Oil finds $100 floor on Saudi politics and output costs

Reuters, Monday 4 Apr 2011

Unrest shifts Kingdom's focus from moderate long-term prices to balancing budget for new welfare programme

(Photo: Reuters)

Oil prices may have found a new floor around US$100 a barrel, supported by rising production costs and higher budgetary requirements in Saudi Arabia, the only country holding any significant spare production capacity.

With oil also finding support from a return to stronger global economic growth, crude markets may have a more lasting justification for price strength than Arab world unrest.

The $100 floor for Brent crude compares to the $75 a barrel "fair price" for producers and consumers identified at the end of 2008 by leading OPEC nation Saudi Arabia.

For a while that served as a guide to markets of when Saudi Arabia, as effective head of the Organization of the Petroleum Countries, might alter supply to manage prices.

Even late last year, before rebellion in Libya saw prices rocket to a two-and-a-half-year high of $120 a barrel, OPEC was finding reasons why it should not try to anchor prices at $75.

Brent last traded below $100 on 8 February and was above $119 on Monday, taking its year-to-date average for 2011 to almost $106 a barrel, ahead of 2008's record annual average of $98.52.

Unrest across the Middle East means Saudi Arabia's focus is no longer on the need to moderate prices to shore up long-term demand and appease the world's biggest oil consumer the United States.

Its attention is on issues closer to home -- countering unrest among the Shi'ite minority that populate the oil-producing Eastern Province.

"It seems clear that Saudi, and therefore OPEC, priorities have now changed as a result of the events of the past few months," said Chris Weafer, chief strategist at Moscow's Uralsib investment bank.

As it strives to stifle trouble, Saudi King Abdullah last month offered $93 billion in handouts.

Weafer estimates Saudi Arabia now needs close to $100 a barrel to balance its budget.

While that is at the top end of a wide range of estimates, there is broad agreement that Riyadh's oil price aspirations are flexible.

"The markets have provided the Saudis with confirmation of the fact that the risk premium is here to stay implying elevated crude prices," said Shelley Goldberg, director of commodities strategy at Roubini Global Economics.

"What this implies is that the Saudis, and others, are likely to throw money at this growing problem to placate doomsayers and oil supply shock vigilantes, which will have the effect of raising their budgetary break-even price for oil. The Saudi "comfort zone" is now over $80 a barrel."

That the global economy is at the start of a new cycle of growth, not entering recession as was the case in 2008 when oil prices were last as high, may encourage Riyadh to think elevated prices will not derail oil demand growth.

In 2008 Saudi Arabia called emergency OPEC talks and said that if necessary it could raise capacity to 15 million barrels per day (bpd) as it tried to halt the record rally to $147 a barrel that was followed by a record crash.

"I don't think they're doing things with the same gravity," said David Arron, a senior fellow, specialised in the Middle East at U.S. thinktank the Rand Corporation. "They don't think the world's on the brink of a major depression."

At least for now, many analysts also see economic recovery as strong enough to withstand $100 oil.

"Our belief (is) that Saudi Arabia was comfortable with the $90-$105 type of price range ... as long as they also remained comfortable that the global economic recovery, led by emerging markets, was on track," said Societe Generale in a note.

Beyond domestic and international economic needs, an industry justification for Saudi's $75 target prices was that it equated to the cost of producing marginal barrels of crude -- the most expensive on the global market from ultra deep water finds.

Increasingly, investment bank analysts, sometimes accused of bullish bias, argue the marginal cost has risen, driven by factors including energy inflation itself and the impact on steel and other costs.

Goldman Sachs assumes that some marginal Russian crude now represents the most costly barrel at around $100.

Paul Horsnell, head of commodities research at Barclays Capital, agrees oil companies need ever higher prices to balance rising costs.

The bank's equities research says the break-even cost for integrated European oil companies is now not far off $100 a barrel.

"Our estimates would show that pre divestments the average break-even oil price required by the integrated group is $95 post capex and dividends," it said.

Short link: