By Simon Watkins – May 01, 2023, 4:00 PM CDT
- OPEC has repeatedly warned of the danger of undermining oil industry investment and has cut production to ensure oil prices remain higher.
- Meanwhile, the United States has rigorously attempted to keep oil prices lower in order to keep fuel prices down and protect against inflation.
- At the same time, Russia is fighting to take market share from OPEC producers by helping to push prices higher while selling its oil at a significant discount.
The recent comment by the Secretary General of the Organization of Petroleum Exporting Countries (OPEC), Haitham Al Ghais, that the International Energy Agency (IEA) should be “very careful about further undermining” oil industry investments highlights the ongoing war between the big net buyers of oil allied to the U.S., and big net sellers of oil in the OPEC grouping. Contemporaneous news that Russia has slashed OPEC’s share of one of the biggest global buyers of oil, India, to the lowest in over two decades also illustrates Russia’s position in the new global oil market order, as analyzed in my new book on the subject.
Al Ghais’s comment is right in and of itself – the transition from fossil fuels to cleaner energy does need to be carefully managed to ensure no disruption to ongoing global power supplies, and this requires investment. However, the implication in his later comments that oil prices must be above US$80 per barrel (pb) of Brent to allow for such investment is wrong. In many of the leading oil-producing countries of OPEC – Saudi Arabia, Iraq, and Iran – the ‘lifting cost’ (the price of extracting one barrel of oil from the ground, not including capital expenditure) is literally just one or two dollars. With genuine capital expenditure added in then this per barrel extraction lifting cost is around six to eight dollars in these countries. Other countries in OPEC have higher figures certainly, but not by much in most of them.
The difference between the actual cost of taking a barrel of oil out of the ground and US$80 is mostly accounted for in the government budgets of OPEC countries not by investment in energy infrastructure to sustain future supplies but rather by investment in other state-directed projects unconnected to the energy sector. In Saudi Arabia’s case, vast sums of money flowing into its flagship oil company, Saudi Aramco, have been used for many years as funding for what might be regarded as various vanity projects (Neom, to name but one) and socio-economic projects (creating the King Abdullah University of Science and Technology, among many others). This, along with several other toxic elements attached to Saudi Aramco, was the reason why it could not find a reputable international stock exchange to take its initial public offering (IPO) and why it struggled to find Western investors to buy into the IPO. It is understandable why Saudi Arabia uses its chief revenue source to fund such projects, but to include these as being a true rationale for oil prices to stay above US$80 pb is to conflate two separate issues as far as much of the global oil market is concerned.
On the other side of the oil price equation is the U.S. and its principal economic and security allies both in Europe and Asia. For these countries that are net importers of oil and gas, sustained oil prices above US$80 pb of Brent, and corollary rising gas prices, mean that inflation will remain higher for longer, which will keep interest rates higher for longer, which will increase the economic damage done to them. For the U.S., these fears have very specific ramifications: one economic and one political, as also analyzed in my new book on the new global oil market order. The economic one is that historically every US$10 pb change in the price of crude oil results in a 25-30 cent change in the price of a gallon of gasoline. 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 and the U.S. economy suffers. The political one is that, according to statistics from the U.S.’s National Bureau of Economic Research, 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 U.S. economy was not in recession within two years of an upcoming election. However, sitting U.S. presidents who went into a re-election campaign with the economy in recession won only one time out of seven. This is not a position sitting President Joe Biden, or the Democratic Party, wants to be in one year out from the next U.S. election.
These reasons are why the U.S. has long sought to rigorously enforce a price range for the Brent crude oil benchmark of US$40-45 pb on the floor (the price at which U.S. shale oil producers can survive and make decent profits) to US$75-80 pb on the ceiling (the price after which economic threat becomes apparent to the U.S. and its allies, and political threat looms for sitting U.S. presidents). This rigorous enforcement saw its apotheosis under former President, Donald Trump. When Saudi Arabia (with the help of Russia) was pushing oil prices up over the US$80 pb of Brent level in the second half of 2018, Trump sent a clear warning to Riyadh to stop doing this. In a speech before the United Nations General Assembly, the then-President said: “OPEC and OPEC nations are, as usual, ripping off the rest of the world, and I don’t like it. Nobody should like it.” He added: “We defend many of these nations for nothing, and then they take advantage of us by giving us high oil prices. Not good. We want them to stop raising prices. We want them to start lowering prices and they must contribute substantially to military protection from now on.” In short, during Trump’s entire presidency, the ‘U.S./Trump Oil Price Range’ was breached only once for a period of around three weeks (toward the end of September 2018 to the middle of that October).
So, what about Russia, the significant ‘+’ part in ‘OPEC+’? For many years up to its invasion of Ukraine in February 2022, Russia had a fiscal breakeven price per barrel of Brent of around US$40. This was for a long period about the same as the level at which U.S. shale producers can make decent profits and around half of Saudi Arabia’s longstanding fiscal breakeven oil price. Things have changed now, with a fiscal breakeven oil price for Russia of around US$115 pb of Brent this year, according to oil industry figures. But this is not the key point. The key point is that following Russia’s invasion of Ukraine, various bans and price caps were introduced on its hydrocarbons products by differing groups of the U.S. and its allies, with a central one being the introduction of a general oil price cap on Russian oil at US$60 per barrel. This came in December from the G7 group of countries (comprising Canada, France, Germany, Italy, Japan, the UK, and the US) and from the EU (which is also a ‘non-enumerated’ additional member of the G7), plus Australia.
Given these factors, then, Russia’s strategy has been very straightforward, but very effective: persuade Saudi Arabia (the de facto leader of OPEC) to increase the group’s oil prices as much as possible while at the same time selling its own oil at a discount to this price, above the official oil price cap. There are plenty of willing buyers for discounted Russian oil whether it is at or above the US$60 pb barrel price cap. China is the main one, but India is a huge buyer too – and the higher OPEC puts up its oil prices, the more attractive discounted Russian oil looks. As also analyzed in my new book on the new global oil market order, neither China nor India (nor several other major oil-buying countries) care at all about existing U.S.-led sanctions against Russia and are happy to buy cheap Russian oil. Interestingly as well, the U.S. itself does not seem too bothered about such sales at discounted prices to the OPEC levels because this has the net effect of subduing oil prices generally within the wider global oil market.
The extent of the success of Russia in duping Saudi Arabia and OPEC into pricing themselves out of key buying markets and allowing Russia to exploit that gap can be seen in the latest figures for India’s oil buying. According to the latest industry figures, OPEC members saw their share of India’s oil market slide to 59% in the fiscal year to March 2023, from about 72% in 2021/22. Russia overtook Iraq for the first time to emerge as the top oil supplier to India, pushing Saudi Arabia down to number three in the latest data.
By Simon Watkins for Oilprice.com
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Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…