Nothing lasts forever -- good or bad.
The global Covid-19 pandemic and Saudi-Russian price war upended global oil markets, sending demand and prices plummeting this spring. The head of the International Energy Agency, Fatih Birol, called it “Black April” and predicted 2020 would go down as the “worst year in the history” of the oil industry.
That prediction is proving premature thanks to the unprecedented breadth and speed of global production cuts and a more robust than expected return in demand as economies reopen.
China, the world’s second-largest oil consumer, imported a surprising 11 million barrels of oil a day in May, and demand there has returned to pre-pandemic levels. China is the first to reopen, but if other economies follow a similar trajectory, demand for oil could be back to its previous average of 100 million barrels a day by early 2021.
Black April did expose some fundamental truths about global oil supply, though. Much has been written about the risk to U.S. shale companies under the current low-price environment -- due to higher drilling costs, faster well-depletion rates, and venture capital business model -- but many national oil companies face their own challenges burdened as they are with underwriting state budgets.
Yes, producers in America’s prolific shale patch need prices around $45 a barrel to “breakeven” and many drillers got hooked on easy credit when oil prices were at $100 a barrel that has since evaporated. The smallest and most over-leveraged of those companies are now seeking bankruptcy protection or being gobbled up by larger competitors.
Still, drillers in the U.S. aren’t saddled with the cost of paying for social and military spending or the wages of government workers and therefore have far greater liberty than the major petrostates to respond to price signals. That’s because the “breakeven price” -- the cost of producing a barrel of oil -- is only half the story.
Saudi Arabia and Russia, for example, are both blessed with billions of barrels of conventional oil reserves that can be lifted from the ground with far less investment than producers in the U.S.
Aramco, Saudi Arabia’s national oil company, has an extraction cost of roughly $2.80 a barrel, and Russia’s oil companies, all closely tied to the Kremlin, are capable of producing oil for between $5 and $10 a barrel.
The spring price collapse, therefore, should have been an opportunity for Riyadh and Moscow to recapture market share lost after the U.S. lifted its 40-year-old ban on oil exports at the end of 2015.
The problem for petrostate leaders like Russian President Vladimir Putin and Saudi Crown Prince Mohammed bin Salman is that they require a much higher “fiscal breakeven” price to sustain their domestic spending agendas and maintain their grip on power.
While Brent, the international oil price benchmark, has climbed back toward $40 a barrel in recent days, Putin needs $42 a barrel to make good on his promises to spend billions of dollars on infrastructure and social programs to raise the living standards of ordinary Russians -- a move designed to boost support for his presidency beyond 2024.
Mohammed bin Salman, meanwhile, wants to ween Saudi Arabia’s off its dependence on oil revenues and transform the kingdom into a modern economy with his Vision 2030 -- an ambitious plan expected to cost trillions of dollars.
Saudi Arabia’s 2020 fiscal breakeven price is estimated at $78.30 a barrel, according to the International Monetary Fund. Of the other dozen members of the Organization of the Petroleum Exporting Countries (OPEC), only Kuwait has a fiscal breakeven cost under $50 a barrel ($49.70). Most need oil prices in the $70 to $90 range to meet domestic spending commitments.
Those commitments leave national producers little room to maneuver, especially compared to private-sector companies operating in a free market. U.S. companies may be beholden to shareholders and creditors, but they don’t have to worry about civil unrest and the possibility of regime change.
The crisis is forcing authoritarian leaders like Putin and Crown Prince Mohammed bin Salman to make tough choices that could destabilize their regimes and have far-reaching geopolitical consequences.
The Kremlin is now reconsidering plans to invest in the national economy and Riyadh has announced that it’s tripling taxes on state employees starting next month to cover some of the shortfall caused by the twin collapse of prices and demand.
Until these states diversify their economies or drastically reduce domestic spending, they are in no better position to withstand a price crash than their American cousins. It’s difficult to see how they can wrestle market share back from U.S. shale, stuck as they are in an endless cycle of production cuts to support prices, especially as shale producers will reenter the market as soon as prices near $50 a barrel.
Putin and the crown prince may pine for the days when they could name their price for oil by managing how much supply flowed onto the market, but those days are gone.