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Nick Cunningham

Nick Cunningham

Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.

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Saudi Arabia’s $100 Oil Dilemma

Saudi

Saudi Arabia is rumored to want oil prices at $100 per barrel, but if prices rise that high, it could sow the seeds of the next downturn.

Saudi officials want more revenues for their budget and a higher oil price to bolster the valuation of the Aramco IPO. But that short-term thinking could spell trouble not just for them, but also for oil prices, and ultimately for longevity of oil demand.

As Liam Denning of Bloomberg Gadfly points out, in the past decade, while oil prices have surpassed $100 per barrel for periods of time, they didn’t stay there for very long. In 2008, when oil nearly hit $150 per barrel, it was quickly followed by the financial crisis and a deep U.S. recession. Then, the period between 2011 and 2014, when oil was north of $100 per barrel, U.S. shale crashed the market with a wave of fresh supply.

If Saudi Arabia aims to drive up prices to triple-digit territory once again – and to be sure, that is only a rumor at this point – there are plenty of ways that could merely create the conditions for another bust.

First, oil prices are rising, in part, because demand is so strong, not just because OPEC is keeping barrels off the market. Oil at $100 would essentially amount to a doubling of the price from the past few years, which would quickly put an end to high demand growth rates.

A corollary to this is that $100 oil would likely impact economic growth. The economic recovery from the financial crisis in 2008 is almost a decade old at this point, much longer than the average upswing. History suggests that we are due for a recession at some point in the not-so-distant future. A spike in fuel prices around the world could help bring that on.

Related: The Bullish And Bearish Case For Oil

“Oil prices are high because the dollar is low,” Daniel Lacalle, chief economist at Tressis Gestion, told CNBC on Thursday. Taking too much oil off to the market for too long could send prices “artificially” high he said. "That is a big concern…Because oil prices don't generate crises; the abrupt and unexpected rise of oil prices creates crises," Lacalle said.

Second, $100 oil would set off yet another round of frenzied drilling, likely resulting in an even stronger wave of new shale supply. Several years of triple-digit oil prices led to a near doubling of shale production in the U.S., a volume that helped crash the market in 2014. A spike in oil prices could result in history repeating itself.

That is worrying because U.S. shale is already growing faster now than it was in the lead up to the 2014 downturn.

Either way, Saudi Arabia runs the risk of sowing the seeds of another bust in the oil market, which, needless to say, would be hugely detrimental to its own interests. “Saudi Arabia can push the price to $100 if it keeps supply sufficiently tight,” Carsten Fritsch, analyst at Commerzbank, told MarketWatch. “But it won’t be without paying a price in the long-term, i.e. causing a new wave of shale oil and oil from other sources.”

More threatening than new supply in the long-term is the prospect of peak demand. There is no shortage of projections about when peak demand might occur, but everyone agrees that it will occur. Electric vehicles still represent a small fraction of the auto market, but they just had their best month on record in the U.S. in March. If battery prices continue to decline, EVs could reach cost parity with the internal combustion engine by 2024.

Related: IMF: Expect Oil To Fall Below $60

However, if oil prices spike, consumers will switch over at a much faster clip.

In other words, in the pursuit of higher revenues this year and next year, Saudi Arabia could not only set off the next downturn but also do structural (i.e. permanent) damage to oil demand, which ultimately raises existential questions about the viability of the Saudi economy as it is currently organized.  

By Nick Cunningham of Oilprice.com

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  • jack ma on April 22 2018 said:
    Not so. Oil and gas are inelastic. Simply put, consumers will simply switch to substitutable elastic goods for other products. Tooth paste in the stores provide 200 types ranging in price for any budget. IMHO
  • snoopyloopy on April 22 2018 said:
    The last point about consumers fleeing oil products for alternatives is by far the most important. While consumers are still contemplating, every dollar increase in the price of oil makes it even easier for fleet managers to decide to ditch the whole charade in its entirety and go to electric, which would coincide nicely with when a plethora of commercial EV options are slated to hit the market. As a result, it also means that high prices might not precipitate a downturn because the price doesn't matter to those not using it.
  • Kr55 on April 22 2018 said:
    The 2014 crash was easily avoidable if OPEC were smarter and just left some room for shale. They actually made everything worse for themselves by creating that crash. They forced all these shale companies and service companies to got into 100% survival mode, finding every possible way to cut costs and evolve technology to get the most from every well. If the crash never happened, shale companies would have lived like hogs in a fat house far longer, throwing money around like it grew on trees, tapped into all their sweet spots with far worse returns than could have been possible.

    OPEC needs to learn their lesson, and they clearly have, there is room in the world for shale's contribution to the ultra-light oil market if OPEC is willing to back off a bit and just enjoy the massive profits they are swimming in. The alternative is more pain, most burning through their reserves (if they are an OPEC country lucky enough to have time), with the only result being shale players cutting more costs and finding more ways to squeeze money from every well, living forever off the free money from investors and banks.
  • Terry on April 22 2018 said:
    Does everyone think now that you have an electric car you won't have to pay for the electricity? When people started running their vehicles on propane the the price of propane quadrupled!!! Electricity will be the same way the only difference will be you have to pay more to light your house. Ask the people in Ontario Canada how they like high electricity costs alot of them could not afford to power their whole house
  • Wayne on April 23 2018 said:
    The future of electric cars is still a long ways off. There is still little infrastructure built into cities - charging stations, etc. So far, for the most part electric cars have been the second or third cars of most families - they still depend on reliable gasoline cars. Or, having an electric car as a status symbol. That's why some European countries stopped subsidizing electric cars - all benefited the well off. And with the influx of the middle class in China and other Asian cities - the demand for oil will continue well into the mid century.
  • Mamdouh G Salameh on April 23 2018 said:
    I don’t see any dilemma for Saudi Arabia in a $100 oil. A sound economic principle is for Saudi Arabia and oil producers around the world to try to maximize the return on their assets and aim for the highest price the global economy can tolerate taking advantage of very positive oil market fundamentals.

    In saying this, I would like to point out two important factors. One is that Saudi Arabia and the overwhelming majority of OPEC members need a price of $100 a barrel or higher to balance their budgets. The other is that while oil is priceless, a fair price according to my calculations ranges from $100-$130. Such a price is good for the global economy in that it enhances global investments, it improves oil producers’ revenues thus enabling them to explore more for oil and expand oil production capacity to meet future global demand and it enables major oil companies to balance their books and resume investing in oil and energy projects. We have seen how low oil prices between 2014 and 2016 very adversely impacted the global economy.

    If oil prices rise too high, the oil market fundamentals will tell us in no uncertain terms and will self-correct as happened after oil prices reached $147 in 2008.

    The claim by Daniel Lacalle that oil prices are high because the dollar is low is not correct. Oil prices are high because they are underpinned by a robust global economy, a fast-rising global oil demand and a virtual re-balancing of the global oil market. Geopolitical concerns, though factored in by the oil market, might add $1-$2 to a barrel of oil.

    While rising oil prices could stimulate more US shale oil production, shale oil production can never offset soaring global oil demand. If that was the case, then why was President Trump attacking OPEC about rising oil prices. He could have left it to US shale oil to do the trick by offsetting the OPEC/non-OPEC production cut and forcing prices down. His attack confirmed at the highest level that US oil production rises are mostly hype.

    The talk about the prospect of peak oil demand is no more than idle talk. With growing global economy and rising world population, a peak oil demand is a myth. Even a wider use of electric vehicles (EVs) in coming years will hardly dent the global oil demand. A post-oil era is another myth.

    Finally I have been repeatedly saying for the last five months that Saudi Arabia’s aim for higher oil prices has nothing to do with the IPO of Saudi Aramco and more to do with its budget needs and its desire to maximize return on its assets. Saudi Arabia is going to withdraw the IPO altogether because it no longer needs it in view of surging oil prices.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • rk on April 23 2018 said:
    Nick,
    If you are an oil and gas writer, how come you have never heard of oil field decline rates? Like about 4-5 million BOPD per year and lack of any reasonable oil discoveries over the past three years. Are you aware that about 27 million BOPD is offshore and decline rates can be over 10%

    Has it occurred to you that many of the Middle East fields are over 60 years old and significantly depleted? Do you not think the Saudis might be telling everyone something? Do you still think it costs peanuts to pump 15 million BOPD of sea water into their aging oil fields? Where is the investigative journalism?
  • citymoments on April 23 2018 said:
    Instead of predicting the price of oil, may I remind everyone of the relative price of crude oil compared to other commodities? Should oil cheaper be than milk or mineral water? At $60 a barrel, it is only 40 cents a liter compared to milk at $2 a liter or mineral water $4 a liter. At $200 a barrel, it is still cheaper than milk and mineral water. If that is the case, people investing in oil production must be very stupid, why not making milk or mineral water instead?
  • Jazzy Lapre on April 23 2018 said:
    Nick, we need more of these bearish stories to get oil back down to $35, keep up the good work. Hopefully we can use solar to get rid of our need for oil.
  • David Jones on April 25 2018 said:
    It seems that oil is in a bind either way. With high prices, renewables will displace production and EVs will displace ICEs faster. Batteries inside EVs are used for renewable energy storage (Tesla for instance) so increases in EV adoption will have a knock on effect regarding energy storage costs in general. That customer revenue is not coming back because once you've experienced the low sound/vibrations, no smell and fluid/stable handling of such a vehicle, it's highly unlikely that future purchases will be ICEs, especially with fully fledged EVs now entering the top of the mass market price segment. With low oil prices, many of the US producers are likely underwater and are staying alive by sucking air out of the lungs of others, probably not a sustainable situation in the long run without heavy handed government help. There could always be some technological breakthrough to lower the price of oil extraction but the general long term trend seems to be towards higher costs while the general trend in renewables and EVs is towards lower costs.

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