Monday, January 05, 2009

Why Even Produce Oil When Its Below $40 (Revised)

Click on the link to get the latest breakeven oil price for major oil exporting nations. We do feel sorry for them, don't we?!! Summary:

2008 breakeven px / 2009 breakeven px
Bahrain $75 / $84
Kuwait $33 / $34
Oman $77 / $78
Qatar $24 / $24
Saudi Arabia $49 / $54
UAE $23 / $24
Algeria $50 / $60
Azerbaijan $40 / $35
Iran $90 / $90
Iraq $111 / $94
Khazakst $59 / $67
Libya $47 / $53

Venezuela depends on oil revenue for half of its public spending and more than 90% of its exports. It is the largest exporter in the Western hemisphere. The budget for 2009 was based on the assumption that oil price would be at $60. Can Venezuela stop exporting now that oil is below $40? The country is too reliant on the revenues. It cannot stop exporting as that would mean 90% of export revenue will be gone. Though Venezuela's cost of production might be on the lower side of $25, but the country is already too dependent on oil revenues.

Major flaw, the government did not invest oil proceeds properly over the last 20 years. If they used the bulk of funds by investing into education, infrastructure and broadening FDI base - now they would have moved up the economic ladder already instead of being primitive drillers-exporters with limited value-add industries.

Its the similar story for many of the oil exporters. The following countries also have a very reliance on oil as a percentage of total exports (2007 figures):
Algeria 98.5%
Libya 97.5%
Nigeria 88.3%
Russia 48.8%
Kuwait 95%
Saudi Arabia 89%
UAE 50.8%

Although oil prices have plummeted to below $40, most OPEC countries are still OK with it as the sharp correction has been counterbalanced by a 30%-60% depreciation in their own currencies vis-a-vis the USD. 14 out of 24 fuel exporters (where fuel is 50% of GDP or more) have a conventional peg to the US dollar, seven oil exporters peg to a basket of currencies including the US dollar and the euro or have a managed float regime, usually de facto targeting the US dollar and the euro. Three oil exporters in the CFA franc zone peg to the euro.

There is also geopolitics consideration. Kuwait, Saudi Arabia and UAE are "friends" of the US and would be more or less influenced by the Americans global strategy. Low oil prices are needed to bring about some support to stave off a global recession.

On the other side - Iran, Russia, Venezuela and Libya would be more inclined to pursue differing political ambitions. They are also more inclined to use oil proceeds to further exert their influence on "weaker nations" so as to support regimes aligned to their own interests. Its a generalised statement but has more truth to it that it appears. Hence Saudi Arabia would be more interested to have a lower oil price for now, one to help the global economy, two, to lessen the monetary might of the Iran, Russia, Venezuela and Libya - ceteris paribus, the latter 4 countries would have things a lot tougher than say Saudi Arabia, UAE or Kuwait with presnt oil price levels. That is also why the "rogue nations" will always be clamouring for OPEC to cut production to boot oil prices. We should be thankful that we have Kuwait, UAE and Saudi Arabia on the side of democratic nations.

Iran has the second largest known conventional crude oil reserves in the world, and it has used them in the past four years as a political and economic weapon to defy and undermine the West while promoting its own agenda. Oil money helped Iran spread its influence in Iraq. Oil money helped it challenge Arab political dominance in the Middle East. Oil money helped spread its influence in Lebanon, through Hezbollah, and in the Israeli-Palestinian conflict, through Hamas. IMF has stated that Iran would face unsustainable deficits if price of oil falls below $75. Iran now has to contend with 30% inflation and its economic status is now extremely fragile. Suffice to say that its political influence has be halted and its domestic economy is crumbling fast.

Russia was still willing to use its vast energy reserves to try to reassert the dominance it lost with the Soviet Union’s collapse.

If you look at the breakeven price for most countries, they are operating at a loss. Oil might be more valuable to be kept in the ground for many of the nations whose breakeven is more than $50 - but they cannot just stop all production: one, exports of oil make up 80%-90% of all export proceeds; two, you still have a substantive number of workforce dependent on the oil industry; three, there have been a lot of sunk cost, infrastructure and supporting industries built around the oil industry in their respective countries, long term supply contracts, etc. - switching things off will basically decimate and destroy the economy. Arabia’s king noted that they need $75 a barrel oil in order to meet their budgets and in order to open up new fields. That’s an important comment since they are the largest of the OPEC countries. Qatar and Kuwait only need $55 a barrel oil. However, even that is still 38% above the current price of $40 a barrel. Hence oil below $40 would result in a massive cutbacks in expenditures, investments, curtailing of seeking new oil fields, going into massive budget deficits, or a combination of these cited effects. In other words, the depressed oil prices actually will see a lot less reinvestment into new oil fields which will come back to bite us a few years down the road.

p/s photos: Lynn Hung Doi Lum


Gamelion said...

Why most producing oil countries like to denominate their oil on US dollar currency ? Would a collapse of the mighty dollar as a world reserve currency cause a massive price hike in the price of crude oil i.e. at USD200~300 ( no joke some very reputable analyst/fund manager has predicted it) . Can the peak oil theory which is a shift to the imbalance of demand and supply of crude oil be still valid at the foreseeable future ? Would a very rapid price increase in crude oil cause the recession even deeper and negate any quantitative easing by the government (Fed mighty weapon of interest rate cutting is limited to ZERO interest) and Government infrastructure spending need a very confidence of public participation ?

Salvatore_Dali said...


not that they want to, even cpo and other main commodities are all denominated in usd, its the most widely used currency, plus the futures n options for hedging are in usd... it would be silly to buy in ringgit n the hedge is in euro... although usd is losing some of its reserve currency status, it is still the most accepted.. a collapse in usd, which i think will happen gradually... will see ppl shift some of the trades in other major currencies, e.g. euro or yen...

if there is a substantive fall in usd, say 30% in a month... not just oil but all commodities will swing up... that will force all to use a different and more stable currency to trade... its not a hellish situation, ppl r not so stupid...

any correction in usd will be an engineered one, the currency is too big for any group to collude... russia, china and japan hold the most usd assets, treasuries... they will not benefit if they all dump together... the world will be in deep recession for a very long time... see how all central banks work together even in this credit crisis, a usd crisis would be many times graver than this crisis.

Hong Chen said...

''Although oil prices have plummeted to below $40, most OPEC countries are still OK with it as the sharp correction has been counterbalanced by a 30%-60% depreciation in their own currencies vis-a-vis the USD.''

I don't really understand this statement. What did you mean by counterbalance? thank you

Salvatore_Dali said...

hong chen,

assume u r malaysia oil minister... you sell 100,000 barrels in Jan 2008 at US$120 = $1.2m, u brin proceeds back to malaysia at 3.20 then = RM3.6m..

today, you sell 100,000 at $40 = $400,000... technically you would HAVE FORGONE TWO THIRDS of proceeds than when you sold a year ago... or lost 67% ceteris paribus... but you get to convert now at 3.5, which is 9.3% higher
... hence if your local currency is a lot weaker, you would have counter the fall in oil price somewhat

Hong Chen said...

Ah... I got it now, thank you for your kind explanation. : )

Pat said...

I recently read an article in CNBC. Apparently the source was from the IMF. The latest figures on the break even prices are here

Production costs are a lot more. Its a huge difference from your figures, which also means that most,if not all, OPEC members are really caught between a rock and a hard place = no short and medium term exploration = higher oil prices in medium and long term = slower global growth recovery.

What's your take on this, SD?? a Happy New Year to you too.

tohff7 said...

The current low oil price is not good at all for the long run.

Oil price will spike when demand starts to recover while supply decrease sharply due to disincentive to invest in new oilfield currently

Colin said...

Doubt if those figures are accurate, this cost of the filed depends on the primarily the development and cost of reserves. Saudi Arabia have mainly simple onshore wells and large reserves, I would expect to be lower.

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