Analysis: The Shocking Sanity Of Saudi Arabia’s $100 Crude Target

The goalposts for international crude prices appear to have moved yet again, with Reuters reporting in mid-April that Saudi Arabia is now targeting US$80/bbl-$100/bbl.

The Kingdom has plenty of reasons for wanting higher crude prices: the upcoming IPO of a small stake in Saudi Aramco to finance projects related to Crown Prince Mohammad’s Vision 2030 to diversify the economy away from oil revenue and its ongoing war in Yemen. But is a US$100 crude target plausible, given the well-known impact of high prices on global oil consumption and non-OPEC supply, and if plausible, how quickly could we again see triple digit prices?

In short, and much to my shock, Saudi Arabia’s US$100 crude target is plausible, and the Kingdom may have been laying the groundwork for a high price strategy through recent efforts to extend and institutionalize oil market co-operation with Russia and a number of other significant non-OPEC oil exporting countries. In November of last year, OPEC and 10 non-OPEC producers extended their crude production pact to the end of this year.

More importantly, at the end of March, Crown Prince Mohammad indicated that Saudi Arabia and Russia were negotiating a long-term pact to control world crude supplies. It has since been reported that a joint organization for co-operation between OPEC and non-OPEC countries may be established once the current crude output pact expires at year-end.

Saudi Arabia, Russia and other significant oil exporting countries may have come to conclude that global oil consumption is under threat in the medium to longer term from actions to combat climate change whether crude oil prices are high or low. It is petroleum product prices that ultimately determine global oil consumption — along with the global economy and technological advancements, of course — not crude prices. If Saudi Arabia and these other major exporters do not raise refined product prices through higher crude prices, consumer governments will simply do so via higher taxes, carbon-related or otherwise.

At the same time, by bringing many of the most significant non-OPEC oil exporting countries indirectly into the OPEC fold, Saudi Arabia and its OPEC brothers severely limit the number of non-OPEC producers that could steal substantial market share from them in a high price environment.

The greatest threat to OPEC market share is the U.S. Light Tight Oil (LTO) revolution, but the Saudis and their comrades may be counting on drillers rapidly blowing through prime drilling locations in major LTO basins and the country’s production going into decline sooner than anticipated and before growth in global oil consumption slows in earnest. That is a definite gamble, considering major oil forecasting organizations have consistently and severely underestimated US LTO growth this decade .The International Energy Agency (IEA), the most optimistic of the major oil forecasters, is projecting US LTO to peak at almost eight million bbls/d in 2025, compared to average production of 6.64 million bbls/d in the first quarter of 2018 — a massive 1.27 million bbls/d above the same period in 2017.

Since agreeing to cut roughly 1.8 million bbls/d as of January 2017, OPEC and its non-OPEC co-conspirators have basically maintained market, if not market share. Non-OPEC supply growth, including increasingly strong growth in U.S. crude production, has been countered by growth in global oil consumption, with oil demand increasing by 1.5 million bbls/d or more for four consecutive years. That will be the first time since the early 1970s; before the first oil price shock, assuming middle of the road projections for this year are correct. Oil consumption has been powered higher in recent years by a strong global economy and low crude prices, the latter of which recently came to an end.

In terms of the Saudis achieving their US$100/bbl target, it could possibly be hit over the next year or so given the potential for additional politically-inspired oil production outages in a wide range of countries, assuming continuing co-operation between OPEC, Russia and the other non-OPEC producers, and the fact OECD commercial oil inventories are already back down to their five-year average.

As discussed in a previous article (Top Geopolitical Hotspots For Crude Oil Through 2019), rising tensions between Saudi Arabia and Iran should provide a solid base of geopolitical uncertainty, but a hot war between these archrivals and a massive supply disruption is unlikely, especially over this timeframe.

But there are many other potential sources of additional supply disruption, albeit significantly less dramatic. The four most likely ones are Iran (new economic sanctions), Libya (election-related violence), Nigeria (militancy in the Niger Delta region), and Venezuela (end game).

OPEC has not been making up for lost production from Venezuela since the December 2016 pact with Russia and other non-OPEC exporters, recently leading to 150 per cent compliance on its 1.2 million bbls/d share of agreed cuts, suggesting Saudi Arabia and its oil pact comrades may not make up for additional lost production from the Latin American country and elsewhere unless crude prices were to surge above US$100/bbl.

Assuming additional disruptions to crude supply, the most likely impediment to US$100 oil over the next year is the Trump administration. On April 20, President Donald Trump blasted OPEC in a Tweet. He wrote: “Looks like OPEC is at it again … Oil prices are artificially Very High! No good and will not be accepted.”

The primary tool at Trump’s disposal for countering high crude prices in the short term is a release from the Strategic Petroleum Reserve (SPR). In May 2017, the Trump administration proposed cutting the amount of crude oil in the SPR by half to roughly 345 million bbls, and the U.S. government has since announced the sale of 100 million bbls between the years of 2022 and 2027 to help decrease the country’s fiscal deficit. A key implicit goal of Trump’s “energy dominance” is to maintain international crude oil and natural gas prices at no more than moderate levels.

Since becoming Saudi Arabia’s de facto leader, Crown Prince Mohammad has adopted a number of radical and unexpected domestic and international policies in an attempt to put the Kingdom on a sustainable path. These include: Vision 2030; the Aramco IPO; last November’s “Velvet Purge”; heating up the regional Cold War with Iran; and the Yemen war. A new high crude oil price strategy could realistically be the Crown Prince’s latest radical and unexpected policy.

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