Author: BlackMask Financial

• OPEC+ has extended its production cuts totaling 3.66 million bpd until 2025.
• Further production cuts by OPEC+ could impact global oil prices and economic stability, particularly affecting China and the U.S.
• Prominent OPEC countries may be reluctant to risk lower oil prices, as doing so could jeopardize the budgets for their ambitious national spending programs.

Early June saw OPEC+ extend its 3.66 million barrels per day (bpd) of production cuts to the end of 2025. It also announced that it would extend another 2.2 million bpd to the end of September 2024. Together, these cuts comprise around 5-6% of global oil demand. Despite this, though, the Brent oil price global benchmark has failed to break through the key US$90 per barrel (pb) level that was last achieved in September. This means that the two prime movers in the OPEC+ alliance – Saudi Arabia and Russia – are way off the oil price needed to balance their budgets. So will they cut production even more?It is a common misconception that Saudi Arabia is awash with oil money. This is not true at all, as the Kingdom is now battling with a 2024 fiscal breakeven Brent oil price of $96.17.  It has forecast a budget deficit this year of SAR79 billion ($21.07 billion), which many oil market observers believe to be extremely optimistic. As in all situations where expenditure is greater than revenue, this situation will only become worse from here. Part of the problem is that the country has never fully recovered from the 2014-2016 Oil Price War or the short-lived 2020 Oil Price War, These two wars were aimed at destroying or at least seriously disabling the then-nascent U.S. shale oil industry, which the Saudi correctly saw as a direct threat to its key oil sector, and therefore to its power in the world. By dramatically increasing production from itself and from its OPEC brothers, Saudi Arabia intended to crash oil prices for long enough that the still-developing U.S. shale sector would see a high percentage of bankruptcies, with those few companies left taking years to recover. Unfortunately for it, the U.S. shale sector demonstrated an extraordinary ability to reorganise itself quickly into a lower-cost industry able to withstand much lower prices than any other producers, including those in Saudi Arabia and OPEC. As a result, it was the latter two players that suffered financially, to the tune of well over US$450 billion in collective lost oil revenues over that two-year period, according to the International Energy Agency, although other commentators believe it to be at least double that figure. Over the course of the 2014-2016 Oil Price War, Saudi Arabia moved from a budget surplus to a then-record-high deficit in 2015 of US$98 billion and spent at least US$250 billion of its foreign exchange reserves over what many senior Saudis said had been lost forever. Another part of the problem is the country’s spending history on various social projects that subsequently spiralled dramatically. These include US$5 billion spent on ship repair and building complex on the east coast, and billions contributed towards the US$23 billion King Abdullah University of Science and Technology. Other projects saw spending estimates spiral even more out of control, most notably the flagship Neom City development. Initially-costed at US$1.5 trillion the linear city project located has been cut back in size from 106 miles long to just 1.6 miles long. Added to these huge overspends, the ill-received Aramco initial public offering in December 2019 meant that the Saudis had to commit to a massive dividend expenditure to sweeten the flotation. More specifically, it guaranteed a US$75 billion dividend payment in 2020, which then rose in 2023 to US$97.8 billion. For 2024, Saudi Aramco expects to pay US$124.3 billion in dividends. Given that Saudi Arabia – along with Iran and Iraq – have the lowest lifting cost per barrel of oil in the world (at just US$1-2 a barrel) it might be though that a temporary solution for its financial woes might be found in simply producing more oil. Although such an increase would push oil prices down, it could be gauged so that they were not pushed down to anywhere near the level of Saudi Arabia’s lifting cost, so allowing it a healthy profit per barrel and plugging the fiscal deficit. However, it remains the case that there is no genuine evidence of Saudi Arabia having the capacity to increase its crude oil production much above 10 million bpd for any sustained period without damaging the long-term integrity of its wells,  The fact is that Saudi Arabia produced an average of 8.267 million bpd of crude oil from 1973 to 1 May 2024, according to figures from OPEC itself. In its entire history, it has only managed to produce 12 million bpd on one occasion – in April 2020 – after which it immediately went back down to 8.49 million bpd. The inability of Saudi Arabia and its OPEC brothers to do anything meaningful further to push oil prices much higher is also a profound concern for Russia. In the first 100 days of its war in Ukraine, it earned nearly $100 billion from oil and gas exports – considerably greater than its cost for continuing to fight the war. As prices spiked, Russia was able to keep its earnings per barrel of oil much higher than the US$60  or so cap in effect around that time as part of various international sanctions by doing off-the-grid deals. These were priced higher than the $60  level, but still undercut the prices of oil from Saudi Arabia and OPEC members. However, as prices dropped, this margin for Russia shrank. After the initial jump in its oil revenues following the 24 February 2022 invasion of Ukraine, Moscow’s fiscal breakeven Brent oil price officially jumped to $115.However, as wars do not adhere to easily quantifiable and strictly adhered to budgets, the unofficial fiscal breakeven oil price is whatever President Vladimir Putin thinks it should be at any given moment.

All this would point to both key countries in OPEC+ likely push for greater production cuts from the cartel sooner rather than later. However, there are two problems for them if they do this. The first is that although Saudi Arabia’s and Russia’s key geopolitical sponsor China can buy oil and gas at 30 percent or more discounts from its core Middle Eastern suppliers through various deals agreed upon in the past few years, the economies of the West remain its key export bloc.

In fact, the U.S. alone still accounts for over 16 percent of China’s export revenues. Any significant increase in oil prices would damage the demand for its products from the West, adding to an already fragile post-Covid economic rebound. Indeed, according to a senior source in the European Union’s energy security complex, the economic damage to China would dangerously increase if the Brent oil price remained over $90-95  for more than one quarter of a year. Even this range is below Saudi Arabia’s fiscal breakeven price and is of little use to Russia either.The other problem is that the U.S. is in the run-up to the 2024 Presidential Election, and it is highly to sitting President Joe Biden’s advantage that oil (and therefore, gasoline) prices remain where they are or lower (historically around 70 percent of the price of gasoline is derived from the oil price). Longstanding estimates are that every US$10 change in the price of crude oil results in a 25-30 cent change in the price of a gallon of gasoline, and for every 1 cent that the average price per gallon of gasoline rises, more than US$1 billion per year in consumer spending is lost. Politically, since the end of World War I in 2018, the sitting U.S. president has won re-election 11 times out of 11 if the economy was not in recession within two years of an upcoming election. Moreover, according to a 2016 study by Laurel Harbridge, Jon A. Krosnick, and Jeffrey M. Wooldridge called ‘Presidential Approval and Gas Prices’, a 10 cent increase in gasoline prices correlated with a 0.6 percent decrease in presidential approval over the study period from January 1976 to July 2007. There are multiple direct and indirect mechanisms that a U.S. President in the midst of a close election could bring to bear on the oil price – economic and political pressure on China and Saudi Arabia, more sanctions on Russia, and increasing its own production and those of its allies, among others), many of which these countries would be keen to avoid.

Standard Chartered has been plotting the path of the oil price rally in what it terms as an “incorrect market reaction to the 2 June OPEC+ meeting”, telling investors in a note on Wednesday that the rally has “significantly further to run”. Since reaching a low point after June 2, Brent crude has rallied by over $9 per barrel, and analysts at Standard Chartered now believe that “with the Q3 supply deficit only partially mitigated by the start of OPEC+ production increases in Q4, we could be looking at a supply deficit beginning in August.  “The increase in demand towards its seasonal peak is the key driver of supply deficits of over 2 million barrels per day in both August and September. We do not expect the market to swing back into surplus in Q4 despite the seasonal fall in demand and increases in OPEC+ output,” Standard Chartered said in an investor report. Analysts are assuming here that OPEC+ voluntary output cuts unwind as planned, but warn that if the market becomes more bearish, “we expect the rolling back of voluntary cuts to take place over a longer timeframe”. 

Standard Chartered is advising investors that the market has not yet priced in a continuation of inventory draws in the fourth-quarter of this year and the first quarter of next year, and sees the potential for $90 oil in early Q3.

Also on Wednesday, Ole Hansen, head of commodity strategy for Saxo, said analysts noted that since the Q4 2022, the U.S. crude oil benchmark, West Texas Intermediate (WTI) has been averaging around $79 per barrel, highlighting “how production restraint by OPEC+ since April last year has helped deliver a period of stable prices, most likely at lower levels than originally anticipated by the group.” Hansen also noted that many cartel members need Brent to trade closer to $90 to balance their budgets.  “From an investor perspective, the crude oil market continues to yield a better return than what the change in the spot price is indicating,” Hansen wrote, noting that WTI spot month futures were trading up around 14% year-to-date. Standard Chartered also noted that while oil’s rally is strong, SCORPIO, its machine-learning oil price model, sees some bearish short-term influencers, most notably three weeks of increasing oil prices against the backdrop of “unusually low implied volatility”.