The crude oil market was the black swan event of 2014. Nobody expected Brent crude to fall $60 a barrel in six months since June 2014, when ISIS seized the city of Mosul from a defeated, disgraced Iraqi army. The Kurdish Regional Government (KRG) used the fall of Mosul as an excuse to annex the oil rich Kirkuk region, setting the stage for a potential future war in Baghdad.
However, even while the US and its allies are bombing ISIS targets in Iraq and Syria, the oil market has totally ignored geopolitical risk in the Middle East and West Africa. There is a glut of at least two million barrels of oil in the world market, thanks to a surge in US shale oil production.
The Saudi Arabian Oil Minister Ali Al Naimi made it clear at the November Opec meeting in Vienna and the recent global energy conference in Abu Dhabi that the kingdom has no intention to play its traditional role of “swing producer” in Opec.
The Kuwaiti oil minister and UAE Energy Minister Suhail bin Mohamed Faraj Fares Al Mazrouei also ruled out an output cut. Ali Al Naimi blamed the fall in oil prices on “lack of coordination” among non-Opec oil exporters (Russia, US, Mexico) and speculators, notably the global hedge funds who have made billions of dollars shorting West Texas and Brent crude oil futures.
I am unable understand the logic of the Saudi Oil Minister’s statement “Whether oil goes down to $20, $40, $50, $60, it is irrelevant”. Statements like this only gave speculators in the oil futures markets a licence to make a multi-billion dollar killing at the expense of Saudi Arabia, the world’s largest oil producer and owner of 25 per cent of the planet’s crude oil reserves.
If Brent goes to $40, let alone $20, I assure Mr Ali Al Naimi that the financial consequences for Saudi Arabia will not be “irrelevant”. Saudi Arabia has now sent a signal to the world oil market that it is willing to flood the market with Arabian Light Ghawar crude even if Russia, Iraq, Iran, Algeria etc agree to cut output. The world now faces a full blown oil price war. Iraq has announced that it will increase production in 2015.
Relations between Iraq and Saudi Arabia have been difficult ever since the election of Nuri Al Maliki in 2005 as the successor to the Baathist regime overthrown by the US military in 2003. Kuwait has also raised its output to near three million barrels a day, with its recent strategic supply deal with China.
No energy journalist in the world can ignore Saudi Arabia’s oil policy shifts and I am no exception. Six months ago, every oil executive, bank economist and oil trader I talked to assured me that $100 Brent was Saudi Arabia’s price for two reasons.
One, Ali Al Naimi publically said so.
Two, the Saudi budget break-even price had risen from $65 to $90 Brent due to the increased social welfare spending. Both these assumptions were flawed. Ali Al Naimi has refused to play the role of “swing producer” in Opec and the budget break-even oil price is irrelevant to Saudi oil policy in the short run.
The Saudi Cabinet’s 2015 budget projects a $39 billion deficit, no spending cuts and assumes a Brent price of only $60 a barrel. The Finance Ministry projects cuts in salaries, wages and allowances (50 per cent of budget spending). The IMF estimates two thirds of Saudi citizens are government workers, so spending cutbacks mean a higher unemployment rate in the kingdom. This will not happen.
Sama’s November foreign reserves were $736 billion in November, so Riyadh can ignore short term financial pressure. This is the reason there are no cutbacks in 2015 government spending. Saudi Arabia will do its best to avoid a fall in economic growth or rise in the jobless rate due to lower government spending. However, the Saudi Finance Ministry conceded that the crash in oil means a $89 billion revenue loss to Saudi Arabia in 2015.
Saudi Arabia assumes oil production will remain unchanged at 9.6mbd in 2015. The IMF estimates GCC oil exporters will have $175 billion lower surpluses in 2015 due to lower oil prices. This means Gulf states can simply no longer afford hugely expensive state subsidies on fuel and utilities.
Wall Street is more optimistic about oil prices next year. Goldman Sachs predicts Brent will trade at $75 by end 2015, as always, the key variable remains Saudi Arabia. The kingdom will remain a key player in global petro-politics in 2015.
By: Sarie Khaled
The writer is a Dubai-based research analyst in energy and GCC economics.
