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A reminder. Cees Bruggemans (right) is an independent economist, so is free to say it exactly as he sees it. And before a lengthy and esteemed contribution as chief economist at banking group FNB, he served Royal Dutch Shell. So his insight into the energy sector is better that most of his peers. In this insightful analysis of what next after the oil price crash, Bruggemans asks the question few would raise – and reaches some fascinating conclusions. – AH
This time it is different, or famously it is not? Oil is collapsing now but shortly to rebound, or is there a more permanent shift to lower prices noticeable?
For every ecstatic comment about collapsing oil prices recently, there are the wagging fingers warning about marginal supply being taken out while oil demand is being stimulated. Ergo, a matter of time before price balance will be restored, and the pendulum starts swinging the other way as output shortfalls arise, and prices rebound.
With many oil supplying countries having become dependent on high oil export prices, the budgetary breakeven price levels even for swing producers such as Saudi are high, and not low. Ergo, a matter of time for the price rebound.
No one will hopefully argue against any such logic. That is the way that oil markets tend to operate.
But is there anything different out there, structurally, that could skew the outcome?
Is the 2014-2015 event comparable to 1986, or is there something else to be noted?
According to the Financial Times Lex Column (24 December 2014), in December 1985 Opec also said it would defend market share instead of (high) prices which then fell 70% in two months from the previous Opec target of $29. Pain ensued for producers, such as the USSR. But a few months later, in the summer of 1986, Opec returned to defend a new price of $18 for members to preserve cash flow.
Ergo, 2015? Will the past pattern be repeated?
First the arithmetic. If in early 1986 prices fell 70% from $29, it means they reached $9. If the next Opec target was $18, it suggests they doubled from their $9 low, but were still nearly 40% below their $29 starting gate.
If that needs to be applied to 2014-2015, do I have a starting gate of $110 last June, a 70% collapse to a low of $33 shortly, thereafter a doubling to a new target of $66, still 40% below the starting gate of $110?
If that is all so, please bring it on because global consumers would dearly love to live on $66 rather than $110 oil in 2015 and beyond.
But that would still suggest nothing to be different this time, if I got the drift right. But is there something different this time? And will it retard an oil price bounce back (or rather the implied workings of monopolistic powers of oil producers)?
For do we reason that the Opec cartel today is the same robust entity it was in 1986, keeping global consumers over a barrel with the same monopolistic powers? Or is there something changed here, and market pricing is reflective less of monopolistic intentions, and more of competitive global supply markets (more, even if not fully so, with global – not just US – fracking the new lever)?
Note how the 1986 reference mentions Opec this and Opec that. This isn’t the case today. It is Saudi first and foremost, with Kuwait in the caboose.
It may just be language, a slip of the tongue, or is it indicative of something far deeper?
Having too high oil prices does not benefit the high-reserve, low-cost ($4 to $5) swing producer(s). The real winners are the marginals (low-reserve, high-cost) which are effectively subsidized in the short term by the big swing producer which does not fully optimise its own long-term future.
What’s the use of 200 years of oil reserves if you won’t be able to fully get its value for your country? That Saudi oil Minister Yamani warning of the 1970s still applies today. What are you weighing up, trading off in that calculation?
The swing producers are best served by a long future of global oil dependence. But given the global growth outlook (modest), the changing globalization prospect, the technological bias (displace), the environmental bias (end), the strategic long-term target price of oil may well have been lowered.
If Saudi budgetary demands are in excess of this (a budget deficit next year of $38bn or 5% of GDP), do they want to sacrifice long-term oil viability by pricing their oil too high, start borrowing the difference (they have scope) or cut back fiscal spending (never popular)?
In 1985, Opec had been going strong for 25 years, having been started in Baghdad in 1960. There was solidarity between the non-West members when confronting the rich advanced countries. They had them over a barrel, and what a joy it was to squeeze.
OPEC been dead for ages @alechogg: Brilliant analysis. Cees Bruggemans: Is OPEC dying? http://t.co/QIBf4OeLbF
— Simon Brown (@SimonPB) December 27, 2014
Fast forward 30 years, and does the world still look the same?
Do Opec brethren still have anything in common? It is recognised by Saudi that whenever price conditions worsen, the marginals cheat by not cutting back on their part of the quota. It is always the swing producer that has to do the heavy lifting. Any compelling reason why they should keep carrying the marginals indefinitely?
Worse, Russia and Iran are geopolitical rogues in the Saudi book (not least by way of Assad’s troubles in Syria). Add to this a potential resurgent Iraq under Iranian auspices.
Sympathy for other oil producers farther afield, in Libya, black Africa, Latin America, Asia? Why ever?
The House of Saud geopolitically may be better served by an alignment with America and China (and cameo roles for Europe and Japan, and other upcoming middle-class consumer countries, whether Korea or India).
Geopolitically with the one, commercially with the other major player interests. Both these major ‘client state interests’ would favour a lower long-term oil price, a complex combination of undercutting ideological opponents and support global growth, all of it coinciding with Saudi’s own long-term national interests.
In so many words, is Opec being strangled the old fashioned way in favour of new geopolitical and commercial alignments (bearing in mind also a long allied position with America)?
Something tells me the world HAS changed enough for this to be plausible. Our world is no longer the one of the 1970s and 1980s.
This is before asking about long-term supply dynamics, especially fracking. How costly is it really? How pervasive globally, longer term? How much new potential supply if high oil prices are maintained, or lowered? How much new fracking gas development? How much oil displacement? And can something be done about modest global demand growth?
Even if the high-cost fracking and non-fracking marginals are eliminated in the short term, what does the long-term still look like?
If you are a Saudi, where would you pitch your tent, geopolitically and commercially?
And this before noting that out of global oil supply of some 90 million barrels daily, how much marginal output is supposed to be taken out for the price to stabilise? Does that allow room for Saudi to lift output by (say) 1 million barrels daily, in which case at $60 over a full year it would reduce its budget deficit by $22bn to 2% of GDP (and lifting it 1.7mbd would eliminate the deficit entirely)?
I suspect $60 might be a nice target price medium term, to watch marginals and geopoliticals wither on the vine, allowing some Saudi output lift while making common cause with new friends that count, compared to the has-beens of an already long gone era.
And borrow a bit during the transition (the Saudis have ample fiscal space).
In other words, don’t think static, think dynamic, reflecting a changing world and changing state interests, politically as well as commercially.
References:
- Anjali Raval “Saudis dig in to protect OPEC market share” Financial Times 24 December 2014
- Ed Crooks “Heavyweights differ on catalyst for oil price rebound” Financial a Times 24 December 2014Ed Crooks “Roots of oil collapse lie in shale boom” Financial Times 27 December 2014
- Editorial “The short-term oil price play of Saudi Arabia” Financial Times 26 December 2014
- Lex Column “OPEC: the year of cartelling dangerously” a Financial Times 24 December 2014
* Cees Bruggemans is the consulting economist at Bruggemans & Associates. His website is at www.bruggemans.co.za and email economics@bruggemans.co.za.
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