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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing for news outlets such as iNVEZZ and…

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Saudi Arabia’s $80 Oil Target Could Backfire

Saudi Oil

Although OPEC and allies have never officially targeted any specific price of oil with the production cut agreement, each member of the pact knows very well where they want oil prices to be in order to balance their budgets that have been stretched thin in the price plunge.

OPEC’s largest producer and de facto leader—Saudi Arabia—is the most closely watched oil nation for hints about an unofficial oil price target, and speculation has been ripe since the start of the deal in January 2017 as to what price the Kingdom is aiming for.

For months, Saudi Arabia has been said to aim for oil at $70 a barrel, but now new hints and reports suggest that Riyadh is likely shooting for oil at $80—to help finance increasingly ambitious domestic policy plans and to boost the valuation of its oil giant Aramco ahead of its much-hyped IPO.

If this unofficial oil price target were reached, however, it could backfire spectacularly on both sides of the oil-market-balance equation—supply and demand.

$80 oil would trigger an even bigger U.S. crude oil production surge that could unravel OPEC’s efforts at eliminating the glut. Oil at $80 could also slow down global oil demand growth, undermining one of the cartel and friends’ key assumptions: that robust demand growth will absorb the non-OPEC supply and that demand growth will continue to be strong going forward. Last year, oil demand growth surprised a bit on the upside, helping bloated inventories to draw down significantly.  

Yet, targeting $80 oil—if we assume that Saudi Arabia is doing that—has its economic reasons. According to RBC Capital Markets, OPEC’s producers need oil even higher—at an average of $88 a barrel—to balance their public spending this year, Bloomberg Gadfly’s Liam Denning writes. Related: Permian Bottleneck Could Impact Global Oil Markets

For Saudi Arabia, the price of oil needed to balance the 2018 public spending is $83 a barrel. The OPEC member that needs the ‘lowest’ price of oil to balance this year’s expenditure is Iran, at $52 a barrel, according to data by RBC Capital Markets.

It comes as little surprise then that Saudi Arabia and Iran—apart from the tense regional archrivalry—are reportedly at odds over where to go next with the OPEC deal, and how high an oil price the cartel should target. Iran is reportedly suggesting that $60 oil is about right so as not to encourage U.S. shale (even more), while Saudi Arabia is in need of higher-than-$60 oil to balance budget spending and lift Aramco’s valuation to anywhere close to the US$2 trillion that officials have been targeting.  

It also comes as little surprise that the latest hint that the Saudis are likely targeting $80 oil is not universally shared among all OPEC members, according to Bloomberg sources who relayed the Saudi ambition for said target. Some nations have privately expressed concern that such a price would be too comfortable for U.S. shale.

It may very well be. At Brent above $60 and WTI at a $3-4 a barrel discount, U.S. crude oil production has exceeded 10 million bpd in each of the weeks in February and March, EIA data shows. The Permian continues to boom, and even in case of takeaway capacity constraints—which have led to around $11 a barrel discount of Midland, Texas, oil to Brent—Permian producers would pump at profit if Brent were to rise (and stay) at $80, Bloomberg’s Denning argues.

Then, higher oil prices could also spur more production from areas outside the hottest U.S. shale play. According to the Dallas Fed Energy Survey from March 2018, the average WTI breakeven price to profitably drill a new well in the U.S. ranges from $47 to $55 per barrel. All the main areas, including the Permian, Bakken, and SCOOP/STACK, have average breakevens at less than $54 WTI, according to executives from 65 E&P firms.

The higher the oil price the Saudis (or OPEC) target and possibly reach, the more areas in the U.S. would be profitable to drill and add to the global oil supply, potentially wiping out the effect of the cuts and depressing oil prices again.  

On the demand side, oil at $80 could hurt global oil demand growth, which was the tailwind last year to help OPEC significantly reduce the oversupply. Demand growth could also slacken should the current U.S.-China trade spat hurt global trade and impact global economic growth. While the effects of a possible trade war are still just in the realm of possibilities and analysts are waiting for all the rhetoric dust to settle, if trade and economic growth were to weaken, they could affect the pace of oil demand growth. This could undermine the assumptions of OPEC and allies that strong demand growth in the short term would help the cartel to achieve its mission to bring inventories down to normal levels.

Related: Saudi Officials Worried About Oil’s Future

“OPEC’s current strategy hinges heavily on the prospects of future demand growth,” Bassam Fattouh and Andreas Economou at the Oxford Institute for Energy Studies wrote in a new paper on OPEC’s policy and choices.

“Thus, the risks of potential ‘trade wars’ and the potential negative impact on the global economy and on oil demand if these risks do materialise should constitute a serious concern for OPEC,” the authors argue.

Even without ‘trade wars’, OPEC could see demand growth slow down at $80 oil, as oil importing nations would be paying $30 a barrel more than they did last year, and double what they paid in 2016.

If $80 oil is really the unofficial Saudi target, and if prices reached that level—amid potential higher geopolitical risks (Iran, Venezuela) for example—U.S. producers could tip the supply side into another oil glut, while demand growth could slow down, leading to another cycle of depressed oil prices.

By Tsvetana Paraskova for Oilprice.com

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  • Mamdouh G Salameh on April 12 2018 said:
    If a country like Saudi Arabia is sitting on the world’s second-biggest proven reserves of oil, it is a viable economic principle to charge whatever oil price the global economy could absorb. This has nothing whatsoever to do with the IPO of Saudi Aramco. I am on record saying regularly for the last four months that Saudi Arabia will eventually withdraw the IPO altogether.

    The global oil fundamentals are positive enough and getting brighter to support a price of $75 a barrel this year rising to $85 in 2019 and $100 or higher in 2020. Moreover, Saudi Arabia and most OPEC members need an oil price higher than $100 to balance their budgets.

    As for US shale oil production, it will continue irrespective of how high or how low oil prices might reach. The shale drillers find themselves in a vicious circle. They need to continue production even at loss just to get loans to keep them afloat and without production they can’t pay outstanding debts which have been on the rise far above the $200 bn extended to them a few years ago.

    Based on the prospects for the global economy in 2018 and 2019, I would say the global oil market could absorb an oil price of $80.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Neil Dusseault on April 12 2018 said:
    Various news sources keep mentioning an "oil rally". This is simply not what is happening:
    See, because a rally would be something that occurs in a particular market for a day (e.g., "The market rallied today on news of..." or "I think there's going to be a rally today based on...").

    Perhaps this could be extended for several consecutive days of gains, even say as much as 2 weeks of oil closing on the upside. But folks, prices have only been going up for several months now. It's mid-April 2018 and prices have come up more than $25/bbl just since last Summer when WTI was in the $40s/bbl. That is not a rally, that is called extortion. It's blatant market manipulation on behalf of the Saudi's who have hijacked the global economy and we here in the U.S. are being held hostage for their prince's ransom.

    Think I am wrong? Consider any and all of the bearish news we have have lately:
    Record U.S. production; Continued increases in oil rig counts reported from Baker Hughes; surprise builds in inventory as reported from both API and the EIA; and yet if you watch the market, you'll realize the very moment prices start to decline--they bounce right back up from certain levels (e.g., $66/bbl and now $67/bbl on WTI) as if those are borders that are forbidden from crossing under.

    In early 2016 when WTI was in the $30s/bbl the U.S. shale industry said, "Just give us $40/bbl"; while Saudi Arabia said they can still be profitable at $10/bbl. Russia's energy minister has repeatedly said that they can survive on $40 oil forever. So, prices went into the $40s, and even far surpassed a technical barrier of $50 before WTI retreated back into the $40s. Oil bulls claim that only so much oil can be obtained in the $40s, and only for so long. Then $60/bbl was viewed as a technical barrier. Now that price is a guaranteed floor for both OPEC and U.S. shale, and then the Saudis clamored for $70 and Brent was over $72 yesterday, now they claim they need $80.

    Anyone else see a trend of where this is going? But the better question is, if oil cannot be produced en mass in the $30s, $40s, $50s, $60s, or even $70s...then why can't we argue that the whole world cannot sustain prices in the $80s or higher? And the best question is, why do we even pretend to have a market anymore when clearly prices are only allowed to move up in favor of the desired price that certain producers demand, as bids are done via algorithmic trading on behalf of hedge fund managers?
  • John McManus on April 12 2018 said:
    A good report from Tsvetana with one caveat.....she doesn't recognize the role of inflation on the US dollar.

    WTI was trading in mid 2009 in a $60 to $70 per barrel range prior to going to about $110 per barrel in 2011. In terms of 2018 dollars this is equivalent to about $78 to $91 per barrel for todays price levels. The current market is still priced at a very attractive value ....substantially lower than values nine years ago....a very good level for large users to cover their needs.

    The value of the dollar is not fixed. Current prices in 2018 are still substantially lower than they were nine years ago prior to the run up to $110.

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