Oil at $80: target price for Saudi Arabia

Although OPEC and allies have never officially targeted any specific price of oil with the production cut agreement, each member of the pact knows very well where they want oil prices to be in order to balance their budgets that have been stretched thin in the price plunge.

OPEC’s largest producer and de facto leader—Saudi Arabia—is the most closely watched oil nation for hints about an unofficial oil price target, and speculation has been ripe since the start of the deal in January 2017 as to what price the Kingdom is aiming for.

For months, Saudi Arabia has been said to aim for oil at $70 a barrel, but now new hints and reports suggest that Riyadh is likely shooting for oil at $80—to help finance increasingly ambitious domestic policy plans and to boost the valuation of its oil giant Aramco ahead of its much-hyped IPO.

$80 oil would trigger an even bigger U.S. crude oil production surge that could unravel OPEC’s efforts at eliminating the glut. Oil at $80 could also slow down global oil demand growth, undermining one of the cartel and friends’ key assumptions: that robust demand growth will absorb the non-OPEC supply and that demand growth will continue to be strong going forward. Last year, oil demand growth surprised a bit on the upside, helping bloated inventories to draw down significantly.

Yet, targeting $80 oil—if we assume that Saudi Arabia is doing that—has its economic reasons. According to RBC Capital Markets, OPEC’s producers need oil even higher—at an average of $88 a barrel—to balance their public spending this year, Bloomberg Gadfly’s Liam Denning writes.

For Saudi Arabia, the price of oil needed to balance the 2018 public spending is $83 a barrel. The OPEC member that needs the ‘lowest’ price of oil to balance this year’s expenditure is Iran, at $52 a barrel, according to data by RBC Capital Markets.

It also comes as little surprise that the latest hint that the Saudis are likely targeting $80 oil is not universally shared among all OPEC members, according to Bloomberg sources who relayed the Saudi ambition for said target. Some nations have privately expressed concern that such a price would be too comfortable for U.S. shale.

The higher the oil price the Saudis (or OPEC) target and possibly reach, the more areas in the U.S. would be profitable to drill and add to the global oil supply, potentially wiping out the effect of the cuts and depressing oil prices again.

On the demand side, oil at $80 could hurt global oil demand growth, which was the tailwind last year to help OPEC significantly reduce the oversupply. Demand growth could also slacken should the current U.S.-China trade spat hurt global trade and impact global economic growth. While the effects of a possible trade war are still just in the realm of possibilities and analysts are waiting for all the rhetoric dust to settle, if trade and economic growth were to weaken, they could affect the pace of oil demand growth. This could undermine the assumptions of OPEC and allies that strong demand growth in the short term would help the cartel to achieve its mission to bring inventories down to normal levels.

Even without ‘trade wars’, OPEC could see demand growth slow down at $80 oil, as oil importing nations would be paying $30 a barrel more than they did last year, and double what they paid in 2016.

If $80 oil is really the unofficial Saudi target, and if prices reached that level—amid potential higher geopolitical risks (Iran, Venezuela) for example—U.S. producers could tip the supply side into another oil glut, while demand growth could slow down, leading to another cycle of depressed oil prices.