The International Monetary Fund (IMF) is offering a warning and some friendly advice to oil-exporting countries, which is, get you act together! The Wall Street Journal reports that the IMF is warning Middle Eastern oil exporters they could face a combined $1.0 trillion budget shortfall in the next five years if crude prices stay at present lows and economic reforms aren’t introduced more rapidly. In other words, either cut spending or cut oil production or sharply raise taxes or face a major economic crisis.
The Journal reports that Masood Ahmed, director of the IMF’s Middle East and Central Asia Department, says these oil-rich countries for now have the capacity to borrow more from the markets, but time is running out because most countries in the region will have burned through their reserves within five years. “Oil exporters will need to adjust their spending and revenue policies to secure fiscal sustainability,” the fund said. “Yes, they have financial buffers, but addressing these issues is a matter of time urgency,” Masood Ahmed, the IMF’s regional director, said at a press conference in Dubai. “Difficult choices have to be made in ways to cut back on spending or to raise other forms of revenue, such as taxes.”
MarketWatch wonders whether or not this will cause Saudi Arabia to cry uncle in its price war with the U.S. shale producers to avoid this looming financial crisis. Maybe not. They say that the fiscal “break-even” price -- the oil price at which the country can balance its budget -- sits well above current levels for Saudi Arabia and many of its fellow Gulf producers. The Belfer Center at Harvard University puts Saudi Arabia’s 2015 break-even price between $95 and $106 a barrel. That's based on the assumption that Saudi Arabia pumps an average of 9.7 million barrels a day in 2015. If they pump more then the break even price falls. Indeed, the cost of getting oil out of the ground in Saudi Arabia is in the low $20.00 area so there is incentive to keep pumping. And besides, the objective of the enterprise was to grab market share away from North America shale and other non-OPEC producers. The question, however, is whether the drop in oil prices which remain more than 50% below the mid 2014 levels, have overtaken the ability of Saudi Arabia and other OPEC members to pump their way out of the fiscal mess their in.
So when your fiscal outlook is not so bright, it is time to put the band back together! The Band! That’s it! The price band that is. Venezuela is going back in time and proposing a new OPEC price band that will drive oil prices back up to $88.00 a barrel with a floor of $70.00 a barrel. While that sounds like wishful thinking, the last time Venezuela proposed a price band they were trying to defend a floor of $22.00 a barrel and a ceiling of $28.00 a barrel.
As I told MarketWatch, “Venezuela, headed by Hugo Chavez at the time, was among those who led the push to set the band in 2000, said Phil Flynn, senior market analyst at Price Futures Group. Even after it was implemented, Chavez suggested raising the upper limit of the band.
The oil market, “was in a very similar environment to what we have now, as OPEC and oil companies were sinking with low oil prices,” said Flynn. “They were desperate and OPEC members back then, like now, showed no restraint in order to hang onto market share.”
But the price band became “obsolete as cut backs in energy spending and the rise in China’s economy made it a relic of the past very quickly,” said Flynn. “We saw OPEC restraint go away as demand started to exceed supply” as the market reached highs in the $50.00 area. The band broke up in 2005 and it was not because of Jake Blues or Yoko Ono. It was because the fallacy of fair price or the perception of what a fair price for oil might be in a changing environment.
We may be in that same environment now. Even with historic cut backs in the energy production, we still got big supply increases like we saw in yesterday’s oil inventory report. Despite the recent massive drop in U.S. rig counts, U.S. production is still hovering above 9.0 million barrels a day. Also, a stunning build of 8.0 million barrels that mostly came from the Gulf Coast. Still demand numbers were strong and that may be a reason why oil is bouncing back today.