Opec’s decision not to cut output is a bold move which is designed to cramp non-Opec suppliers, especially US shale oil producers, a report said, adding that the decision was led by Saudi Arabia in a move to maintain its market share.

Opec members have realized that by cutting production to support oil prices Opec will inadvertently allow continued non-Opec production rises, mainly US shale oil, which will result in corresponding loss in Opec market share, added the report entitled “Oil market dynamics and Saudi fiscal challenges” released by Jadwa Investments, a Riyadh-based financial services advisory firm.

Opec, by not cutting production in an over supplied market, is trying to limit the growth of oil which is produced at a higher marginal cost. Although the obvious target is US shale oil, which has a breakeven of between $65-90 per barrel, other longer term oil investments would also be affected, such as the Russian Artic reserve development and the Brazilian ultra-deep sea pre-salt development, both of which need prices of $100+ per barrel to be profitable.

“Opec’s strategy of trying to limit growth on non-Opec presents risks, most notably that no action on limiting production could lead to even further price declines and that these price declines do not slowdown supply growth from US shale oil,” said Dr Fahad Al-Turki, chief economist and head of Research, Jadwa Investments.

High price forecast: $100/95 per barrel for 2015/2016

“A combination of factors would see oil price reach our high price forecast,” said Dr Al-Turki.

Any disruption to supply from potential geopolitical hotspots, Iraq, Iran and Russia/Ukraine is likely to send prices higher, back above $100 per barrel.

Another factor that would push prices up is a quicker than anticipated economic recovery, that is, a drastic improvement in the EU and Japanese economy. Lastly, any future production cuts from Opec (including Saudi Arabia) would lift prices to the higher scenario of $100 per barrel in 2015 and $95 per barrel in 2016.

A cut in Opec is still unlikely in the near term and the recent Vienna meeting has illustrated that there is deep disagreement between Opec members about how to respond to lower oil prices.

Low price forecast: $79/78 per barrel for 2015/2016

The low price scenario is the least favourable to most of the major oil producers but does not represent a catastrophe for the oil industry. No further geopolitical related disruptions together with limited improvement in the global economy, with only the US leading economic growth, will see prices drop to $79/78 per barrel in 2015/2016.

Countries which have high public expenses and fiscal breakeven points, such as Iran and Venezuela, would be very uncomfortable with this price scenario, whilst some shale oil companies in US could cease production.

Impact of lower prices on Saudi Arabia

Saudi Arabia’s response to the fall in prices has been to decrease its official selling price (OSP), with OSP’s cut across all regions (Europe, America and Asia). In 2014 Saudi Arabia has witnessed increased competition in two of its key export markets, the US and China. In the US, Saudi’s supply of heavier crude has come under pressure from Canadian imports.

Saudi exports to the US were steady around 1.2 mbpd (millions of barrels per day) in the first half (H1) of 2014 but dropped to below 1 mbpd in September, whilst at the same time, US imports from Canada totalled their largest ever, at 3.5 mbpd.

Saudi Arabia also faces competition in the Asian market with other Middle Eastern suppliers also cutting OSP’s to Asia, underling the trend in discounting prices. A number of countries are vying for market share in this growth region, especially so in China, where Saudi crude has recently lost out to Iraq, Iran and Russia.

The decision to cut OSPs by Saudi Arabia, rather than production, shows that in a very competitive global oil market, with ample supply from non-Opec sources, prices are not a priority, for now, rather the expansion, or indeed maintenance, of market share is the primary objective. As a result, based on our baseline price forecast we do not see Saudi production falling too dramatically in the next two years.

“We project full year average production in 2014 at 9.7 mbpd; this will decline slightly to 9.6 mbpd in 2015 and then to 9.4 mbpd in 2016. However, at our high price forecast, which assumes cuts by Opec, of which, around 400 tbpd would come from Saudi Arabia, Saudi supply would fall to 9.1 mbpd in 2015 and 9 mbpd in 2016.

“Lower Saudi output would also be seen if the low price forecast were to materialize. In this scenario we would see Saudi production fall to 9.5 mbpd in 2015 and 9.3 mbpd in 2016,” said Dr Al-Turki.

A number of variables could result in different price levels over the next two years but prices of $85/83 per barrel for 2015/2016 are most likely, the report said.

At this level, prices would assist global economic recovery and push some US shale oil out of the market. Lower oil prices will have a direct impact on the balance of payments and fiscal position of Saudi Arabia.

“While we expect the government to maintain elevated fiscal expenditures, negative sentiment associated with fiscal deficits could slow down non-oil economic activity,” Dr Al-Turki concluded. – TradeArabia News Service