Republicans are urging U.S. President Barack Obama to use oil as a weapon in the West's diplomatic struggle with Russia over the future of Ukraine. By issuing permits to export American oil and gas, they argue, he could reduce Europe's dependence and hit Russia in the pocket. It is by no means certain, however, that America has the infrastructure to make a difference – and it is not only Russia that would suffer from a falling oil price. The Arab oil exporters of the Gulf are similarly burdened and the major U.S. and European oil companies are geared to expensive production.
The Russian government depends on oil and gas revenues to shore up about half of its budget. Spending is increasing at a rapid rate, but in recent years, that has been compensated for by a high oil price and rising output. Russia was the world's top oil producer last year, pumping 10.5 million barrels per day, but the government's expanding budget – swollen by social spending promises and Olympic extravagance – was estimated to balance last year at $110 (U.S.) per barrel. In order to fully fund this year's spending, an oil price of $115 is required.
Meanwhile, other oil exporters have been gearing up their budgets to higher levels of oil income. Saudi Arabia's 2014 budget is set at 855 billion riyals ($253.2-billion), the biggest ever and according to Bank of America Merrill Lynch, it sets the fiscal breakeven oil price at $85 per barrel. However, with typical levels of Saudi overspending (and the need to smother with cash any Arab Spring-inspired domestic discontent), the real spending outcome could reach 1 trillion riyals, implying the need for much higher international oil prices.
Last week, Moody's published a stress-test of the finances of several Gulf Cooperation Council nations. Assuming an oil price decline to $90 per barrel, Moody's concluded that the economies of countries such as Saudi Arabia and the United Arab Emirates would both suffer significant impacts, requiring government spending cutbacks. Worst affected would be Bahrain and Oman, the former hugely dependent on oil, despite it being a shrinking part of the economy. Bahrain's fiscal breakeven price is $119 and Oman will require $100 per barrel this year, says Moody's.
The dependence of so many on expensive oil is alarming. It bodes ill for the prospects of a peaceful resolution of the political and social conflicts erupting in the Middle East and North Africa. Rather than expand the political process, the Gulf states have opted to bribe their discontented young citizens with welfare payments while at the same time buying armaments and security apparatus to quell civil disturbance at home and to interfere in regional disputes. This leaves little room to reduce the burden of the state and diversify the economy away from hydrocarbons.
For hawkish Republicans, the vulnerability of so many OPEC states as well as Russia is grist to their mill. However, they should be careful what they wish for because the problem of high costs does not just plague government oil exporters but private sector producers as well.
In Houston last week, major oil exporters attending the CERA energy conference fretted about the soaring cost of producing a barrel. Within little more than a decade, the cost of producing oil has risen fourfold. The chief executive of Chevron, quoted in the Financial Times, suggested that in terms of cost, "$100 per barrel is becoming the new $20." It has galvanised the oil industry into a new focus on profitability and cost-cutting, in part due to the weakness of downstream refining businesses but also sparked by the ever-expanding capital budgets of drilling in deep water offshore or into complex tight oil formations.
According to Sanford Bernstein, the marginal cost of U.S. oil production had risen to $114 per barrel last year, boosted by deepwater Gulf of Mexico costs and the new technology required for shale and tight oil. Last week, a report from Scotiabank suggested that Canadian oil sands were less costly to produce than some of their rival U.S. shale oil projects. However the average cost of $60-65 per barrel referred to oil from producing assets, while new projects came in at $100 plus.
Those who hope that America will drown its enemies in cheap oil are likely to be disappointed. If and when the President opens the tap we might expect a very brief hosing of the European continent, during which a small number of U.S. exporters will yield good margins. The wells will then run dry. The majors are already scrutinising their biggest projects for profitability, while the smaller companies that dominate the shale oil sector can turn off expenditure quickly, in response to lower oil prices.
Perhaps the biggest change that will emerge from America's newfound oil strength is not the prospect of a politically weaker OPEC or Russia, but of America behaving as a swing producer in order to keep prices high. Hundreds of private oil producers may soon be switching shale oil drilling on or off, in response to price signals. For Russia and the Arab oil exporting states, it might be a huge relief.
Carl Mortished