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Lower Oil Prices Wreak Havoc On The Saudis

Lower Oil Prices Wreaks Havoc On The Saudis
Saudi Aramco oil pipe lines, Jubail
Image by
Suresh Babunair

The U.S. Energy Information Administration (EIA) said on Wednesday in its most recent Short-Term Energy Outlook that Brent crude oil spot prices averaged $60 per barrel in October, down $3 per barrel from September and down a whopping $21 per barrel from October 2018. London-traded Brent crude is the premiere global oil benchmark, though there are numerous other price benchmarks for both global and regional traded crude oil. NYMEX-traded West Texas Intermediate (WTI) is the most common U.S. oil benchmark.

The Middle East, for its part, is now launching a new oil price benchmark to rival both Brent and WTI. The Abu Dhabi National Oil Company (Adnoc) and nine of the world’s largest energy traders have partnered with the Intercontinental Exchange to set up by early next year the world’s first Murban crude oil futures contracts, CNBC reported on Monday. The development could shake up the pricing of oil in the region, the report said.

Going forward, the EIA forecasts that Brent spot prices will average $60 per barrel in 2020, down from an average of $64 in 2019. EIA forecasts that WTI prices will average $5.50 per barrel less than Brent prices in 2020. The EIA also expects that crude oil prices will be lower on average in 2020 than in 2019 because of forecast rising global oil inventories, particularly in the first half of next year.

The EIA forecast is similar to other projections from various banks and consultancies that also see weaker global oil prices next year. The quandary of lower oil prices will impact all oil producers, but particularly OPEC de facto leader Saudi Arabia that has a fiscal breakeven price point of around $86.50 per barrel, according to the International Monetary Fund (IMF).  

The irony for the Saudis is that they actually have one of the lowest oil production breakeven price points in the world, less than $10 per barrel according to state-run Saudi oil giant Aramco. The disparency makes you wonder why for the sake of national survival; the Saudis can’t reduce public expenditures enough to keep its fiscal breakeven point closer to its production breakeven point.

Pain for the Saudis, however, isn’t just coming from lower oil price projections but in order to put more pressure under prices in hopes of even a minor price respite, it needs to not only keep the ongoing OPEC+ production cut in place, but actually either trim or convince other members to cut oil production even more.

Given that the Saudis are already cutting deeper than other members and more than called for in the OPEC+ deal, its unlikely that Riyadh will cut more production. It may also be a hard sell to convince other producers to cut output, particularly Russia who also relies on natural gas exports, both pipeline and liquified natural gas (LNG) to help balance its books.

Weaker oil prices will also impact U.S. shale production as more U.S. producers are bowing to pressure to pay investor dividends instead of plowing more money into increased production. However, though U.S. production will take a hit in a prolonged low oil price environment, it will nonetheless continue to keep global oil markets saturated with the precious black commodity.

As I’ve written previously, the 800-pound gorilla in the room continues to be weakened economic growth and hence slower global oil demand due to ongoing trade tensions between the U.S. and China. Even if phase one of a trade deal is reached, it won’t be enough to adequately resurrect global economic growth and corresponding oil demand. For that to happen, a permanent cessation of the trade war needs to take place, something that will not likely happen in the foreseeable future, at least as long as President Trump occupies the White House.

The prospect of another four year Trump administration of course is fraught with unknowns; however, it seems to bode well for both U.S. economic and trade interests – even if it will come at the expense of global oil prices.

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