QUITE a common argument out there is that if and when higher cost US shale oil production shuts down, oil prices will start creeping up again – and they will soon reach close to $100 a barrel again by Q1 of next year. Here is another scenario that I think is worth some very serious thought:
- Saudi Arabia wants to keep higher cost shale oil production off the market for a long time in order to maintain its geopolitical relationship with the US – ideally, I guess, until higher cost producers in the US shut down permanently.
- This isn’t going to happen within the next few months. It will surely take a great deal longer as you are hardly going to quit the shale oil business altogether on the back of a few months of weaker prices. Thus, Saudi Arabia will have to keep the market sufficiently supplied with crude for long enough to achieve its objective.
But I also keep being told about the high “social costs” that Saudi Arabia and other OPEC have to pay in order to keep their populations happy. The chart above shows what I am referring to and so might be taken as an indication that substantial cuts in production by OPEC producers are inevitable and will happen very soon.
At least in the case of Saudi Arabia though, it seems to have built up ample financial reserves to cope with a very extended period of lower oil prices.
“Though public spending has risen in recent years, Saudi Arabia’s foreign reserves have risen more,” wrote The Economist in this article.
“Net foreign assets were 2.8 trillion riyals ($737 billion) in August—over three years’ current spending. It could finance decades of deficits by borrowing from itself even if oil were cheaper than it is now. “Over the past year production by non-OPEC countries, such as Russia and America, has risen from 55 million barrels a day to 57 million barrels a day. “The Saudis might conclude that the main beneficiaries of dear oil have been non-OPEC members. “
And Saudi Arabia seems to think that it cannot repeat the 1981-1985 mistake of trying to stabilise the market by cutting production from 10 million barrels a day to 2 million barrels a day. All that happened was that it lost market share to fellow OPEC members.
Here’s another thing to consider concerning the above chart: There is no way that the oil price can ever stay at anywhere close to the levels needed by Iran, Venezuela, Algeria, Nigeria, Ecuador, and quite possibly Iraq and Angola, for anywhere near long enough to make a material difference to the budgets of these countries. The global economy cannot tolerate $98-140 a barrel crude. All you would end up with is demand destruction and prices quickly falling back to more sustainable levels.
In such circumstances, therefore, wouldn’t it better for everyone to chase market share?
Some people will say, “$98 dollars a barrel? Surely, you are being a bit extreme here. Hasn’t the world lived with prices in the region of $100 for six years or more?”
True, but that was only because of central bank stimulus, I would argue, and that stimulus is now being withdrawn. All that easy credit from central banks masked the damage that high oil prices were doing to the budgets of oil importers in developing countries – and to the people in those countries on low incomes. For example:
- Indonesia has spent $132 billion on fuel subsidies ((1,600 trillion Rupiahs) over the last five years. During the same five years, because of the huge strain on its budget, it was only able to spend 1,200 trillion Rupiahs on social welfare programmes and infrastructure.
- India spent $23 billion, or 1.6 trillion Rupees, on fuel subsidies during its previous financial year. That money would have much better spent installing toilets.
It is great news, therefore, that Indonesia is now planning to reduce fuel subsidies and that India has already decided to deregulate diesel prices. Lower oil prices have obviously given both governments the room to launch these initiatives.
Chemicals companies should be cheering these decisions to the rafters and would be better off hoping oil prices don’t rise again to the point where policy reversals become necessary.
The reason is that the hundreds of millions of people in the emerging world who have to live on $1-2 a day can only benefit from lower prices. And it is these people who will drive global chemicals demand growth in the future.