Oil: How dependent is Saudi Arabia on US goodwill?

 

The Brent crude spot price declined of late to as low as USD 58 per barrel. The main factor driving this renewed price slide was speculation that Saudi Arabia may expand production – in return for the recent public backing which the United States has given Riyadh in connection with the “Khashoggi affair.“

Saudi energy minister Khalid Al Falih announced that the desert state had ramped up its crude output from 10.6 mbd in October to “more than 10.7 mbd“ last month, explicitly in response to customer demand. However, anonymous speculation is flying around the market in the teeth of this official statement, claiming that production has been boosted to more than 11 mbd. In the context of the current “surplus supply debate“ and of market expectations that a supply cut by OPEC+ is in the immediate offing, it would obviously be extremely counterproductive for the price of black gold if Saudi Arabia was pumping up oil at such high levels.

Given that US President Donald Trump only recently thanked the Saudis in a highly publicity-conscious fashion via Twitter for helping to keep a lid on oil prices and then later declared, in a surprisingly clear-cut manner, that the USA will remain a “steadfast partner“ of Saudi Arabia despite its government being possibly implicated in the murder of journalist Jamal Khashoggi, speculation emerged that Washington may now, at least for the time being, be having a big say in determining the Saudi production volume.

In a volatile foreign-policy environment, marked by constantly shifting co-operations and dependencies, it is impossible for us to assign the rumours about the Saudis which are doing the rounds to the realm of myths. However, it would seem to us to make just as little sense to price in a scenario in which Saudi production decisions were only reached in future after having been “given the nod” by Washington.

In our opinion, Saudi crown prince Mohammed Bin Salman, who has been hurt on the foreign-policy front by the “Khashoggi affair“ and who is therefore vulnerable at home as well, will set somewhat more store still by Washington’s crude-oil interests in future when determining his target function. This is particularly likely to be the case because the heir to the Saudi Arabian throne will seek a closer alliance with the USA in order to protect himself in the domestic-policy arena from the anti-MBS movement, which is growing more united and sensing that its day may be gradually dawning. On the other hand, a scenario involving Saudi Arabia taking US interests into consideration to a greater extent does not mean that there is now a threat of a massive plunge in crude-oil quotations.

From a purely subjective viewpoint, we think that Saudi Arabia would prefer a Brent crude price in excess of USD 70 because of the exorbitant importance of crude-oil revenues for the government budget – especially in the light of the budgetary projects envisaged for the coming 10 to 15 years (“Vision 2030“) and of the fact that currency reserves dwindled from USD 731 billion to USD 500 billion between August 2014 and August 2018.

Our reading of the situation is that Donald Trump is setting his sights on as low crude-oil prices as possible for two reasons. Firstly, he wishes to deter the Federal Reserve from moving along an interest-rate normalisation path which he regards as too aggressive and therefore damaging to the US economy. Secondly, he would like to take some pressure off the world economy – to the detriment of OPEC, or rather OPEC+ – so as to have more strategic room for manoeuvre regarding his trade standoff with China. However, he would be mistaken to lose sight of the interests of his domestic crude-oil industry when pursuing such an “as-low-as-possible” strategy. Our reasoning is as follows: despite the massive cost reductions achieved in the low-price time interval lasting from year-end 2014 to Q3 2017, shale-oil companies in the USA require WTI crude prices of at least USD 55-65 in order to maintain their present production momentum. In the current Brent-WTI spread environment (roughly USD 10), that would correspond to prices of around USD 65-75 for Brent crude. So “as low as possible“ is the macroeconomic requirement, and “as high as possible” is what is needed microeconomically; we think that this trade-off implies that the USA can live with a Brent crude oil price of USD 65 to (a maximum of) 75 in the medium term.

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