Putting a Floor Under Oil Prices

Only three years ago, it was thought that Saudi Arabia –<br /> the largest oil exporter and second largest producer in the world –<br /> could generate large budget surpluses with oil at $70/barrel. In recent<br /> weeks, new estimates state that the country would need oil at<br /> $75/barrel just to balance the budget – never mind trying to post a<br /> budget surplus.

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OPEC Spending Putting a Floor Under
Oil Prices

Only three years
ago, it was thought that Saudi Arabia – the largest oil exporter and
second largest producer in the world – could generate large budget
surpluses with oil at $70/barrel.  In recent weeks, new
estimates state that the country would need oil at $75/barrel just to
balance the budget – never mind trying to post a
budget surplus. The country’s oil minister has stated that the
nation would work to stabilize prices at the $100/barrel level – which
is a first. Saudi Arabia has traditionally held the role of OPEC
moderate while Iran and Venezuela have been hawks who favor higher oil
prices.  Saudi Arabia has always balanced its need for oil
revenues with the knowledge that if left unchecked, high oil prices
have tended to precede recessions.

OPEC and Crude Oil Prices
to view a larger version of this chart


The reason
for this change in policy would most likely be due to the country’s
response to the uprisings across the Middle East last year. Fearing
unrest, the government of Saudi Arabia has unveiled a huge increase to
public spending that totals almost $130 billion. The Saudi commitment
to stabilizing oil in the $100/barrel range should serve as a wakeup
call for consumers and investors alike.

The reason
that Saudi Arabia’s budget should matter is that as the nation spends
money at a breathtaking clip, it will require higher oil prices to keep
its budget from spilling large amounts of red ink. It is thought that
like last year, the nation will end up spending more money than the
official budget calls for. Therefore, the world should not look to
Saudi Arabia to use its powers of persuasion and size amongst its OPEC
peers to reign in oil prices. In fact, the Institute of International
Finance estimates that the break–even oil price for Saudi Arabia will
move to $110 over the next three years.

as the chart shows it is not just Saudi Arabia that needs high oil
prices to meet its spending commitments. Russia needs prices of over
$100/barrel to balance its budget. Together, Saudi Arabia and Russia
account for a little over 20% of the world’s oil production. Therefore,
it would be hard to argue that these two major oil producers would be
willing to bring down prices.

unintended outcome of these budget constraints amongst the oil
producing nations is that the longer oil prices stay elevated, the more
the energy industry will spend to find new sources of oil. Improvements
in drilling technology have allowed oil to be found at ever greater
depths in the oceans and allowed parts of North America to become new
and significant oil producers. For example, North Dakota now produces
over 500,000 barrels daily and its production now surpasses that of
OPEC member Ecuador.

consumers this means that hope at the gas pumps will prove ill advised.
For investors, this should mean that continued investment in the oil
shale plays in Texas, North Dakota and other parts of North America
should continue.

Partners – Capital Management

a Sea of Opportunity


This report is for information purposes only and is neither a
solicitation for the purchase of securities nor an offer of securities.
The information contained in this report has been compiled from sources
we believe to be reliable, however, we make no guarantee,
representation or warranty, expressed or implied, as to such
information’s accuracy or completeness. All opinions and estimates
contained in this report, whether or not our own, are based on
assumptions we believe to be reasonable as of the date of the report
and are subject to change without notice. Past performance is not
indicative of future performance. Please
note that, as at the date of this report, our firm may hold positions
in some of the companies mentioned.

Copyright (C) 2012 Pacifica Partners Inc. All rights reserved.

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