Photo credit: AP
Saudi Arabia, one of the world’s top oil producers, is also the largest economy in the Middle East. We all know Saudi Arabia is sitting on massive reserves with oil production coming from giant oil fields where it probably costs less than $20 to produce 1 barrel of oil. However, it would be a big mistake to consider the extraction cost as the price required to break-even.
Saudi Arabia was one of the countries that bought peace in order to avoid social unrest. This “peace” is represented by a $125 billion spending program which amounts to 30% of GDP. It’s a domestic fiscal stimulus in order to tackle high unemployment amongst the national through a massive public investment program which includes building new cities, ports and expanding their oil production capacity.
“The break-even oil price the Gulf kingdom requires to balance its budget will jump from $68 last year to $88 this and then $110 in 2015, according to new estimates by the Institute of International Finance, a leading industry group.”
These numbers are very interesting as they set an invisible floor under current oil prices. As Saudi Arabia’s spare capacity decreases due to increasing domestic oil consumption, high oil prices will be more than welcome by the Saud family not only to sustain their domestic spending program but also to make up for the dollar devaluation thanks to Ben’s printing press in the US. After all, oil contracts are settled in US dollars. On the other hand, strangling the golden laying goose is to be avoided at all cost by making sure the price of a barrel of oil does not endanger the global economic recovery (i.e. they will talk the price down every now and then).
So we get several variables supporting high oil prices into the foreseeable future:
- Continued USD weakness
- Turmoil contagion risk still present in the MENA region
- Increasing demand to be met with supply from more expensive sources
- Increasing breakeven prices required by several producers for “budgeting needs”
- An abundant and cheap source of energy is not yet available to replace oil.
This does not mean oil will never revisit $40 a barrel again. Keep in mind that oil is a global commodity that impacts every business/product out there one way or another. Any economic jitters on a global scale will immediately impact the price of a barrel of crude.
Start getting used to oil prices above $100 a barrel dear Reader….
