Since 2016 when the oil price was below 40 dollars per barrel, the Gefira analysts wrote over and over again, that it would be back over the hundred dollars per barrel by 2020. World oil production is about 98 million barrels per day, and in the second half of this year, oil demand will break a historical threshold of 100 MB/d. The 3 top producers – the US, Saudi Arabia and Russia – are responsible for 33% of the world oil production. The US produces about 10 million barrels of oil, and it also imports 8 million barrels oil per day. 18% of all consumed oil in the world finds its way to US storages or refineries.
Both the US and Saudi Arabia not to mention Russia desperately need a much higher price of oil. The US will issue an unusual amount of treasuries in the coming years as the budget deficit reaches new highs, and the Federal Reserve began selling its US debt holdings. High oil prices are a tax on the US and European consumers, collected by foreign oil producers and the surplus profits are reinvested in sovereign wealth funds which buy US securities and debt obligations. Four of the top five most significant sovereign wealth funds received their revenue from oil; Norway’s Government Pension Fund Global, Abu Dhabi Investment Authority, Kuwait Investment Authority, and SAMA Foreign Holdings (Saudi Arabia).
US shale oil producers are said to be able to produce twice as much oil from the same well and for that reason their production costs have been reduced significantly. While the daily production of a well doubled, it is far from certain if the lifetime of the well is the same. Analysts do not know whether a double output depletes a well twice as fast. If that happens, the outlook for the US oil industry is far worse than it is assumed now. The US oil industry needs a higher oil price to make the US energy independent.
The government in Saudi Arabia needs more oil revenue to balance its budget. Saudi Arabia is run as a private property which earns its revenue from oil and the pilgrims that flock to Medina and Mecca.
The house of Saud cannot survive on a prolonged low price. The Saudi princes have ambitious plans to restructure the economy and make Saudi Arabia less dependent on oil. It is far from certain whether the Saudi princes will succeed in it. The low oil price did not prevent the US shale oil from being extracted, and higher oil price is now indispensable for the survival of the House of Saud.
Graph 1
graph 2
The best way to drive up the price is to keep the market in short supply which is why Aramco, the only oil producer in the Kingdom, is reducing oil supply. If the Saudis can raise the oil price to 95 dollars per barrel by reducing their oil production by 2 mln barrels per day, their profit (revenue minus cost) will increase. Aramco, in collaboration with Russia, is in the position to manipulate the oil market.
We made fictive scenarios based on the assumption that a reduced oil production will increase the price of oil. While the relations between the reduction in production and oil price in graph 1 and 2 are hypothetical, they are instructive.
Since 2014 all oil companies have reduced their capital expenditure, and investments in the exploration of oil have dropped considerably. For that reason, it is not expected that other producers can replace the oil the Saudis keep from the markets.
The Saudi and US strategy to increase the oil price is already successful because Venezuela is efficiently barred from the global oil market by the Trump administration and more turmoil is being created in the Middle East. We expect more to come.
