What now for the oil price?

Feb. 2, 2009
Two questions loom heavily over the oil market: Where is the bottom of the price slide? And what level will prices seek once the bounce occurs?

Two questions loom heavily over the oil market: Where is the bottom of the price slide? And what level will prices seek once the bounce occurs?

If the oil market were fully competitive, the price would gravitate toward the level that induced the highest-cost producer to issue an extra unit of supply. Oil entering the market then would cover a cost spectrum, with lowest-cost production always at maximum capacity.

The oil market, though, isn’t fully competitive. A group of producers, members of the Organization of Petroleum Exporting Countries, deliberately limits output to keep the oil price higher than it otherwise would be.

To the extent OPEC succeeds at this, it represents a cartel. But work as a cartel is harder than it looks. Success, measured as price levitation and achieved through production restraint, generates pressure on cartel members to produce more than they have agreed to do. The tension is always great between group goals and the revenue needs of individual members.

OPEC, of course, describes its role less as a price manipulator and more as supply guarantor and market balancer. Yet its work involves the limitation of low-cost production and supplementation by higher-cost production that otherwise wouldn’t be competitive. That the consequent price elevation works to OPEC’s economic advantage is no mere coincidence.

Inherent instability

A market undersupplied by low-cost producers and oversupplied by high-cost counterparts is inherently instable. And its price is no longer governed by the next barrel from the highest-cost producer but by the revenue needs of the low-cost producer having the most spare capacity.

That would be Saudi Arabia.

The kingdom holds at least 70% of the idle capacity in today’s shrinking market. So questions about prices in the next few months have answers in Saudi revenue targets.

In a Jan.15 Global Oil Report dispatch, the Center for Global Energy Studies (CGES) in London used published financial data for 2008 and budget figures for 2009 to estimate Saudi requirements.

After a 2008 fiscal surplus 15 times planned levels in 2008, the Saudi budget assumes sharply lower revenue this year along with spending reductions CGES considers unlikely.

“Over the last 5 years Saudi expenditures have overshot their planned levels by 21% on average, and last year they were 24.4% higher than the budgeted amount,” it says.

In 2008, the kingdom reported total income of $293 billion and expenditures of $136 billion, with $8 billion of debt retirement.

For this year, CGES projects Saudi income of $159 billion, expenditures of $169.6 billion, and debt retirement equal to last year’s level. It had to estimate the split between capital and current spending in 2008 because the figures aren’t published.

The 2009 income forecast assumes $112 billion from exports of oil and natural gas liquids, based on an OPEC basket price of $54/bbl, average crude production at the Saudi quota level of 8 million b/d, and liquids exports of 830,000 b/d. The forecast crude production would be down 1.23 million b/d from last year’s level.

With crude and liquids output at those rates, Saudi Arabia needs an OPEC basket price of $41/bbl, after nonoil and other income, to meet its running expenses and to service national debt.

To meet those expenses and also make $40 billion in capital expenditures—$25 billion for Saudi Aramco and $15 billion for infrastructure—the kingdom needs an oil price of $59/bbl, CGES says.

Adding $8 billion in debt retirement to the assumed outlays raises the required oil price to $62/bbl.

$75/bbl target?

A comment by King Abdullah at an Organization of Arab Petroleum Exporting Countries meeting in Cairo in November, however, implied a price target of $75/bbl.

CGES considers that goal unreasonable with the global economy performing as poorly as it has recently.

“Our work suggests that despite deep cuts in output, OPEC is unlikely to coax the basket price much above $54/bbl as an average for 2009,” CGES says. “As it happens, an OPEC basket price of $54/bbl with 8 million b/d of output is enough to cover Saudi Arabia’s running expenses this year and leave almost $30 billion for investment, which would satisfy Saudi Aramco’s annual requirement for capital and allow $5 billion for infrastructural spending.”

It also would leave the high-cost producer afloat.

CGES identifies “the most expensive oil around today” as production from the Canadian oil sands, total costs of which it estimates at no more than $50/bbl.