Middle East Research and Information Project: Critical Coverage of the Middle East Since 1971

As of mid-May 2015, crude oil prices had fallen to the lowest level in recent years, under $60 a barrel for US domestic benchmark West Texas Intermediate (WTI) and about $66 a barrel for the international Brent benchmark. These market prices are compared to several types of “break-even” prices and affect decision-making by oil producers at several levels: whether price covers just production costs or incorporates a satisfactory level of profit, whether budgets balance and whether long-term capital investment is attractive. At today’s prices, fewer producers are breaking even, OPEC’s ability to act as a cartel is breaking down and some higher-cost operators in North America are closing down as they go broke while producers in Russia and Venezuela go into debt.

In the most basic meaning of “break-even,” WTI and Brent crude oil prices indicate whether companies (privately or nationally owned) are covering their actual costs of production, including exploration, development, extraction, transportation and administrative expenses. That is, these prices are the minimum needed for revenues to equal costs, to “break even” without making a profit. This calculation affects decisions about how much product to bring to market in the short term, given existing productive capacity. When prices are low, only the oil that is cheapest to produce will be marketed while more costly operations are idled or shut down. A second meaning of “break-even” is when prices are high enough to both cover costs and provide enough profit to satisfy investors. For private corporations, the higher the potential profit, the greater the drive for new drilling and new technology.

As of 2009, onshore Middle Eastern producers using mainly traditional well technology were estimated to have had the lowest average cost of production in the world, at $27 per barrel, while onshore production in Russia and elsewhere in the world averaged around $50 per barrel. Deepwater and ultra-deepwater production (e.g., in the Gulf of Mexico) was somewhat more costly, between $52 and $56 per barrel, while costs of production from newer sources were much higher: $65 for North American fracked shale oil, $70 for extraction from oil sands and $75 in the Arctic.

Market prices for oil ride the rollercoaster of the business cycle and so fell steeply during the financial crisis of 2008 and subsequent recession to lows of around $40 a barrel for WTI crude and somewhat higher for Brent. At that time, Middle Eastern producers suffered from lower revenues that depleted their foreign reserves and led them to curtail big investment projects, but they were, on average, still able to cover their production costs, while other producers, such as in Russia, operated at a loss if they did not halt production altogether.

With the recovery in global economic growth after 2010, especially in large “emerging” markets like China and India, prices rose again, peaking in mid-July 2014 at about $105 per barrel for WTI and $114 per barrel for Brent crude. This long rise had made new exploration and increased extraction from shale, oil sands and exotic locales like the Arctic more attractive. Rising prices also induced more investment in innovation for non-traditional processes like slant and horizontal drilling and for more sophisticated fracking techniques. But as this new oil, especially from North America—the US in particular—flooded into the markets, with increases in supply outpacing the growth of demand, prices began to fall again, landing in March-April 2015 at a little more than half their peak.

Another version of the second type of “break-even” price is the “fiscal break-even price,” which incorporates “profit” that accrues to public entities rather than private corporations, in particular nations that depend mainly on hydrocarbon exports to fund their governments and balance their annual budgets. For the major Middle Eastern OPEC producers, including Algeria, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia and the UAE, hydrocarbon products (including crude oil, natural gas and their derivatives) account for between 25 and 50 percent of GDP, 50 to 95 percent of export revenues, and 50 to 95 percent of government revenues. When oil revenues are high and rising for a number of years, as they were from 2005 to 2008 and then again from 2010 to 2014, the surplus inflows can be used by governments not only to pay the bills but also to build up foreign reserves and invest in both domestic development and overseas portfolios. Hence the third type of “break-even price,” the one that covers production costs, balances budgets, and finances big projects and long-term investments.

Among the Arab Gulf exporters, according to Deutsche Bank estimates, the 2015 “fiscal break-even price” of oil was lowest for Qatar, Kuwait and the UAE ($77, 78 and 80, respectively), but above $100 for Saudi Arabia ($104), Oman ($110) and Bahrain ($138). The per-barrel Brent prices of the first quarter 2015 were sufficient to cover their production costs but insufficient to cover their fiscal needs, affecting not only public spending but also private economic activity, as shown for example in the sharply declining liquidity of local financial markets as private-sector confidence waned.

Gulf news sources report that, while Qatar and Kuwait sustained their high level of project development in the first quarter of 2015, the pace of project development slowed in the UAE, especially in real estate, and dropped by over 40 percent in Oman. Local analysts in Kuwait are predicting a budget deficit for fiscal 2015/2016, and describe this financial situation as “dangerous” in so far as the government is determined to press ahead with both its investment and economic reform plans. Following International Monetary Fund advice, the Kuwaiti government has raised some domestic fuel prices, ironic as that may seem given falling world prices, and may even impose a corporate income tax on domestic private companies in order to diversify its sources of revenue and reduce dependence on income from hydrocarbon exports.

Both the UAE and Saudi Arabia are fighting the flooded oil market with more floods. The UAE announced plans to invest $25 billion over five years to enhance offshore oil production, aiming to increase its total output from the current 2.8 million barrels per day (bpd) to 3.5 million in 2017/2018, and it will be drawing down on its foreign reserves to do so, even borrowing on international markets if necessary. The Saudis, meanwhile, increased oil production to a record 10.3 million bpd in March and April “in response to global demand,” with the aim of defending market share in the face of US surplus output. In order to increase public-sector wages and pensions in celebration of King Salman’s ascendance to the throne, and to cover its commitments to social and infrastructure spending, not to mention its record military spending as the biggest global buyer in 2014, the Saudis are allowing the budget deficit to widen dramatically, from 1.9 percent of GDP in 2014 to 14.5 percent in 2015 and covering it by drawing down on their accumulated foreign reserves.

Bahrain and Oman, the weakest of the Gulf producers, have no choice but to follow Saudi leadership, but have much less financial room to maneuver. With small foreign reserves, they will have to cut expenses sharply or finance their budget deficits by borrowing. Other members of OPEC, such as Venezuela, Iran and Nigeria, actively argued for cutting production to restore prices, but the Saudis refused. While OPEC’s ability to cooperate as a group has been eroding for many years, its cartel power seems to be breaking down entirely in this situation. The Saudis reasoned that higher-cost producers, especially the US, should be willing to cooperate to stabilize supply and prices. If not, the Saudis figure that they can just wait it out as many North American operators suspend operations or close up shop, a process they expect will stabilize supply by mid-2015 and enable prices to rise again as demand increases this year and beyond.

While some US-based analysts agree, not everyone is so sanguine about this calculation. According to the Economist in April, only small non-conventional producers in the US are going bankrupt. The big players—Chevron, Shell, BP, Exxon—are idling older and less productive rigs and have laid off thousands of workers, but they are busy consolidating by buying up smaller firms and vertically integrating their control over production, refining and distribution in the North American market in anticipation of better conditions by year’s end. Due to steady innovation that is raising productivity from those shale and sands operations still underway in North America—including by big foreign operators like the Norwegian company Statoil and the French-owned Total—the costs of production of oil there are falling, while the costs to traditional non-innovating Middle Eastern producers rise. The US Energy Information Agency predicts that, due to falling costs and ample supply, prices will recover to no more than 70 percent of the peak 2014 price in the foreseeable future. The agency estimates that US oil will account for 12 million bpd by 2017, 15 percent of global output, and that the US will take over from OPEC as the preeminent power in the world oil market.

How to cite this article:

Karen Pfeifer "Breaking Even, Breaking Down or Going for Broke?," Middle East Report Online, May 22, 2015.