The following analysis of how this weekend’s attacks against Saudi Arabia’s largest oil facility will affect oil prices is offered by Chris Weafer, Senior Partner, Macro-Advisory Ltd., Moscow
Attacks against Saudi Arabia’s largest oil facility will inevitably spike the price of Brent when the market reopens after the weekend break. But, as has been seen many times in the past, such actions rarely keep the price high for very long. How long will depend on how long it takes Aramco to restore production and whether there is any follow up actions.
Russia will make more money for a while. Meantime, the price spike will boost Russia’s oil exports and oil tax revenue. Every extra $1 on the oil price means $7.5 mln extra in export revenues every day, and 75% of that (at this high price) will go to the budget. It will also provide support immediately for the ruble. But, for how long and by how much will depend on the Saudis. History suggests the boost will be short-lived.
Without a terrorism risk premium, Brent may stay closer to $60 p/bbl. Prior to the weekend attack, the price of Brent crude has been trading in the high $50s to mid $60s p/bbl for several weeks as traders wait for a more definite signal of what may be the greater influence on the oil market through the coming winter and into next year. Through August, the price dropped by 9%, from just over $65 p/bbl at the start of the month to $59.25 p/bbl. Since then, to September 13th, the price has fluctuated around $60 p/bbl.
The IEA expects a stronger market in 2H. Optimism that Brent may stay above $60 p/bbl, i.e. assuming no more attacks against oil installations, comes from the IEA’s expectation that inventory draws will increase through the 2nd half of this year and that global oil demand will increase by 1.3 mln bbl/d near year. The backdrop support comes from a belief that Saudi Arabia will do whatever is necessary to keep the oil price from collapsing as it needs the money to support the budget and to create a favorable backdrop for the planned Aramco IPO.
How long will Saudi support the oil price? However, the more production it cuts, the higher the average oil price it needs and there maybe a limit to how much it is willing to do to support the US oil production surge. This, plus the fact that expected US production growth in 2020 alone covers the IEA’s expected growth in global demand that year, and fears that the departure of the very hawkish John Bolton as Trumps security advisor, could see a rapprochement between Washington and Tehran and the return of at least some Iranian oil. However, that was before the weekend attack, for which the US blames the Iranians
Moscow is in a comfortable position. Moscow is in a relatively comfortable position as the budget will breakeven at $49 p/bbl this year and the government has said it is willing to see a lower ruble exchange rate to compensate for any oil price weakness, something that the Saudis and other Gulf states are unable, or unwilling, to do.
The reasons to hope that Brent will stay above $60 p/bbl:
First, there is the threat of more attacks against oil installations across the Gulf.
Although the US-China trade war threat blows hot and cold with annoying frequency, the IEA is sticking with its 2020 demand growth forecast of 1.3 mln barrels per day (average), up from the 1.2 mln bbl/d rise recorded in 2018 and the 1.1 mln bbl/d growth expected this year. The key drivers of that growth are expected to be China (+0.5 mln bbl/d), Other Asia (+0.5 mln) and a 0.4 mln bbl/d growth in OECD economies
Saudi Arabia needs between $85 and $88 p/bbl for Brent to balance its budget. It is never very clear on the exact amount but, clearly, the more it cuts production, to balance the market, the higher the average price it needs. Hence, the optimistic view is that, should the supply grow elsewhere then Saudi will cut more and persuade the other Gulf states to do the same. Especially as it is again planning the major IPO for Aramco and Riyadh, especially the Crown Prince, will desperately want to avoid a failure or a weak market backdrop.
The US Fed is signaling it may ease rates again sooner than later. That would support the IEA’s view that, irrespective of the growing use of renewables and electricity in transport, US oil demand should grow by 200,000 bbl/d in 2020 to an average of 19.5 mln.
US oil inventories fell steeply in late August, with a drop of over 10 mln reported in one week.
The reasons to fear that Brent will drop to a much lower level:
First, the dismissal of the hawkish US President’s National Security Advisor, John Bolton, raises the possibility that President Trump may yield to EU pressure and restart talks with Iran. In that event, it is possible that the US may ease some sanctions and, for example, return to the 400,000 bbl/d export limit it allowed up to May this year. That would boost the supply side and make it difficult for Saudi to get OPEC support to cut current production to accommodate the Iranian return. However, what remains to be seen is what will be the follow through from the attack in Saudi.
US production is relentlessly moving higher. The average daily total (all oil and liquids using IEA methodology) in 2018 was 15.52 mln bbl/d. The average expected for this year is calculated by the IEA at 17.26 mln bbl/d and for 2020, the IEA expects an average of 18.5 mln with the year end figure closer to 19.00 mln. It means that the rise in US oil production in 2020 will almost itself cover the expected growth in global oil demand.
What this means for Russia.
Budget breakeven is now below $50 p/bbl. The Central Bank recently confirmed that, with the current average ruble-dollar exchange rate and the current budget spending assumptions, the breakeven oil price for the federal budget this year should be $49.20 p/bbl. Hence, Russia is in a much more comfortable position that are most of the OPEC producers. As stated, it is thought that Saudi Arabia needs at least $85 p/bbl based on current production.
Sanctions forced the government to make the economy less reliant on oil revenues. Moscow’s more comfortable position is as a result of the actions forced because of US sanctions. The state finds it much more difficult to borrow money to fund a budget deficit and the Kremlin is, in any event, unwilling to even consider running a deficit because of the risk to national security and economic stability.
The Central Bank has now greater control over the ruble exchange rate and can essentially keep it close to 65 versus the US dollar, apart from the short-term volatility mostly attributed to sanctions concerns. If the oil price were to dip to, e.g. $50 p/bbl, then the CBR could ease the R/$ rate to 70 and still see the budget balance at close to the target of $44 p/bbl in 2020. On the other hand, if the oil price were to spike higher, for longer, the CBR will aim to prevent the ruble from moving higher than, e.g. R/$62, because of the loss of competitiveness.