Oil Wars: Why OPEC Will Win
In the green corner we have the US shale producers. In the red corner we have the oil exporting countries of OPEC. Assuming the fight is fought to a conclusion, who wins?
OPEC wins. The US shale producers will shut down first. The reasons are:
• The US shale producers are motivated by economics, and all other things being equal will have an incentive to cut production at or around the point where production cost exceeds sales price.
• The OPEC countries are motivated by social imperatives. They have historically used their oil wealth to finance social programs, build infrastructure and subsidize basic foodstuffs and other items such as gasoline (which costs one cent/liter in Venezuela). Cutting back on social spending courts civil unrest and cutting back on oil production cuts spending, so they have a disincentive to cut oil production. (As long as the oil price exceeds cash production costs, which it does in all OPEC countries by a substantial margin, they in fact have an incentive to increase production).
But not all OPEC countries are created equal. Some can stand the pain longer than others, and here we will look into the question of who might go to the wall first if low oil prices persist.
But first the US shale producers. The recent graphic from Business Insider reproduced in Figure 1 is not backed up by much in the way of explanation but my understanding is that it shows current production and breakeven production costs at US shale oil plays based on Citigroup estimates. If we take these results at face value we find that almost all US shale oil production is economic at crude prices of $70/bbl, but 40% of it becomes uneconomic at prices below $60/bbl and almost 90% of it at prices below $50/bbl:
Figure 1: Breakeven production cost estimates, US shale oil plays
Keeping these results in mind we will now move on to the OPEC countries. They have two different production costs. One is the cash production cost, which is usually much lower than the cash production cost in US shale plays. The other is the “budget breakeven” cost, which is the oil price needed to cover production costs plus social spending and which is usually considerably higher than the cash production cost in US shale plays. Figure 2, which superimposes the approximate 95% range of US shale play production costs (from Figure 1) on 2012 OPEC production and budget breakeven costs, summarizes the situation. If production cost was the only thing that mattered to OPEC the US shale producers would rapidly go under:
Figure 2: Budget and production breakeven cost, OPEC, Russia and US shale oil plays (Original graph credit Agora Financial and Total S.A).
OPEC’s production and budget costs are, however, not well-defined. The table below summarizes the results of my search for hard numbers to use in the analysis:
Having no particular reason to prefer one set of estimates over any other I discarded all of them and used the “oil price needed to balance fiscal 2015 budget” numbers provided by the Wall Street Journal, which a) are from a single source, b) cover all the OPEC countries, c) are broadly in line with the budget breakeven numbers in the Table above and d) are specific to 2015 budgets. Here are the estimates:
It’s important to note here that these estimates are not the same as the OPEC countries’ “official” budget estimates, which are generally lower and already being lowered further (Iraq has already cut its 2015 budget estimate to $70/bbl and is now considering a further cut; Venezuela is reportedly down to $60). However, they do provide a fixed point of reference that we can use to evaluate relative exposure.
Note also that a non-OPEC country –Russia – appears at the end of the table. I added Russia to the mix because it’s a major oil exporter that finds itself in a similar position to the OPEC countries. The $100/bbl number comes from the Moscow Times.
A simple way of gauging a country’s overall exposure to low oil prices is to calculate the percentage of its GDP supplied by oil export earnings. This, however, is not a straightforward exercise in practice because different data sources sometimes give wildly conflicting figures. For example, the 2013 nominal GDP of Venezuela was $US 227.2 billion according to the IMF and $US 438.3 billion according to the World Bank, and according to OPEC 2013 oil export earnings in Angola were $US 68 billion but only $US 27 billion according to EIA. The numbers I used were derived as follows:
GDP: I used the median value of the three 2013 nominal GDP estimates given by Wikipedia plus the 2013 nominal GDP estimates from OPEC (link below).
Export earnings. I used the 2013 estimates from the OPEC 2014 Annual Statistical Bulletin. As noted above these are sometimes quite different to the numbers given in the EIA’s OPEC Revenues Fact Sheet but they are comparable to the numbers I backed out of the BP 2014 Statistical Review (earnings = production minus consumption times price). The estimate for Russia is from EIA.
Oil export earnings as a percentage of GDP are summarized in Figure 3:
Figure 3 Kuwait is the most oil-dependent economy, closely followed by Libya and Angola, and Russia the least oil-dependent. The estimates for Libya and Iran are distorted by civil unrest and sanctions but by how much is hard to say.
A more complex question is the impact low oil prices will have on national economies. Impacts will, of course, vary depending on the specific circumstances of the country, but since a detailed country-by-country analysis is beyond the scope of this post I performed a simplified analysis using the following assumptions:
• Base year 2015
• The volume of oil exports in 2015 is the same as in 2013
• Budget deficits at different assumed oil prices can be calculated as the difference between the price/bbl needed to balance the 2015 budget and the assumed oil price, times oil export volume.
The results at $70/bbl oil, with the deficits expressed as percentages of GDP, are shown in Figure 4:
Figure 4 Kuwait and Qatar have no deficits because their budget breakeven prices are lower than $70. Ecuador, the UEA and Russia have minor deficits. Nigeria, Iran, Venezuela, Iraq, Algeria, Angola and Saudi Arabia have significantly larger ones. Libya looks hopeless.
And at $50/bbl oil (Brent is at $63/bbl as I write) the situation begins to look bleak for Angola and maybe Saudi Arabia as well:
Figure 5 These results are semi-quantitative at best, meaning that there is no certainty that Angola would in fact suffer a 25% budget deficit should the oil price stay at $50. However, they do provide a measure of relative risk, and the indication here is that Angola, Saudi Arabia and Iraq are potentially a lot more vulnerable to protracted low oil prices than Ecuador, Russia and Kuwait.
But this does not necessarily mean that Saudi Arabia will fold before Ecuador. Another factor that must be taken into account is how much money each OPEC country has in the bank, one measure of which is its foreign reserve holdings. How long could each country cover its annual budget deficits by drawing on its foreign reserves? Figure 6 shows the results for the $50/bbl scenario, which we can probably take as the “worst case”. Libya moves up to mid-pack and Venezuela, Nigeria and Ecuador are now the first to cry uncle (the foreign reserves data are from Wikipedia).
Figure 6 So what do we conclude from all this? I asked Euan Mearns for his opinions and he kindly offered the following insights:
All of the OPEC countries have money in the bank while all of the shale operators are reported to have large debts. This argues in favour of the OPEC countries being significantly fitter than the shale operators in the low price environment.
Nigeria and Venezuela seem most exposed to the downturn and will have to borrow within months to survive. I dare say that the wealthy Gulf States may help in order to maintain solidarity.
The UAE looks surprisingly vulnerable which points to the crisis being over within two years.
My opinion? No OPEC country is going to stop pumping because of economic constraints, nor is any OPEC country facing budget shortfalls – which is all of them except for Kuwait and Qatar – so no one is going to cut production in an attempt to drive up the oil price. A more likely eventuality is that growing economic woes will lead to insurrections in some OPEC countries, and here I agree with Euan that Venezuela and Nigeria are prime candidates. (Iran bears watching too.) But as we have seen from recent events in the Middle East, oil has a habit of continuing to flow come what may. So barring a major uptick in global demand it’s conceivable that low oil prices could be with us for some time.
Source – http://euanmearns.com/
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