1. Saudi Arabia to Continue Fueling Low Crude Oil
Prices
Issue: One of the key driving forces behind falling crude oil prices is the Kingdom of
Saudi Arabia’s (KSA) ability and willingness to endure the negative effects of low prices
in the short-term as it seeks to benefit substantially in the long-term. With an estimated
$750 billion in foreign reserves and extremely low production costs, the KSA can sustain
itself on prices as low as the $20 per barrel (bbl) range without suffering from any major
economic setbacks. Although it does not control the global oil price alone, the KSA and its
Gulf State allies account for nearly 30% of the global crude oil market and it is now using
that leverage tominimize the impact of North America’s shale oil “boom”, as well as inflict
harm on the economies of its competitors in the world oil market.
Impact: The price of Brent crude oil hit $45.19 this week, its lowest mark since 2009.
While a price this low hurts theeconomies of every major oil producing country including
the KSA, other producers such as Iran, Russia and Venezuela require a much higher
“break even” price than the Saudis do, and the cost of production for shale and gooey tar
sands oil flooding the market from the U.S. and Canada is much higher than it is for Saudi
crude. Since the KSA can profit from selling a cheaper product at a lower price than any
other country in the world, it can afford to sit back and watch the price of crude oil drop
while dipping into the coffers of its vast reserves tomake up the losses. Meanwhile, other
oil producing countries have only two options: they can either continue selling their
products at unprofitable prices or cut back on production and risk losing market share to
the Saudis.
Next Steps: Even with oil prices dipping to a six-year low, the KSA has maintained that
it will not decrease production anytime soon. According to Saudi Oil Minister Prince Ali
al Naimi, “[Saudi Arabia] is going to continue to produce what we are producing, we
are going to continue to welcome additional production if customers come and ask for
it…[That] position we will hold forever, not [just] 2015”. While this is almost certainly an
empty promise, as oil accounts for about 40% of the KSA’s total GDP and its 2015 budget
is registering a $38.6 billion deficit due mostly to the expected low oil prices throughout
the coming year, the Saudis can afford to ride out the low prices for at least the next 3-5
years without suffering any kind of major economic setbacks.
More information below:
The impact of oil on the Kingdom of Saudi Arabia’s (KSA) budget:
The KSA retains the largest slice of global crude market share at 15.11% according
to RBC Capital Markets. Add in the Saudi’s Gulf State allies-the United Arab
Emirates (5.65%), Kuwait (4.03%), Qatar (2.98%) and Oman (1.63%)-andthe total
market share rises to 29.4%. They also represent about 40% of global production
2. and 80% of all reserves. Furthermore, these countries all have nationalized oil
making it very easy for them to control exactly how much oil they produce. As the
largest players in OPEC, these countries alone can basically set production rates
for the rest of the Member states. If other countries choose to decrease production
while the Gulf States maintain or raise their production, they risk losing market
share. The inverse is also true, leaving the Gulf States vulnerable to losing market
share if they decrease production. Since they are all Sunni Arab controlled
countries, their interests are often aligned and they will generally act in unison by
following the KSA’s lead. So, while the KSA does not control global oil prices
alone, it still has the largest influence on prices because it can take the quickest
actions which will have the most immediate effect on the price of crude oil.
The KSA also has a relatively low “break even” rate of $89-93 per barrel (bbl)
compared to higher rates for Iran ($136/bbl), Venezuela ($121/bbl) and Russia
($102/bbl). TheKSAcan make a profit by selling its oil as low as the$20/bbl range,
however their budget is based on oil at around the $100/bbl range, which means
it will experience deficits at lower prices. A $38.6 billion deficit has already been
factored into the KSA’s 2015 budget, but with an estimated $750 billion in foreign
reservestheSaudis can easily afford a deficit that size, or evenlarger, for 3-5 years.
This seems precisely what the Saudis are prepared to do; according to Saudi
Finance Minister Ibrahim al Assaf, “…over three to five years...The (economic)
depth we have…will be enough until prices get better. We have the ability to
endure low oil prices over the medium-term.” Oil accounts for about 90% of the
KSA’sexport earnings, 80% of government earnings and close to40% of total GDP.
For the KSA, the long-term benefits are enough to offset the short-term negatives.
They can “punish” rival countries such as Iran and Russia who economically
support the Assad regime in Syria, cannot afford the current oil prices and are
already suffering as a result of U.S. and E.U. sanctions. It can also make shale and
gooey tar sands oil production in the U.S. and Canada unprofitable, forcing them
tolose market share or push them out of the market altogether. U.S shale gas break
even points are highly variable ranging from $40/bbl-$160/bbl, but most
American-produced shale oil requires prices to be higher than $70/bbl in order to
make a profit. Synthetic oil produced in Canada is even more costly with a full
quarter requiring prices above $80/bbl. TheU.S. alone has added roughly 4 billion
barrelsof crude oil exportsper day tothe global total of about 75 billion since 2008,
and as of 2014 it had climbed over both the KSA and Russia as the largest oil
producing country in the world.
Elasticity of oil demand:
The elasticity of oil demand for the world’s largest economies and on a global net
basis is very small, by some estimates as low as -.25. This is due to the fact that
3. responses to changing oil prices that would reduce demand are timely both on the
personal and thepolitical levels. For example, on thepersonal level, if an individual
needs their car to get to work their demand for gas will not change as the price of
oil fluctuates. That individual will still have togo to work as the price rises, and will
not travel farther than work if the price falls. Over time, however, the individual
can make changes that will reduce their demand such as moving closer to work or
purchasing a more fuel-efficient vehicle. But, the individuals to feel the greatest
impact from an increase in oil prices are those least likely to have the means to
invest in things like a new apartment or a new car because they are those at the
bottom of the economic spectrum. Likewise a country can cope with an increase in
oil prices with greater fuel-efficiency standards for vehicles, but because changes
in policies like that take such a long time to be implemented the effects on overall
oil demand occur a long time after a change in price. So, for developed countries,
demand in response to a change in oil prices is extremely small because there is
little that an individual or a country can do to in the short term to change oil
consumption and the small changes that will take place happen over a length of
time. For developing countries, the price elasticity of demand for oil is theorized to
be even lower than that of major developed countries, by some estimates as low as
-.07 in the short term.
There is no way topredict accurately just how much a 50% drop in oil prices would
affect global GDP because it is impossible to predict how the impact would be
distributed and how individual countries would respond to such an event. There is
a theory that every 25% drop in oil prices has a roughly $1 trillion stimulus effect
on the global economy, so a 50% drop would represent a $2 trillion stimulus.
Considering the U.S. is approximately 25% of the world’s economy, it would
theoretically experience a $500 billion (one quarter of $2 trillion) net positive
impact from a 50% drop in oil prices. These numbers, however, are mostly
conjecture. Generally speaking, the impact on GDP of a drop in oil prices will be a
net positive on a global basis since there are more consumers of oil than there are
producers. For individual countries, those that import more oil than they produce,
like the U.S. and China, will generally see a positive effect. Conversely, those
countries that export more oil than they consume, like the KSA and Venezuela, will
typically experience a negative net impact. The few exceptions are for those
countries that rely heavily on commodity–based economies, like Brazil, and
countries that engage in large amounts of trade with oil-producing countries, such
as Poland (tradepartner of Russia), which will experience net negative effects from
a drop in oil prices.