Saudi, Russian Freeze Fallout Does Little To Change Crude Outlook (04/20)

At this point, several factors suggest that the result of the Doha talks has little to do with the real overall global supply/demand outlook. Firstly, slowing global economic growth makes a production freeze self-defeating. The Saudi and Russian governments are both starved for cash; reducing any form of income when growth is necessarily dependent upon deficit spending is comparable to shooting yourself in the foot with your own gun. The Saudi government is running at a near record budget deficit, so a production freeze means they would be forced to add to that deficit, or add to the difficulties of paying it down, i.e. reducing government expenditures

Secondly, the Russian economy is currently in recession. They're unlikely to opt to worsen the effects by cutting back on revenues, which are sorely needed for fiscal stimulus. Russia's debt to GDP ratio is not nearly as high as Saudi Arabia's, however, slower global growth and lower oil prices have taken a toll on government revenues which provides a generous incentive to forego a production freeze.

Finally, since 2009, essentially every government and central bank of the developed world has sustained asset prices by way of various forms of fiscal stimuli. This has hiked up sovereign debt levels in the process without creating any self-sustaining, productive, economic activity. As a result, government and central bank spending/printing is currently required on a perpetual basis in order to maintain any level of meaningful GDP growth (an extreme of the Keynesian Cross/Multiplier model).

Since 2012 Saudia Arabia's total government revenue fell by roughly (-56%); from $1.2 trillion to $546 billion today. Losing 14% percent of government revenues for four consecutive years while the country's economic growth relies on government spending details a situations that is just short of a national economic crisis. Add to that the fact that the Saudi regime is currently undergoing a reorganization of leadership in which the final decision on economic policy is held by a younger, locally educated man with decidedly different perspectives on the relegation of power and resources.

Fragile internal politics, falling revenue/subsidies, and tepid global economic growth has created risk averse regimes that are unlikely to gamble too heavily on the ability to manipulate global oil prices via a freeze in production.

Saudi, Russian Freeze Fallout Does Little To Change Crude Outlook

At this point, several factors suggest that the result of the Doha talks has little to do with the real overall global supply/demand outlook. Firstly, slowing global economic growth makes a production freeze self-defeating. The Saudi and Russian governments are both starved for cash; reducing any form of income when growth is necessarily dependent upon deficit spending is comparable to shooting yourself in the foot with your own gun. The Saudi government is running at a near record budget deficit, so a production freeze means they would be forced to add to that deficit, or add to the difficulties of paying it down, i.e. reducing government expenditures

Secondly, the Russian economy is currently in recession. They're unlikely to opt to worsen the effects by cutting back on revenues, which are sorely needed for fiscal stimulus. Russia's debt to GDP ratio is not nearly as high as Saudi Arabia's, however, slower global growth and lower oil prices have taken a toll on government revenues which provides a generous incentive to forego a production freeze.

Finally, since 2009, essentially every government and central bank of the developed world has sustained asset prices by way of various forms of fiscal stimuli. This has hiked up sovereign debt levels in the process without creating any self-sustaining, productive, economic activity. As a result, government and central bank spending/printing is currently required on a perpetual basis in order to maintain any level of meaningful GDP growth (an extreme of the Keynesian Cross/Multiplier model).

Since 2012 Saudia Arabia's total government revenue fell by roughly (-56%); from $1.2 trillion to $546 billion today. Losing 14% percent of government revenues for four consecutive years while the country's economic growth relies on government spending details a situations that is just short of a national economic crisis. Add to that the fact that the Saudi regime is currently undergoing a reorganization of leadership in which the final decision on economic policy is held by a younger, locally educated man with decidedly different perspectives on the relegation of power and resources.

Fragile internal politics, falling revenue/subsidies, and tepid global economic growth has created risk averse regimes that are unlikely to gamble too heavily on the ability to manipulate global oil prices via a freeze in production.

Russia and Saudi Arabia in Crude Position Post Doha Talks

Saudi Arabia and Russia are both stuck between a rock and a hard place. If they ramp up production to supplement budget deficit spending then they face the prospects of reduced revenues, should production lead to further price declines via an absence of a reciprocal aggregate demand in quantity. On the other hand, if they freeze or cut production, they may still face falling revenues as a decrease in supply doesn't necessarily equal higher prices with static demand, that would lead to increased revenues.

Furthermore, since the US is now the third-largest oil producer in the world (almost neck and neck with Saudi Arabia), a significant part of oil production policy in Russia and the Middle East now has to factor in more than basic market fundamentals. The effects of any action that artificially manipulates supply now have to be factored in with US shale producers and their affect on supply dynamics. If a production freeze does lead to higher prices, shale oil producers will resume production and benefit asymmetrically as their output levels are not subject to OPEC policy makers. Higher crude prices means higher revenues for the producer with the largest quantity of output, and shale oil producers will take advantage of that opportunity. A production freeze in this sense does not entirely benefit Saudi Arabia as they lose the opportunity to price less efficient producers out of the market; therefore a freeze is a sort of boon to the shale industry as well as a headwind for Saudi government revenues.

For the moment, the most viable option for the Russian and Saudi governments appears to be to let the market decide where crude oil will trade, based on supply/demand fundamentals and the prospects for global economic growth.

USO / CL - Crude Oil

USO / CL - deal or no deal, crude could see 45 and beyond before seeing 35. #crudeoil #DohaTalks

— Rubin (@rubinoftoronto) April 15, 2016