [short-sellers] that they will be ouching - they did ouch in April." April, of course, did turn out to be the cruellest month so far this year for short-sellers after OPEC+ announced surprise further oil production cuts of around 1.16 million barrels per day (bpd).  This said, there are two key points about the oil price before and after the surprise OPEC+ output cut that should be noted for oil prices in the shorter- and longer-term. The first is that OPEC+ might well do the same thing in June as it did in April, and for the same reason. And the second is that this will make very little difference to the likely downwards trajectory of oil prices in the next few months, just as happened after the surprise April output cut.

The key reason why OPEC+ will continue to surprise with additional oil output cuts is simply that Saudi Arabia and many other OPEC countries need oil prices higher to survive and prosper. 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 likely to be a lot higher than that. It should be remembered here 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. The difference between this actual cost and the official Saudi fiscal breakeven oil price is based solely on its own estimates of spending and these can vary wildly from one month to the next. They do so because they are subject to the whims of senior Saudis who regard all Saudi Arabia's state income - and most of it still comes from oil and oil products - as funding for whatever pet project they have in mind at the time.

A notable case in point is the ever-expanding budget for Saudi Arabia's 'Neom Project'. Originally estimated to cost US$500 billion, two sources close to the project spoken to exclusively by now believe it will cost at least double that. Neom will be a new city (and surrounding area) spanning some 10,200 square miles. According to its own advertisements, it will be 'An Accelerator of Human Progress' that may include such features as an artificial moon, glow-in-the-dark beaches, flying drone-powered taxis, and a Jurassic Park-style attraction featuring 'animatronic' lizards. This type of jejune expenditure, funded in large part from Saudi Aramco's revenues, was another key reason why no serious investors in the West wanted anything to do with the disastrous Saudi Aramco initial public offering, as analysed in full in my new book on the new global oil market order.

Whilst Saudi Arabia and its OPEC brothers need oil prices as high as possible to fund these flights of fancy, the direct opposite is true for the U.S. and its main allies in the West and the East. These countries 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 reasons are 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. 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).

After Russia's invasion of Ukraine in February 2022, the U.S. and some of its key NATO allies determined that a line had finally to be drawn in Europe across which they would not tolerate any further Russian advances. This time, unlike Russia's near-unopposed annexation of Ukraine's Crimea region in 2014, these allies were prepared to undergo the short-term pain of losing cheap and plentiful oil and gas supplies from Russia for the longer-term gain of re-energising the NATO security alliance in all its formidable form. The catalysing of this division between the U.S. and its security allies on the one hand and the Russia-China alliance on the other, and the resultant jockeying of position with key oil and gas players in the Middle East, is a core element of the new global oil market order as analysed in full in my new book. A key part of these efforts are geared towards keeping oil and gas prices down, and these have broadly been successful so far. Releases of reserve oil stocks by the U.S. and from International Energy Agency countries, subtle but sustained intervention in the financial oil and gas markets, and new deals made with oil suppliers across the Middle East and North Africa have nullified much of what OPEC+ has tried to do in driving these prices higher. Given the massive political will of the U.S. and its allies in wanting to keep prices lower, then lower they are likely to stay.

And what of Russia's role in all this? Essentially, Russia wants OPEC members to push oil prices as high as possible so that it can undercut all of them at prices better than the capped prices at which it is officially allowed to sell oil. There are plenty of willing buyers for discounted Russian oil whether it is at or above the US$60 pb barrel price cap. China is the main one, but India is a huge buyer too - and the higher OPEC puts up its oil prices, the more attractive discounted Russian oil looks. As also analysed in my new book, neither China nor India (nor several other major oil-buying countries) care at all about existing U.S.-led sanctions against Russia. Interestingly as well, the U.S. itself does not seem too bothered about such sales at discounted prices to the OPEC levels because this has the net effect of subduing oil prices generally within the wider global oil market.

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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