By Tim Daiss
It’s been almost three-and-a-half years since global oil prices dipped to precarious levels for major oil producing nations. Oil prices had plunged from more than $100 per barrel in mid-2014 to dipping below the $30/barrel price point by January 2016. At the time global oil markets were so saturated with the precious black commodity that OPEC de facto leader and the world’s largest oil exporter Saudi Arabia was experiencing severe fiscal pain. The Kingdom had to pass politically unpopular austerity measures, ran record budget deficits, had to roll back pay for government workers, as well as raise funds in a number of international bond sales.
By the end of 2016, Saudi Arabia had issued a whopping $67 bn in international bond sales for much needed operational cash. Yet, the financial problems the Saudis experienced were largely of their own making. As U.S. shale oil production ramped up in 2014, the Saudis, instead of trimming production to remove barrels from the market and put upward pressure on prices, decided to open the production spigots to protect market share and also likely drive U.S. shale producers, whose production break-even points at the time were still high, out of business. Though some U.S. producers were forced out, others learned to produce for less and stayed alive, issuing in a lower shale oil production break-even point environment across the U.S. oil patch.
The only way out in late 2016 was for Riyadh to turn to non-OPEC producers, namely Russia, and craft the first so-called OPEC+ production cut to drain global markets of the supply glut. It eventually worked and by the end of 2017 OECD oil inventory levels were around five-year averages – the goal of the production cut. Yet, Saudi Arabia lost considerable power to sway global oil markets and had to do turn to intervention from non-OPEC producers.
Oil market dynamics
Currently, there are a myriad of dynamics at play in global oil markets for the Saudis to grapple with. First, they have to make a decision by next month whether or not to keep the second, and current OPEC+ production agreement to remove 1.2 million bpd of oil from markets in place or not. However, many of the factors currently affecting oil markets are out of Saudi control.
U.S. sanctions against Iran and Venezuela, oil output problems in Libya and Canada all come into play as does perhaps the biggest dynamic of all in global oil markets – the impact that the ongoing trade war between the U.S. and China will have. With the U.S. recently increasing tariffs on $200 bn worth of Chinese goods from 10 percent to 25 percent and the possibility that another $300 bn of goods could be hit, along with China’s retaliation by increasing tariffs on $60 bn worth of U.S. goods also from 10 percent to 25 percent, economic growth, and global oil demand will weaken going forward, though it will take a number of months before the pain will be fully felt.
Too early to call?
While it’s premature to make a forecast where global oil prices could end up amid a downturn in global economic growth, but without healthy demand, particularly in emerging markets, and within China itself, that tepid demand, even if OPEC+ tried to intervene, will put considerable downward pressure on prices. Prices could drop precipitously to the $50 price point. While Saudi Arabia still has one of the lowers oil production break-even points, the problem for Riyadh is that its fiscal break-even point is north of $75 per barrel. The IMF, for its part, said recently that the Kingdom needs oil at around at least $80-$85 per barrel to balance its books.
U.S. shale producers, for their part, would also cut production in an oil market with prices south of $50 but likely not at levels seen in earlier low oil price environments in 2015 and 2016. Most shale producers in the Permian basin now have a break-even cost between $46-$50, while some Permian producers can make money even if oil dropped as low as $32 per barrel. Stay tuned, things are only going to get more interesting.