Saudi Arabia is rumored to want oil prices at $100 per barrel, but if prices rise that high, it could sow the seeds of the next downturn.
Saudi officials want more revenues for their budget and a higher oil price to bolster the valuation of the Aramco IPO. But that short-term thinking could spell trouble not just for them, but also for oil prices, and ultimately for longevity of oil demand.
As Liam Denning of Bloomberg Gadfly points out, in the past decade, while oil prices have surpassed $100 per barrel for periods of time, they didn't stay there for very long. In 2008, when oil nearly hit $150 per barrel, it was quickly followed by the financial crisis and a deep U.S. recession. Then, the period between 2011 and 2014, when oil was north of $100 per barrel, U.S. shale crashed the market with a wave of fresh supply.
If Saudi Arabia aims to drive up prices to triple-digit territory once again - and to be sure, that is only a rumor at this point - there are plenty of ways that could merely create the conditions for another bust.
First, oil prices are rising, in part, because demand is so strong, not just because OPEC is keeping barrels off the market. Oil at $100 would essentially amount to a doubling of the price from the past few years, which would quickly put an end to high demand growth rates.
A corollary to this is that $100 oil would likely impact economic growth. The economic recovery from the financial crisis in 2008 is almost a decade old at this point, much longer than the average upswing. History suggests that we are due for a recession at some point in the not-so-distant future. A spike in fuel prices around the world could help bring that on.
Related: The Bullish And Bearish Case For Oil
"Oil prices are high because the dollar is low," Daniel Lacalle, chief economist at Tressis Gestion, told CNBC on Thursday. Taking too much oil off to the market for too long could send prices "artificially" high he said. "That is a big concernâ¦Because oil prices don't generate crises; the abrupt and unexpected rise of oil prices creates crises," Lacalle said.
Second, $100 oil would set off yet another round of frenzied drilling, likely resulting in an even stronger wave of new shale supply. Several years of triple-digit oil prices led to a near doubling of shale production in the U.S., a volume that helped crash the market in 2014. A spike in oil prices could result in history repeating itself.
That is worrying because U.S. shale is already growing faster now than it was in the lead up to the 2014 downturn.
Either way, Saudi Arabia runs the risk of sowing the seeds of another bust in the oil market, which, needless to say, would be hugely detrimental to its own interests. "Saudi Arabia can push the price to $100 if it keeps supply sufficiently tight," Carsten Fritsch, analyst at Commerzbank, told MarketWatch. "But it won't be without paying a price in the long-term, i.e. causing a new wave of shale oil and oil from other sources."
More threatening than new supply in the long-term is the prospect of peak demand. There is no shortage of projections about when peak demand might occur, but everyone agrees that it will occur. Electric vehicles still represent a small fraction of the auto market, but they just had their best month on record in the U.S. in March. If battery prices continue to decline, EVs could reach cost parity with the internal combustion engine by 2024.
Related: IMF: Expect Oil To Fall Below $60
However, if oil prices spike, consumers will switch over at a much faster clip.
In other words, in the pursuit of higher revenues this year and next year, Saudi Arabia could not only set off the next downturn but also do structural (i.e. permanent) damage to oil demand, which ultimately raises existential questions about the viability of the Saudi economy as it is currently organized.
By Nick Cunningham of Oilprice.com
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Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. More
Comments
OPEC needs to learn their lesson, and they clearly have, there is room in the world for shale's contribution to the ultra-light oil market if OPEC is willing to back off a bit and just enjoy the massive profits they are swimming in. The alternative is more pain, most burning through their reserves (if they are an OPEC country lucky enough to have time), with the only result being shale players cutting more costs and finding more ways to squeeze money from every well, living forever off the free money from investors and banks.
In saying this, I would like to point out two important factors. One is that Saudi Arabia and the overwhelming majority of OPEC members need a price of $100 a barrel or higher to balance their budgets. The other is that while oil is priceless, a fair price according to my calculations ranges from $100-$130. Such a price is good for the global economy in that it enhances global investments, it improves oil producers’ revenues thus enabling them to explore more for oil and expand oil production capacity to meet future global demand and it enables major oil companies to balance their books and resume investing in oil and energy projects. We have seen how low oil prices between 2014 and 2016 very adversely impacted the global economy.
If oil prices rise too high, the oil market fundamentals will tell us in no uncertain terms and will self-correct as happened after oil prices reached $147 in 2008.
The claim by Daniel Lacalle that oil prices are high because the dollar is low is not correct. Oil prices are high because they are underpinned by a robust global economy, a fast-rising global oil demand and a virtual re-balancing of the global oil market. Geopolitical concerns, though factored in by the oil market, might add $1-$2 to a barrel of oil.
While rising oil prices could stimulate more US shale oil production, shale oil production can never offset soaring global oil demand. If that was the case, then why was President Trump attacking OPEC about rising oil prices. He could have left it to US shale oil to do the trick by offsetting the OPEC/non-OPEC production cut and forcing prices down. His attack confirmed at the highest level that US oil production rises are mostly hype.
The talk about the prospect of peak oil demand is no more than idle talk. With growing global economy and rising world population, a peak oil demand is a myth. Even a wider use of electric vehicles (EVs) in coming years will hardly dent the global oil demand. A post-oil era is another myth.
Finally I have been repeatedly saying for the last five months that Saudi Arabia’s aim for higher oil prices has nothing to do with the IPO of Saudi Aramco and more to do with its budget needs and its desire to maximize return on its assets. Saudi Arabia is going to withdraw the IPO altogether because it no longer needs it in view of surging oil prices.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
If you are an oil and gas writer, how come you have never heard of oil field decline rates? Like about 4-5 million BOPD per year and lack of any reasonable oil discoveries over the past three years. Are you aware that about 27 million BOPD is offshore and decline rates can be over 10%
Has it occurred to you that many of the Middle East fields are over 60 years old and significantly depleted? Do you not think the Saudis might be telling everyone something? Do you still think it costs peanuts to pump 15 million BOPD of sea water into their aging oil fields? Where is the investigative journalism?