OPEC breakevens go far beyond simply paying to service wells

As OPEC prepares for its 173rd regular meeting this week, individual member countries must decide what oil price they really need.

OPEC countries all use the revenue from oil and gas production to fund sometimes massive social programs. These programs, in theory, are the OPEC countries’ toss of a bone to their citizens. It’s their piece of the benefits from oil and gas production.

But then came the oil price downturn of 2014. That forced OPEC member governments to cut programs and dip into cash reserves, as revenue dove with commodity prices. While many OPEC countries have managed to decrease their spending, most have not been able to balance their budgets at current prices.

$40-$60 oil won’t cut it

Saudi Arabia, for example, has large social welfare programs that have proved difficult to rein in. This means the kingdom needs high oil prices despite having the largest oil output in OPEC and extremely low costs of producing oil. According to Bloomberg, Saudi Arabia needs $83.80 per barrel to balance its budget. This price is not likely to occur any time soon, and the resultant deficit is one of the reasons for Saudi Arabia’s push toward a proposed IPO of a portion of Aramco: it’s a source for the kingdom to generate much needed cash.

What OPEC (Saudi) Desperately Needs and Why Thursday’s Meeting is Vital

Source: EnerCom Analytics

Based on current Brent prices, a total of five OPEC members have managed to bring required breakevens down below the price of oil, but eight others have not. Some, like Nigeria and Venezuela (Nigeria needs Brent to be selling above $125; Venezuela needs Brent above $200 per barrel), are nowhere close to breaking even while some, like Algeria and the U.A.E, need only a small boost in crude prices to break even.

Countries like Kuwait and Iran, which need about $50 oil, have less need to vote for a production cut than Saudi Arabia and Venezuela. Countries that are just breaking even, or need slightly higher prices, like Gabon, Algeria and U.A.E probably have the most motivation to extend cuts, as a small increase in prices could make a big difference as to oil revenue bolstering their governmental budgets.

Saudi Arabia, with its pending Aramco IPO and its dwindling national coffers, also has an incentive to keep prices high.

U.S. shale plays are at breakeven now

While some OPEC members still need a boost in prices to break even, their competitors do not. KLR’s research team has analyzed the breakevens of major U.S. shale plays, determining the oil price required to return investment. Unsurprisingly, the Permian has the lowest breakevens among the U.S. shale plays, at $41 WTI.

The Wattenberg and Eagle Ford also have breakevens below $50/bbl, while the Bakken and SCOOP/STACK need just over $50.

Only Kuwait and Iran are competitive at about the $50 mark, and other OPEC members need higher oil prices to balance budgets.

What OPEC (Saudi) Desperately Needs and Why Thursday’s Meeting is Vital

Source: EnerCom Analytics

It is worth emphasizing, though, that OPEC’s “breakeven” and that of U.S. shale are not exactly defined as the same thing.

In general, it costs much less for OPEC countries to simply produce oil. For decades industry analysts have regarded increasing production from Saudi Arabia’s Ghawar oilfield as simply “opening the spigot.” Compare that to the massive amount of planning, land acquisition, capital raising and oilfield work required to produce oil via the highly technical and extensive drilling and completion programs needed to successfully produce U.S. shale oil.

Saudi Arabia in a tight spot

But the OPEC countries have significant social obligations beyond just paying for wells to produce oil.

Saudi’s leadership—the royal family—has paid for expensive social welfare programs for decades, removing the incentive to work and allowing the royalty to continue to live like kings—literally. When oil was above $100 per barrel, the level of incoming revenue made this possible. But when oil prices were sliced in half after OPEC’s Thanksgiving Day 2014 meeting, the lower price wreaked havoc on the Saudi coffers and the nation’s bean counters.

Two-thirds of employed Saudis hold government jobs, and wages in the public sector are on average about 1.7 times higher than in the private sector, Foreign Policy reported.  With 45% of all government spending for government wages, something had to give.

Trying to balance the budget, in September 2016, the Saudi government announced it was reducing ministers’ salaries by 20% and cutting benefits and allowances for all public employees. Being awarded a significant pay cut didn’t set well with the government worker population, so in April 2017 the Saudi Royal Court reinstated salary benefits to the two-thirds of Saudi workers who saw their incomes cut in 2016, Foreign Policy reported.

In the meantime, Deputy Crown Prince Mohammed bin Salman is leading a government reform effort to wean the Saudi economy off of oil, but he has his work cut out for him in a society that has never valued ‘hard work’ the way typical western economies do. Youth unemployment is reported to be 30%.

“But just how far and how quickly Mohammed bin Salman will be able to push depends on a society more accustomed to stasis than change. Saudi analysts now say the salary cuts came too quickly, were too blunt a measure, and didn’t offer enough tangible indicators of progress in return. Reinstating them may not have been the ideal fiscal move — but it was the only political option,” Foreign Policy reported.

After the price of oil halved in 2014 and 2015, the Saudi budget hit double-digit deficits. The country’s central bank burned through nearly $200 billion in reserves and looked to the international bond markets to raise cash, Bloomberg reported. Though it still has the lowest debt-to-GDP ratio of any country in the G-20, the long-term outlook foresees continually growing deficits, according to Bloomberg.

In the meantime, if the price of oil stays below the kingdom’s all-in national breakeven number of $83.80 and the growing deficit takes the kingdom’s remaining cash and/or if Saudi continues to borrow money to pay for its expensive social programs and government salaries, and if the crown prince is unsuccessful in  introducing a new, non-oil dependent economy to Saudi Arabia with lots of meaningful jobs that are embraced by the large number of unemployed youth of the country, a level of oil prices that remain below Saudi Arabia’s all-in national breakeven number will be the harbinger of very tough times to come for the kingdom.

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