Lower Oil Prices Lead to Sovereign Budget Shortfalls

Greetings! In my most recent blog post, I discussed the correlation between lower oil prices and a reduction in jobs. This post is the second in a series of posts which will be dedicated to a deeper dive into the shale oil industry and the economics of oil as it relates to federal governments around the world.

Oil prices have come under severe selling pressure since the summer of 2014. However, before I can discuss the impact that lower oil prices are having on federal governments’ fiscal budgets around the world, readers need to understand the different types of oil classifications.

In the United States, we focus on the price of West Texas Intermediate light sweet crude oil. However, most of the world uses Brent light sweet crude oil prices as a key benchmark for worldwide oil prices. The primary differences are referenced below with the definitions provided by Wikipedia.org.

West Texas Intermediate (WTI)
“West Texas Intermediate (WTI), also known as Texas light sweet, is a grade of crude oil used as a benchmark in oil pricing. This grade is described as light because of its relatively low density, and sweet because of its low sulfur content. It is the underlying commodity of Chicago Mercantile Exchange’s oil futures contracts. WTI is lighter and sweeter than Brent, and considerably lighter and sweeter than Dubai or Oman.”

Brent Crude Definition
“Brent Crude is a major trading classification of sweet light crude oil that serves as a major benchmark price for purchases of oil worldwide. This grade is described as light because of its relatively low density, and sweet because of its low sulfur content. Brent Crude is extracted from the North Sea and comprises Brent Blend, Forties Blend, Oseberg and Ekofisk crudes (also known as the BFOE Quotation). The Brent Crude oil marker is also known as Brent Blend, London Brent and Brent petroleum.”

As can be seen in the chart below, Brent crude oil generally carries a premium in price above West Texas Intermediate crude oil. The chart below, provided by the Federal Reserve’s FRED database, illustrates the price differential in the two oil benchmarks:

Graph 1

As can clearly be seen in the chart above, both oil benchmarks have seen major selling pressure since the summer of 2014. Recently we have seen a slight bounce higher in prices, both oil benchmarks are lower by more than 50% since the 2014 highs.

Now that readers have a better understanding of the two primary oil benchmarks, I wanted to share with readers what oil prices several Middle Eastern countries based their fiscal budgets around. The following chart and data come directly from “Which Oil Producers Are Breaking Even?” by Elliot Bentley, Pat Minczeski, and Jovi Juan of the Wall Street Journal.

Graph 2“The world’s biggest petrostates need to sell oil at a certain price to balance their budgets. But there is a wide gap between the prices at which different producers break even.” The difference in Brent crude oil prices for each country to balance their budget demonstrates some very wide gaps. The specific data about each country is shown below:

Libya – Breakeven Price $184.10 per Barrel of Brent
  – 2013 Production in Barrels/Day 0.98 million
  – 2013 Gross Domestic Product – $65.52 billion

Iran – Breakeven Price $130.70 per Barrel of Brent
  – 2013 Production in Barrels/Day 3.19 million
  – 2013 Gross Domestic Product – $367.10 billion

Algeria – Breakeven Price $130.50 per Barrel of Brent
  – 2013 Production in Barrels/Day 1.76 million
  – 2013 Gross Domestic Product – $212.45 billion

Nigeria – Breakeven Price $122.70 per Barrel of Brent
  – 2013 Production in Barrels/Day 2.37 million
  – 2013 Gross Domestic Product – $521.81 billion

Venezuela – Breakeven Price $117.50 per Barrel of Brent
  – 2013 Production in Barrels/Day 2.49 million
  – 2013 Gross Domestic Product – $227.18 billion

Saudi Arabia – Breakeven Price $106.00 per Barrel of Brent
  – 2013 Production in Barrels/Day 11.60 million
  – 2013 Gross Domestic Product – $748.45 billion

Iraq – Breakeven Price $100.60 per Barrel of Brent
  – 2013 Production in Barrels/Day 3.06 million
  – 2013 Gross Domestic Product – $229.33 billion

Russia – Breakeven Price $98.00 per Barrel of Brent
  – 2013 Production in Barrels/Day 10.53 million
  – 2013 Gross Domestic Product – $2.0968 trillion

United Arab Emirates – Breakeven Price $77.30 per Barrel of Brent
  – 2013 Production in Barrels/Day 3.23 million
  – 2013 Gross Domestic Product – $402.34 billion

Qatar – Breakeven Price $60.00 per Barrel of Brent
  – 2013 Production in Barrels/Day 2.07 million
  – 2013 Gross Domestic Product – $202.45 billion

Kuwait – Breakeven Price $54.00 per Barrel of Brent
  – 2013 Production in Barrels/Day 2.81 million
  – 2013 Gross Domestic Product – $175.79 billion

Norway – Breakeven Price $40.00 per Barrel of Brent
  – 2013 Production in Barrels/Day 1.83 million
  – 2013 Gross Domestic Product – $512.58 billion

Sources: International Monetary Fund [break-even prices except as noted: Nigeria and Venezuela (Deutsche Bank); Angola (Angolan government); Ecuador (Finance Ministry); Russia and Norway (Fitch Ratings)].

Based on the data shown above, the average government budget breakeven in Brent crude oil price terms is $101.78 per barrel. As can be seen below, the current price of Brent crude based on the close of business on February 2, 2015 was $51.74 per barrel.

Graph 3

Based on the current price data and the average breakeven prices discussed above, the current Brent crude oil prices are putting every country discussed above in a fiscal catastrophe with exception to Norway. The overall average budget breakeven price is almost 2x the current Brent crude prices.

This data reinforces the potential threat that some countries have budgets that are severely upside down relative to Brent crude oil prices. The potential for fiscal deficiencies could cause countries that have budgets that are negatively impacted by lower crude oil prices to be incentivized to increase their energy production further to plug fiscal holes.

If this scenario were to come to pass, we could see lower Brent crude oil prices in the future. The complexity of global energy markets makes it difficult to forecast prices. However, the volatility of prices recently in oil markets has been fairly extreme with very wide price changes from one day to the next.

Energy is obviously critical to all nations, particular those nations whose fiscal budgets are based solely on Brent crude oil prices. However, if prices do not rebound soon several sovereign nations in the Middle East are going to experience significant capital dislocations within their financial structures. Should fiscal strain lead to further instability throughout the region, it is very likely that global geopolitical risk will intensify.

In closing, while this data does not help us forecast price, it does provide a contextual framework to help understand the forces that are impacting energy prices. It is important to understand the possible impact that oil producing countries’ budgets could have on the price of crude oil worldwide and the potential geopolitical risks associated with lower oil prices in the future. In my next blog, I will be dissecting the U.S. shale industry in greater detail and updating readers on rig count data and energy sector unemployment numbers. Until then, Happy Investing!

http://en.wikipedia.org/wiki/Brent_Crude
http://en.wikipedia.org/wiki/West_Texas_Intermediate
https://research.stlouisfed.org/fred2/graph/?id=DCOILWTICO,DCOILBRENTEU
http://graphics.wsj.com/oil-producers-break-even-prices/
https://research.stlouisfed.org/fred2/graph/?id=DCOILBRENTEU