Slumping Oil Price Has Left Saudi Arabia With Few Options
As brent oil returns to COVID-era prices, OPEC might have to more to keep the commodity off the market.
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Brent oil is back to trading around the low $70 per barrel (BBL), back to the level it was in 2021 when OPEC first took production out of the market in an effort to support themselves through the COVID crisis.
Since the oil price reached highs of $130 per BBL during the Russian invasion of Ukraine, it has not looked back and has been on a one-way trend that is down! This is despite OPEC+ continuously trying to jawbone the price higher each time trying to hold back more and more production, hoping to bide time until the post-COVID recovery finally takes place, allowing prices to move back north of $90 per BBL. Well, it is three years post-COVID and prices are now threatening to fall below $70 BBL. How did they get it so wrong?
We have often opined that commodities are best left to their own natural demand/supply mechanism that permits them to find a natural floor or a ceiling as and when cycles change. Interfering with its price evolution only delays the inevitable and that is what Saudi Arabia, mostly via the OPEC+ group, has been trying to do.
Given their future aspirations of being a global tourist hub and weaning themselves off of oil revenue dependency, they have spent an enormous amount banking on much higher oil revenues to help them get to their goals. The only problem is that, given their budget deficit spending plans, they need brent oil prices north of $90 BBL at the minimum to be breakeven.
They have spent what they don’t have. Their only plan was to keep about 3 MBPD to 5 MPBD of oil out of the market, strong-arming the rest of OPEC+ group, as they convinced themselves that it would allow oil to stay supported in the $80 to $90 range until eventually it made its way back higher once the entire world recovered.
Well, the entire world has recovered and gone bust into and out of COVID, yet the oil price has not managed to rally. Why? By controlling their prices and allowing them to be much higher for longer, Saudi Arabia allowed the rest of the world, i.e., non-OPEC nations, to keep pumping production to the max, taking advantage at a time when demand was slowing down. Demand was hurt in a world that was battling higher inflation and a Fed bent upon getting it down, and the higher oil price did not do anyone any favors.
Another false illusion was China magically coming out of its post-COVID slump and demanding oil by 700,000 BPD to 1 MBPD. One assumes that China will always grow, as they are so used to it growing over the past decade given their urbanization efforts. But China is going through a secular decline, and most western economists are in denial, despite President Xi Jinping stating otherwise. Their focus has changed and they are not in the business of just printing to get growth higher.
The property market has slumped and banks are inundated with bad loans. Given the multipolar world and all of the potential geopolitical conflicts, China is securing up on its national security and has been building a national strategic reserve for oil. It has been planning over the past few years and it does not need to buy oil whenever, but instead it tries to buy it more strategically. Chinese oil demand has been down 300,000 BPD this year instead of the growth everyone has pencilled in. Now, to make those numbers work, it would mean some form of miracle for China in the last three months to make up the average.
Saudi Arabia has played a big role in keeping oil off the market, not only via the OPEC+ group, but also via their voluntary reduction cut of 1 MBPD along with another 1 MBPD from other members, which has now been extended from September to December this year. Two more months, who cares?
The market knows those barrels are just waiting to come back. One of our slogans this year has been, "there is no shortage." We have 5 MBPD of oil just waiting to come back any time. Before, the U.S. was holding up, but now that its own consumers are trapped, its own demand is slowing down. Will Saudi Arabia finally throw the towel in and crush prices down, killing everyone else as they did back in 2020 before COVID hit? It is what they should have done years ago but were too scared to do.
Brent is trading around $70 BBL and that is with 5 MBPD of oil out of the market. Imagine where it would be trading if it was allowed to do so freely. That's a reality that not many in the Middle East want to think about, and yet they keep calling for future investment. You can control supply, but you will never be able to control demand.
At the time of publication, Bengali had no positions in any securities mentioned.
