Our translation of an analysis by Olga Samofalova that appeared at the site of Russian business journal Vzglyad.
The Saudis need more expensive oil than Russia
April 20, 2018
Russia and other oil exporters have had an unexpected stroke of luck. Oil has for the first time risen to new highs since the end of 2014 and trades around 74 dollars. Together with the weakening of the ruble, this promises double benefits to the Russian budget. However, Saudi Arabia is still unhappy - it needs oil at 80-100 dollars per barrel, while Russia is comfortable even at 64 dollars. Why?
Both brands of oil: Brent and WTI - have risen to new highs since the end of 2014. Brent is trading around $ 74, WTI - at $69 per barrel. What is moving prices up?
First, in recent months, oil has supported the fundamental factors of supply and demand. The growth of the world economy led to an increase in demand for oil. On the other hand, the OPEC+ deal, in which Russia participates, limited the supply, and now more or less all members are meeting their obligations to reduce production. As a result, the demand in the oil market exceeds supply, which is reflected in the data on the decline in oil and petroleum products in the United States and other countries, says Marcel Salikhov, head of the Economics Department of the Institute of Energy and Finance (IEF).
Also in recent years, price-influencing factors like shale oil have appeared. "Over the past six months, it became clear that although producers of shale oil in the US are increasing production, they are not doing so to the extent generally expected. They have short-term problems, and it is not yet clear how quickly they will be able to respond to rising prices and increase production,” says Marcel Salikhov.
There are also short-term factors that helped oil jump. This is a geopolitical reward against the background of the Syria situation, sanctions against Russia and trade wars in the United States. "US sanctions against Russia have had a negative impact on the markets and the ruble exchange rate, but, on the other hand, have raised oil prices. This has partly redounded to the benefit of the Russian economy,” Salikhov said.
In the meantime, the Belarusian president Alexander Lukashenko directly linked the Skripal case to the rise in oil prices, without, however, explaining the connection. Asked to comment on the Skripal case, Lukashenko sent a veiled message: "Commenting is not my job, it’s yours (journalists’). We hardly know much and can argue it. Look at things in a broader light: the price of oil has risen? It grew! I won’t go any further than that. Think."
"His logic, in my opinion, is very doubtful and too complicated. Formally, there is the Skripal case, which has resulted in sanctions imposed on Russia, and additional sanctions may be considered, and this can affect the oil market,” says Marcel Salikhov.
Perhaps Lukashenko was hinting at someone who could benefit from the attempted murder of the Skripals: someone who very much wants to raise oil prices. Thus this attack is not aimed at Russia. Because Russia would have enough to balance the budget at about $53 per barrel, as calculated by the Moscow investment bank "Renaissance Capital." At the beginning of the year, Energy Minister Alexander Novak said Russia is generally comfortable with a price of around $64 per barrel. And the price of 60-65 dollars, which is already significantly higher than the pledged level in the Russian budget, has been holding for quite some time lately, so there was no need for Russia to change anything.
On the other hand, a higher price also creates favourable conditions for the growth of shale oil production in the United States. And this player can easily upset the balance of the supply and demand again and crash oil prices. Though better than average, a stable price of 60-65 dollars per barrel will dampen the enthusiasm of the manipulators.
But a price of 80-100 dollars per barrel is needed for Saudi Arabia, as it announced the day before. And these verbal interventions helped oil add a couple more dollars." The comments from Saudi Arabia were viewed by the market as a hint of a willingness to maintain production constraints, despite the fact that the oil reserves in the storage facilities are now close to the five-year average values," says financial analyst FxPro Alexander Kuptsikevich. Many OPEC members, incidentally, also need more-expensive oil, in particular Yemen and certainly Venezuela, which continues to reduce the extraction of fuel, which has an extremely high production cost.
Why do the Saudis have a more expensive oil than Russia? The fact is that the Saudis have a fixed exchange rate, while Russia has a floating exchange rate. As a result, oil prices affect the Russian economy and the economy of Saudi Arabia in completely different ways.
"In Russia, the main beneficiary of rising oil prices is the budget. We can assume that 80-90% of the gain from the price increase is taken by the budget, while the rest goes to the companies. At the same time, we have the opportunity to smooth out fluctuations in oil prices due to the floating ruble exchange rate, so that they will affect the economy less. Plus, the Ministry of Finance conducts interventions in the market, which additionally eliminates fluctuations,” the expert explains.
In Saudi Arabia, the rate of the national currency is fixed, and they do not have mechanisms to protect against fluctuations in oil prices. "Therefore, when oil prices decline, the Saudis are forced to spend reserves to support the exchange rate. For them, the higher the oil prices, the higher the positive effect. Russia does not have this situation: when oil prices rise, the ruble is also strengthened, and this somewhat reduces the positive effect for the economy," says the IEF expert.
This is now a non-standard situation, where oil prices have risen, but the ruble rate has declined. "In the current situation, the Russian Ministry of Finance receives a double benefit. If there were no sanctions, then with an increase in the price of oil, the ruble would be greatly strengthened," Salikhov said.
In addition, the Saudis need expensive oil in order to sell 5% of its oil giant Saudi Aramco. This IPO promises to be the largest in history. The Saudis have been trying to sell the stake for several years, but it's unprofitable to do this in a falling market.
The Saudis have large reserves of $250 billion. However, the budget deficit for only 2018 is calculated at 52 billion dollars, and Crown Prince Mohammed’s plans are extremely ambitious. He proposed the Vision 2030 program, which talks about building a smart city for $500 billion, a $200 billion solar energy project and many other equally expensive projects. Therefore, the Saudis need expensive oil in order to have enough for current needs and for the future. Russia does not even want to further reduce production for the sake of price.
On Friday, a regular meeting of OPEC+ members will take place, at which the parties can discuss new forms of the agreement. Now there are only two options for the OPEC+ deal: either the RF is in on the agreement and cuts production, or it withdraws from the deal. But there is concern that if Russia withdraws from the deal, then oil prices will fall again. Therefore, the parties can develop an intermediate option at the next OPEC meetings - some operational mechanisms of influence on prices; now the operational impact is only through verbal statements of the Russian Energy Minister or Saudi Arabia, says Salikhov. In other words, link the levels of production cutbacks to the real price of oil.
The fact is that with high oil prices, American shale can quickly increase production so that they will again spoil the fundamental stability.
It is difficult to make forecasts for oil, but it is likely that the price of oil will drop to $60, then rise to $90 per barrel.
According to the source, “the balance of risks is rather on the downside. Unless, of course, some military confrontation in the Middle East begins. Then, of course, the price can go as high as $100. But this is an extreme scenario, and the basic scenario is as follows: the US will increase production and OPEC+ will have to exit the agreement or reduce its scale. This will have a downward impact on oil. But the price of $60 more or less suits everyone: us, Saudi, the Americans, and consumers," notes the expert.
Original Russian-language text: