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Oil Markets Are Slumping!
By Syed Rashid Husain
08/22/2011

With markets mellowing, prices falling and demand simply unstable, an interesting debate is raging all around. Saudis (as indeed other producers) can't afford an oil price slump - which media headlines are staring in front. Pundits are up in arms, saying the Kingdom will act sooner, rather than later, to avert the downslide. It has no other option, implying the producers are least bothered by the woes of the consumers and the state of the global economy.

Oswald Clint, analyst at Sanford C. Bernstein thinks Saudi Arabia may reduce its oil output sooner than it did after the financial crisis in 2008, basing the argument on the premise that the Saudi authorities need oil prices above $85 a barrel to meet their spending obligations. Expenditures are rising. Only the power plants and electricity distribution networks upgrading required by 2020, would need more than $100 billion. The recent payouts announced for the citizens by King Abdullah in Saudi Arabia and the other oil rich Arab states are cited by other pundits too as a prime motivation to keep the prices high.

Slugcatcher, the Western Australian energy writer back in April pointed out: Budgets, more than bullets and geology, have emerged as the driving force behind the oil price staying well above $100 a barrel, with Slugcatcher seeing $110 as the base price (not the ceiling) from 2015 onwards.

The Institute of International Finance (IIF), an exclusive bankers club, in a report titled, Saudi Arabia: Higher Social Spending to Forestall Unrest, published late in March said that Riyadh has been forced to invest in its human capital to prevent instability in the region. And then it said, for Saudis to spend more on civil society means that the oil price must stay high and it must continue to suck in the lion's share of the $1 trillion in revenue that is now flowing annually to members of the Organization of Petroleum Exporting Countries.

According to the IIF report, Saudi Arabia last year needed an oil price of $68/barrel to balance its budget. This year it needs $88 and by 2015 will need $110.

To put that escalator ride into clearer focus, it was only 10 years ago that Saudi needed $20-25/barrel.

Saudi Arabia needs an oil price of more than $100 within the next six years to prevent a deficit in its budget while the breakeven price of its crude could reach as high as $321 a barrel by 2030, a Jadwa Investments report too said late last month. This surge in the breakeven price of the Gulf Kingdom's crude will be a result of a steady decline in its oil exports, a sharp rise in public spending and the absence of other major sources of income, the report underlined.

Jadwa projected Saudi Arabia's total revenue to rise from around SR735 billion ($196 billion) in 2010 to SR843 billion ($225 billlion) in 2015 and peak at SR1, 120 billion ($299 billion) in 2030. But it expected expenditure to race far quicker than revenue as it will surge from around SR637 billion$170 billion) in 2010 to SR893 billion ($238 billion) in 2015 and 2,453 billion ($654 billion) in 2030.

"Based on the above assumptions, we estimate that the breakeven oil price required to balance actual government revenue with actual government expenditure will not rise above $100 per barrel (for Saudi export crude) until 2017 and will stay below $120 per barrel until 2021," the study said.

The report showed that by 2025 Saudi Arabia would need $175 per barrel to balance actual revenues to expenditures, and by 2030 the breakeven price would reach in excess of $320 per barrel. But by then oil export volumes would be around 1.5 million barrels per day lower than domestic oil consumption, it said.

Now most these reports are based on the premise that the producers are endeavoring to keep the oil markets firm. But is that such an abnormal, absurd and deviant craving?

Who among the producers' targets less returns for its products? Whatever products one has to offer to the world markets, one aspires for the best of the possible prices, whereas, the buyers also compete for the best possible bargains. There is a haggle in the process. This is what markets are all about. Ultimately market forces prevail and a win-win situation is arrived at.

It is inherent in every producer to try and maximize the returns. And they employ all the gimmickries at their disposal to avert any real slump in the market. This is their bread and butter and they tend to somehow control the markets.

But then if the crude producers tend to do the same - if at all - there is a hue and cry all around. Let's concede - for argument sake - that oil producers too want to maximize their returns. And then there is another dimension to this issue too. After all most of the crude producers have virtually single product economies. The glitter in Abu Dhabi, Riyadh, Kuwait and Doha, the well being of the citizens and the resident of the oil producing region, all is owed to this liquid gold.

And let's also concede that when at the OPEC meetings fireworks are generated between the doves and the hawks, both are basically trying to maximize their returns - one in short term and the other in the longer run. Their inherent interests command them to do so.

If the hawks aspire for a still higher market price and a tightening of supplies to ensure that - indeed there are reasons for that. They are looking at the short view of the market. They have little spare capacity and with their reserve levels low, they know they are a short terms player in the market in the real sense. And they want to make hay while the sun is shining.

On the other hand if the doves, the likes of Saudi Arabia, strive to keep the markets moderate - their long term interests commands them to do so. Their large reserve base makes them a long term player. They know they have a long innings to play. And for them ensuring demand security is significant in more than one ways. If prices continue to stay too high, for too long, demands gets compromised. Major, long term players can't afford that. They don't want to perform hara-kiri.

Both doves and hawks endeavor securing their interests. And there is nothing absurd about it. In free market conditions, a win-win situation emerges for everyone. And this is what one should strive for. Putting pressure on some to interfere with the market mechanism doesn't work in the long run. And crude markets are no exception.

Source: Arab News, Saudi Arabia, August 21, 2011. Changes were made in keeping with the editorial policy of www.memrieconomicblog.org

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