Oil and Gas in the Capitals
Does the Saudi budget oil price set the floor in world oil markets? While the oil price assumptions of the 2009−2010 budgets of Middle Eastern oil-producing countries remain conservative, differences in price assumptions reflect several geological, technical, social, political and economic factors. Poorer countries continued to assume higher prices than richer countries, with Bahrain, Iraq and Yemen assuming prices above $50/bbl and Kuwait and the UAE assuming prices at $35 and $38/bbl, respectively. Pundits estimate the Saudi budget oil price to be around $40/bbl. It is worth noting that price assumptions are “state secrets,” and all the reported numbers are calculated by various groups and experts. Also, price assumptions have moved downward more than once as oil prices continued to decline in recent months. Are they important? Do these price assumptions affect world oil prices? Generally speaking, they don’t. They are mere markers to guide finance policymakers. In most countries, the budget oil price assumption is independent of the oil export policy. In addition, the budget oil price assumption is not necessarily the price that balances the budget. Several oil-producing countries are running budget deficits with their current oil price assumptions of $35–$60. However, we have to distinguish between direct and indirect effects. Direct effect. A budget oil price assumption affects world oil prices directly and in the short run only if the oil producer is large enough and willing to defend that price by cutting production. In this case, the price assumption becomes a price floor. Saudi Arabia is the only country that fits these conditions: It has been the world’s largest producer, cut production more than its quota, and is not willing to increase production despite its recent increase in production capacity. Since no other OPEC country has these characteristics, one can conclude that only the Saudi price assumption matters, so it becomes the floor in the world oil market: $40/bbl. But the above conclusion can be easily rebuffed. Saudi is more flexible than any other oil-producing country in meeting its budget requirements. It can increase production and make revenues from volume rather than higher prices. It can use some of its foreign reserves. It can also borrow from local and international financial institutions. Ultimately, it can still reduce spending if oil prices continue to decline, as it did numerous times in the past. A senior Saudi official told me once that the Saudi government takes a long-term view. But in the short term, they are in the business of managing expectations, locally and internationally. “We are very flexible. We can reduce spending requirements,” he said. He also hinted that along with such changes, the Saudi people will start lowering their expectations. Indirect effect. The indirect effect of the budget oil price assumption on world oil markets could be more important than the direct effect. If world oil prices are equal or higher than the budget price, lower spending will slow economic growth and reduce E&P and maintenance spending. Future world oil supplies will decline, and prices will rise. If the price assumption is higher than actual oil prices, the country’s debt will increase, and its ability to attract foreign investment and loans will decrease. Either way, future production will decline. “Budget price” and “fair price.” If the price of oil exceeds the price assumed in the budget, oil producers are “happy,” but does that mean the price is fair? The answer is NO. Some Middle Eastern countries have already declared that the fair price is $75/bbl, almost double the average of budget prices. But if prices increase to $120/bbl, for example, what will be the budget price? Accordingly, will the “fair price” change? It’s clear that the “fair price,” like the “budget price,” is a moving target. The budget price, at least, is known, measurable and identifiable, especially by policymakers. The “fair price” is subjective and as elusive as other terms used by politicians in consuming countries, such as “energy security” and “energy independence.” Despite extreme volatility, some OPEC ministers considered $18/bbl to be fair at certain times, while others considered $200/bbl to be the fair price. If OPEC members cannot agree on the “fair” price, how do we expect to have a fair price for the world? Is the price fair from the point of view of producers or consumers? It is ironic that some OPEC ministers speak of fairness from the consumer’s point of view. And even in this case, is it fair from the point of view of all consumers or only some? Of industrialized countries or of developing countries? We can go even further: Is the oil price fair from the environmental point of view or the humanitarian point of view? Of the current generation, future generations, or all? Of NOCs or IOCs? Those who believe that budget oil price assumptions affect the oil market should focus on the Saudi price assumption and forget about the others. Even then, there is no evidence of a link between the Saudi output cut and the budget oil price assumption. Most of the Saudi arguments are linked to the cost of production (depending on how Saudis define costs) and maintaining supply. However, the true effect of these prices is in the long run. Lower prices reduce the size of budgets, spending, economic growth, and E&P and maintenance spending in the oil-producing countries.
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