Monday, 5 January 2015

What does the Saudi budget say about oil prices in 2015?

Despite the tough rhetoric, Saudi Arabia may need to cut its oil production to avoid making a sizeable budget hole even bigger

Oil market observers have been keenly waiting for the 2015 Saudi budget announcement. The price of oil assumed for the budget was supposed to indicate the likelihood of an OPEC production cut this year—a higher price assumption suggesting a higher probability of a cut. But when the budget was announced, there was considerable disagreement about the oil price assumption used by the Saudis. Some thought it was in the range of $55 to $63; others believed it was $75; still others reckoned it was close to $80.

The reason behind the disparity is that the Saudis do not explicitly publish the oil price projection on which they base their budget. In fact, they are very terse when it comes to publishing their sources of expected revenue and how much of it comes from oil versus non-oil sources. Therefore different analysts use different assumptions about non-oil revenue, total oil production and exports to back out the assumed oil price.

This has not only led to a wide range of estimates for the oil price used in the budget, but also to contradicting hypotheses about what the Saudis and OPEC are likely to do next. The total revenue figure published by Saudi Arabia is in fact consistent with two contradictory scenarios.

1. The status quo. In which the current production and export levels are projected to continue into 2015. This requires a price of around $60 per barrel to get the total revenue figure announced by the Saudi government. 

2. An OPEC cut. In which Saudi Arabia cuts its production and exports by around 1m barrels per day as part of coordinated cuts by OPEC members. This gives an oil price of around $72 per barrel.

While both scenarios are consistent with the $190.7bn total revenue number announced in the budget, the first one may not be feasible under current market conditions. If the Saudis continue to pump oil at the existing rate, then the market will probably be significantly oversupplied in 2015. This would result in a further fall in oil prices from their current levels (which are already below $60), and the $60 price used in the status quo scenario may not be achievable. This would lead to an even higher deficit than the $38.6bn the budget assumes. On the other hand, the OPEC cut scenario and its price assumption seem more in line with the 2015 expected demand and non-OPEC production growth.

So for all their tough rhetoric against production cuts, the Saudis may end up reducing their  oil production to avoid making a sizeable budget hole even bigger.