It's fashionable to argue that low oil prices can endure for years because the cost of producing oil in much of the Middle East is as little as $10 (U.S.) a barrel. So the Saudis will keep the spigot pried wide open to choke off more expensive production elsewhere – U.S. shale, the Canadian oil sands, offshore Brazil and West Africa.
The low-cost argument is a fallacy because it ignores the social costs of the oil-producing countries. Take Saudi Arabia. According to Deutsche Bank, Saudi Arabia in 2015 would have required about $100 (U.S.) a barrel to balance its budget; the average price was about half that level. This year, as a result of austerity measures, the Saudis will require $77 oil for fiscal break-even. But that's about double the current price for Brent crude, the international benchmark.
Translation: Big, fat deficits.
The good news, for Saudi Arabia at least, is that the reserves it built up during the era of triple-digit oil – about $600-billion at last count, down from a peak of $800-billion – will allow it to avoid a financial crisis for a few years. The bad news is that the weakest OPEC and non-OPEC countries cannot. Venezuela is on the verge of default. Nigeria, Africa's biggest economy and its biggest oil producer, is asking the African Development Bank and the World Bank for $3.5-billion in loans. Russia is entering its second year of deep recession. Little Suriname is hurtling toward an international bailout. The economies of many other countries – Angola, Algeria, Azerbaijan and Ecuador, among them – have stalled while their foreign reserves wane.
If Saudi Arabia persists with its damn-the-torpedoes pumping policy, outright disaster awaits the weakest oil-producing economies. In time, the crisis would hit Saudi Arabia, too. That's why low oil prices can't endure forever, although they could stay low for some time. For oil-dependent economies such as Saudi Arabia and Venezuela, the social costs of low oil are simply too high. Never mind the pumping costs; it's the budget break-even costs that matter.
Research from Deutsche Bank and the International Monetary Fund shows no country that depends on oil exports for most of its income can reach break-even at today's prices. Libya last year would have required more than $180 a barrel to balance is books, Russia more than $100 and Kuwait about $80.
Of course, their temptation is to pump more even as the price falls in a forlorn effort to use sheer volume to boost oil revenues. Global production has remained intact as a result, even though oil prices are down by 40 per cent in the past 12 months. So far, Saudi Arabia's strategy has backfired, although it could still work. In some markets, the Saudis have even lost market share. Russia has overtaken Saudi Arabia as the top oil exporter to China.
Low oil prices in oil-exporting countries can have devastating social, political and economic consequences. Case study No. 1 is Venezuela. Every economic number is going against the country.
With proven oil reserves equal or bigger than Saudi Arabia's, Venezuela should have been a Latin American energy and manufacturing powerhouse. Instead, president Hugo Chavez, who died in 2013, used the high oil prices during his reign to embark on an obscene spending spree. When the boom ended, Venezuela had no cushion. In 2014, gross domestic product fell 4 per cent; last year, it fell 10 per cent. Inflation is running at triple-digit levels and the currency is essentially worthless. The budget deficit is 20 per cent of GDP. The country has no fiscal fix-it strategy. It has not even eliminated fuel subsidies or raised fuel prices. The Financial Times reported this week that $1 buys 10,000 litres of gasoline.
It is hard to see how Venezuela can avoid a default whose shock waves could damage all the countries around it. Nigeria, meanwhile, has seen its foreign-exchange reserves fall by half to about $28-billion since the oil sell-off began in mid-2014. It has imposed capital controls. In a mark of desperation, both Russia and Saudi Arabia are considering selling off the family jewels to give them some financial breathing room. Saudi Arabia is considering the sale of a minority stake in Saudi Aramco, the world's biggest oil company; Russia is considering the privatization of Aeroflot and oil giant Rosneft.
The weak oil-producing countries are begging Saudi Arabia and Russia to cut oil supplies while keeping their own output intact. The problem is, no country wants to move first. But the pain for the weak oil exporters is becoming unbearable. The Organization of Petroleum Exporting Countries, born in the early 1960s, is already finished as a price-fixing cartel because of Saudi Arabia's market-share-grab gambit, one so aggressive it appears to have factored in the sacrifice of Venezuela.
Venezuela appears to be a goner. Other oil exporters will be less keen to sign their own death warrants and will demand higher prices to offset their social costs. For them, the only question is whether the Saudis are willing to play mean for another year or two.