Saudi Arabia needs oil prices at $50-$55 a barrel to fund its imports and offset remittance outflows.
Just three years ago, when the OPEC+ oil giants pulled out, the US found itself playing the role of peacemaker. Now it is more visible on their target.
The Saudi-Russia oil nexus has the potential to spell all kinds of trouble for the US economy – and even for President Joe Biden’s re-election campaign. OPEC+’s decision this month to cut crude output, a second time since Biden flew to Saudi Arabia last summer seeking a boost, could be just the beginning.
That April 2 announcement, which raised oil prices by nearly $5 a barrel, already means recession risks are greater than they otherwise would be – because consumers spending more on energy have more money to spend on other goods. There would be less cash left over – and inflation would be higher. Meanwhile, Russian President Vladimir Putin receives a huge war-tomb to finance his invasion of Ukraine.
But more important is what the OPEC+ move says about the likely path of oil prices in the coming years.
In a world of shifting geopolitical alliances, Saudi Arabia is breaking away from Washington’s orbit. The Saudis set oil production levels in coordination with Russia. When they wanted to ease tensions with regional rival Iran, they brokered a deal with China – leaving the US out of the loop. In other words, Western influence on the oil cartels is at its lowest point in decades.
And OPEC+ members all have their own priorities, from Saudi Crown Prince Mohammed bin Salman’s ambitious plans to Putin’s wars. Whatever extra revenue they get from charging more for oil is helpful.
Asked about US concerns that OPEC+ has chosen to cut production twice since President Biden’s visit to Saudi Arabia, a State Department spokeswoman said the administration is working to lower domestic energy prices and America is focused on ensuring energy security. The spokesman said the US views the production cuts as ongoing volatility in the market, but will wait to see what action OPEC+ ultimately takes.
Meanwhile, the threat of competition from US shale fields, a deterrent to price increases in the past, has waned. And while there is a global effort to reduce fossil-fuel use — and higher prices will accelerate that effort — the dash to drill in the past year shows that the zero-carbon economy is more a long-term than a short-term driver. The aspiration remains.
Add all this up, and while some analysts say demand constraints mean the recent surge in prices may prove fleeting, with prices projected above $80 a barrel in the coming years — $58 between 2015 and 2021. Above average per-barrel price.
crude shock
It has been a volatile 18 months or so in crude oil markets, with three main phases.
- In the wake of Russia’s invasion of Ukraine – and even more so immediately afterwards – prices soared, reaching around $120 a barrel in June 2022.
- Then the trend reversed. Recession worries in Europe, rapidly rising interest rates in the US, and China’s COVID restrictions combined to push the price down to around $75 in December.
- Demand started picking up in early 2023, largely due to the reopening of China, the world’s biggest importer. Last month’s banking turmoil halted the rally – but it had resumed even before the surprise OPEC+ output cut, which lifted prices from $80 to $85 a barrel.
For the global economy at large, low oil supplies and high prices are bad news. Major exporters are definitely the big winners. For importers, like most European countries, more expensive energy is a double whammy – pulling down growth even as inflation rises.
America falls somewhere in between. As a major producer, it benefits when prices rise. But those benefits — in contrast to the pain of higher pump prices — are not widely shared.
Bloomberg Economics’ SHOK model predicts that for every $5 increase in oil prices, US inflation will increase by 0.2 percentage point – not a dramatic change, but at a time when the Federal Reserve is struggling to get prices under control. Well, not even welcome.
There are three key reasons why more such shocks could happen: geopolitical shifts, shale maturity and a boom in Saudi spending.
geopolitical friction
For decades, the US-Saudi “oil for security” pact has been a pillar of the energy market. Now it’s faltering. Symbolized by the 1945 meeting between President Franklin D. Roosevelt and King Abdul Aziz ibn Saud aboard an American cruiser in the Suez Canal, the deal gave the United States access to Saudi oil in exchange for guarantees of the kingdom’s security.
But the settlement is no longer what it used to be:
- In 2018, Washington Post columnist and Saudi dissident Jamal Khashoggi was murdered at the Saudi consulate in Istanbul.
- In 2019, Biden – then a presidential candidate – threatened to turn Saudi Arabia into a pariah state and block arms sales.
- In 2021, early in his presidency, Biden released an intelligence report assessing that Crown Prince Mohammed, the kingdom’s de facto ruler, was responsible for Khashoggi’s murder.
- In October 2022, OPEC+ cut oil production by 2 million barrels per day – less than three months after Biden flew to Riyadh demanding an increase. The White House described the move as “short-sighted”.
- Last month, Saudi Arabia and Iran agreed to restore diplomatic ties in an agreement brokered by China and signed in Beijing.
- The Saudi government has also agreed to join the Shanghai Cooperation Organisation—a grouping along with China and Russia seen as rivals to Western institutions—as a “dialogue member”.
“The Saudis are looking for an offensive defense,” said John Alterman, director of the Middle East program at the Center for Strategic and International Studies, a Washington-based think tank. “Given what the Saudis see as a fundamentally unpredictable US policy, they feel it is irresponsible not to seek a hedge. And fundamentally unpredictable, you’re looking at a US policy that That changed quickly between Obama and Trump and Biden.”
Following the April 2 move, Saudi officials said it was motivated by national priorities rather than any diplomatic agenda.
“OPEC+ has been successful in stabilizing oil markets now and in the past, and contrary to the claims of Western and industrialized states, it has nothing to do with politics,” said Mohammed Al Sabban, a former adviser to the Saudi oil ministry.
shell buffer?
In the past, OPEC+ has often been torn: It wanted higher prices, but worried they would attract more competition, especially from US shale oil. That disagreement sparked a price war between Russia and Saudi Arabia in 2020 – which ended when then-US President Donald Trump brokered a deal.
But the dilemma barely exists anymore. Rising US wages and inflation have increased the cost of shale production, leading to slower production growth. And companies are giving priority to distributing profits to shareholders rather than investing in expanding production.
Saudi Arabia has an expensive social contract with its citizens, promising prosperity in exchange for political approval.
OPEC+ needs a budget
Meanwhile, oil producers have their own objectives.
Saudi oil is cheap to extract. And the state only needs $50-$55 per barrel prices to fund its imports and offset remittance outflows. But it requires a higher price of $75-$80 to balance the budget – and even that doesn’t tell the whole story.
Saudi Arabia has an expensive social contract with its citizens, promising prosperity in exchange for political approval. To keep its side of the deal, the government needs to invest in its non-oil industries – which employ most Saudis. Petrodollars pay that bill.
Saudi Arabia’s sovereign wealth fund aims to spend $40 billion a year on the domestic economy — including building NEOM, a futuristic city in the desert with an estimated price-tag of $500 billion — on top of outside investment. These figures are not visible in the budget. To meet all these goals, Saudi Arabia needs an oil price of around $100.
Meanwhile, in Russia President Putin is counting on oil revenue to fuel his war machine. Bloomberg Economics Russia economist Alex Isakov calculates that a price tag of $100 a barrel is needed to balance the Kremlin’s books.
October Surprise?
To be sure, the White House appears unfazed by the latest round of production cuts. This may partly reflect expectations that the actual production decline may be less than the headline number of more than 1 million barrels per day. Compliance among OPEC+ member states with cuts may also be less than perfect. In February, Russia promised to unilaterally cut production. In fact, the flow had started reducing only last week.
Nevertheless, the consensus among analysts is for oil prices to average $85-$90 per barrel this year and next. What if OPEC+ decides to make another cut in production ahead of the US presidential elections next year, making Biden less likely to win?
Bloomberg’s economic outlook modeling tool – SHOK – suggests that a cut in oil supply of about $120 a barrel in 2024 will keep US inflation at around 4% by the end of 2024, compared to a baseline forecast of 2.7%. And conventional wisdom says that higher pump prices hurt incumbent politicians at the ballot box.
Of course, a shock to the US economy would raise the risk of a broader recession that dampens appetite for oil and lessens the effects of supply cuts. Still, the US share of global GDP is declining, and nations such as China and India are major contributors to oil demand. China buys vast quantities of Russian and Iranian oil at a discount – partly shielding it from price rises.
India, another large and fast-growing economy, is also getting cheap fuel from Russia, which has become its biggest supplier. Understandably, Delhi – which has expressed disappointment with OPEC+ cuts in the past – remained silent about the latest round.
“For the first time in recent energy history, Washington, London, Paris and Berlin do not have a single ally within the OPEC+ grouping”
it goes in cycles
High oil prices have a tendency to sow the seeds of their own collapse, encouraging more investment in production by firms to capture the larger profits.
Oil gluts followed the 1970s boom in the 1980s, as production expanded in Siberia, Alaska, the Gulf of Mexico, and the North Sea. The pattern was repeated in the oil boom of the 2000s, which ended in 2014 with the emergence of US shale and cratering prices.
There is more urgency this time. Environmental goals are pushing countries to reduce their dependence on fossil fuels. National security concerns in Europe – which, until the war in Ukraine closed, were heavily dependent on Russian oil and gas – could speed up the transition.
And there’s no guarantee that the Saudis, Russia and the rest of the OPEC+ cartel will be able to maintain their united front. This is easy to do when prices are high – but when the cycle turns, members prove less inclined to limit supply.
Yet, at least for now, the price of the world’s most important commodity is being determined by a country that America can no longer count on as a friend.
(This story has not been edited by NDTV staff and was auto-generated from a syndicated feed.)