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$80 oil could backfire on Saudi Arabia

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OPEC’s largest producer and de facto leader—Saudi Arabia—is the most closely watched oil nation for hints about an unofficial oil price target, and speculation has been ripe as to what price the Kingdom is aiming for.

For months, Saudi Arabia has been said to aim for oil at $70 a barrel, but now new hints and reports suggest that Riyadh is likely shooting for oil at $80—to help finance increasingly ambitious domestic policy plans and to boost the valuation of its oil giant Aramco ahead of its much-hyped IPO.

If this unofficial oil price target were reached, however, it could backfire spectacularly on both sides of the oil-market-balance equation—supply and demand.

$80 oil would trigger an even bigger U.S. crude oil production surge that could unravel OPEC’s efforts at eliminating the glut. Oil at $80 could also slow down global oil demand growth, undermining one of the cartel and friends’ key assumptions: that robust demand growth will absorb the non-OPEC supply and that demand growth will continue to be strong going forward. Last year, oil demand growth surprised a bit on the upside, helping bloated inventories to draw down significantly.

Yet, targeting $80 oil—if we assume that Saudi Arabia is doing that—has its economic reasons. According to RBC Capital Markets, OPEC’s producers need oil even higher—at an average of $88 a barrel—to balance their public spending this year, Bloomberg Gadfly‘s Liam Denning writes.

For Saudi Arabia, the price of oil needed to balance the 2018 public spending is $83 a barrel. The OPEC member that needs the ‘lowest’ price of oil to balance this year’s expenditure is Iran, at $52 a barrel, according to data by RBC Capital Markets.

It comes as little surprise then that Saudi Arabia and Iran—apart from the tense regional archrivalry—are reportedly at odds over where to go next with the OPEC deal, and how high an oil price the cartel should target. Iran is reportedly suggesting that $60 oil is about right so as not to encourage U.S. shale (even more), while Saudi Arabia is in need of higher-than-$60 oil to balance budget spending and lift Aramco’s valuation to anywhere close to the US$2 trillion that officials have been targeting.

It also comes as little surprise that the latest hint that the Saudis are likely targeting $80 oil is not universally shared among all OPEC members, according to Bloomberg sources who relayed the Saudi ambition for said target. Some nations have privately expressed concern that such a price would be too comfortable for U.S. shale.

The higher the oil price the Saudis (or OPEC) target and possibly reach, the more areas in the U.S. would be profitable to drill and add to the global oil supply, potentially wiping out the effect of the cuts and depressing oil prices again.

Source – Business Insider


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