Analysis
Global oil prices (WTI) decreased by more than 55% between March 3rd, 2020 and March 18th, 2020, from $47.18 per barrel (ppb) to $20.83 ppb in just two weeks. This was the largest oil price drop since 2014 and the lowest price since November 1998. The global pandemic in combination with an oil supply glut made oil markets more volatile than ever. Next to the knowledge of the current oil price, the most important tool for investors and analysts to utilize and weather current market conditions is a clear understanding of the breakeven prices for oil.
While the 2014 oil price drop was similar, it occurred over months not weeks. The main reason for the 2014 drop was the increase in US oil production introduced by new fracking methods. The US, as the world’s largest oil consumer, became the world’s largest oil-producer and accrued considerable market share to the disadvantage of Saudi Arabia and Russia. Fears over future US production rates resulted in new alliances. Saudi Arabia, as the leading nation of OPEC, aligned with Russia. OPEC+ was formed in 2016 as a counterbalance. OPEC+’s objective was to curb oil output while seeking an increased global oil price. This strategy was not entirely successful as oil prices remained in a comparatively pre-2014 low level. The alliance continued until early 2020 when Russia decided to withdraw because Moscow realized the strategy of OPEC+ to maintain oil prices at a high level as unsuccessful.
The 2020 drop in oil prices occurred abruptly and was unanticipated; several factors contributed. The first event was the outbreak of the coronavirus pandemic which resulted in a sharp economic downturn. Historically, sharp economic declines cause lower oil prices as global demand for oil shrinks. The second event was Russia’s decision to not agree to Saudi Arabia’s request for an oil production cut within OPEC+. This led to the de-facto dissolution of OPEC+ and with it a strong instrument for controlling the global oil price. The third event was Saudi Arabia’s consequently decision to increase production and oversupply the oil market, resulting in a sharp oil price drop. The oil price remained low for several weeks and ran into the risk to drop to a price of $10 ppb, according to analysts. OPEC and Russia returned to the table by the end of March 2020 and agreed on an unprecedented oil production cut of 10 million barrels per day. The recovery of the oil price remains to be seen. In the long term, oil prices will increase. The question is how far it will go and where it will stay. The breakeven price for oil-producers is probably the most important tool to find the real price for oil.
A breakeven oil price becomes key for energy market analysts in predicting and assessing future trends, particularly when enduring turbulent or unstable economic conditions as described above OR as we are currently facing. A breakeven oil price is also a useful tool for investors and political analysts. An explanation and guideline are laid out here on how to read and interpret breakeven oil prices. This provides a better understanding of the current oil price situation and indicators of future trends.
Understanding the Breakeven Oil Price
The breakeven oil price is the price of oil that makes it worthwhile for an oil-producer to produce and sell oil. In perfect market conditions, the producer who has the lowest breakeven price gains the most profit, whereas the producer with breakeven prices below the market price will not survive. The knowledge for each oil-producer of its own and ideally its competitor’s breakeven price is thus essential.
The calculation of breakeven prices is rather complex. For example, the production costs for oil does not equal the breakeven price of oil. Production costs exclude crucial costs like taxes, investments, exploration costs, forward sunken-costs, running costs, transport costs, and dividend payments. The oil price necessary at a specific, most profitable production rate to cover all costs equals the breakeven price. Oil-producers have low to no incentive to disclose their breakeven numbers to their competitors. If oil-producers disclose their breakeven prices, they might be inaccurate, misleading, or incomplete. Many independent institutes or authorities gather their breakeven price information and this information is more reliable.
Even when breakeven prices are close to accurate, many other factors determine whether an oil-producer is competitive. Those factors can include the flexibility to reduce or increase production, which could be a temporary or final closure of oil rigs or a technically affordable reduction of output. Oil-producers can also vastly differ in their ability to endure lower than breakeven oil prices, based on individual producers’ financial reserves, oil reserves and existing oil wells, and governmental sponsorship, especially for national oil companies.
Breakeven oil prices can vary by how companies, analysts, and institutes report them. Breakeven oil prices often reflect a zero balance of production and recovery costs, but in some cases, a profit margin is already included, which could be 10% or 30% of profits. The breakeven price for one or more oil-producers (e.g. an oil-producing company) is often presented in two different numbers, which is either the breakeven price that covers only the costs for oil production from existing wells or the breakeven price that also covers costs for development and exploration of new wells. The latter breakeven price is a more useful indicator of a producer’s profitability. Most significantly, there are different types of breakeven oil prices. The breakeven price can be calculated and reported for a single producer, company, region, or a country’s budget balance. Eurasian Ventures has created the following list of common types of breakeven prices and how they can be interpreted.
Types of Breakeven Oil Prices
Individual Breakeven Price
For a private smaller-sized company, the breakeven oil price is the most important factor as it indicates a company’s future profitability. The US shale oil industry consists of a large number of smaller oil companies and a few large companies. These companies compete in a regional area with global prices. Every company has an Individual Breakeven Price, based on their ability to find and extract oil. In contrast to breakeven prices of large international oil companies, Individual Breakeven Prices are based on one company and one geographical area or type of extraction, such as shale oil. Individual Breakeven Prices are also a good indicator of the efficiency of a company competing in a certain region. The breakeven price for US shale oil companies differs between $20 and $70 ppb.
Regional Breakeven Price
Many companies’ data is combined to determine a medium breakeven price for a specific region, especially in the shale sector. The most prominent and profitable region for the US shale industry is the Permian Basin and Eagle Ford, both in Texas. The Regional Breakeven Prices are reported between $23 to $26 ppb? for existing oil wells. The average Regional Breakeven Price of US shale oil for the development of new wells is almost double that between $46 and $48 ppb. The large difference is based on shale oil wells as they usually deplete faster than conventional ones, such as those in the Middle East or Western Siberia.
International Company Breakeven Price
The breakeven oil prices for international oil companies, such as Exxon Mobil, Chevron, Shell, and British Petroleum are different in many aspects to Individual Breakeven Prices of smaller oil companies. Although the International Company Breakeven Prices are designed for individual private companies as well, the difference is that International Company Breakeven Prices are not regionally tied and less dependent on one specific type of extraction, such as shale oil or conventional oil drilling. Instead, international companies have stakes and ownership of oil wells in many different regions, as well as expertise in different forms of oil extraction. Their breakeven price is thus based on the individual breakdown of each company’s resources of oil production. At the same time, International Company Breakeven Prices are a less reliable indicator of the economic performance of the oil company. Different from smaller oil companies, which operate solely in the shale oil industry, the economic performance indicators for large oil companies include the number of proven oil reserves, forward-looking investments, indebtedness, infrastructure, and subsidiaries, such as petrochemical production or service companies amongst others. The breakeven price of an international oil company is thus, not necessarily lower than those of smaller companies. In most cases, the breakeven prices of international companies are higher. Exxon Mobil, one of the largest international oil companies, has a comparatively high breakeven price of $73 ppb. However, it has a broad portfolio of revenue streams including petrochemical production which balances the company’s volatility in periods of low oil prices.
Technical Breakeven Price
As international oil companies operate in a variety of lucrative regions, they have also developed or acquired a diverse set of efficient drilling methods such as shale oil fracking, deepwater drilling, and oil sand mining. These extraction methods have differing exploration costs and complex drilling practices. The type of method determines the Technical Breakeven Price, which differs broadly between onshore drilling, offshore drilling, deep-water drilling, shale oil drilling, oil sands mining, and heavy oil drilling. The Technical Breakeven Price is often linked to regions such as offshore drilling in the Arctic, offshore drilling in the Gulf of Mexico, or oil sands drilling across Canada.
The following breakeven prices presented in this paragraph are estimations, provided by Rystad Energy New Middle Eastern onshore well exploration requires a regionally tied average Technical Breakeven Price of $42 ppb for the new exploration. The average breakeven price for oil sands mostly extracted in Canada is $83 ppb, amongst the world’s highest Technical Breakeven Prices.
There are important issues for the interpretation of the Technical Breakeven Price. First, there is a difference in the average Technical Breakeven Price, which is $42 ppb for conventional oil production in the Middle East and $83 ppb for oil-sand mining in Canada. The variance of the breakeven price for each extraction method can be significant. While the breakeven price for shale oil is between $37 and $55 ppb, which is a difference of $18 ppb, the variance of the Russian onshore breakeven price is between $33 and $72 ppb, a difference of $39 ppb. Russian onshore oil-producers may have the potential to reduce their breakeven prices closer to $33 ppb. Also, Middle Eastern oil-producers have an average breakeven price of $42 ppb, but the lowest breakeven price in the Middle East is around $20 ppb for Saudi Arabian oil-producers. Shale oil-producers have decreased the breakeven price for shale oil from $65 in 2015 to $46 ppb for new wells within five years, demonstrating its efficiency.
Fiscal and External Breakeven Price
Reported breakeven oil prices for Saudi Arabia often show two or more diverging prices. Two breakeven prices exist for an oil-producing and oil-exporting country. It is the breakeven price for a state-controlled national oil company and the separate breakeven price of oil that balances a country’s fiscal budget. The financial, economic and political stability of many oil-producing countries is dependent on oil exports and consequently on the global oil price. The US, as the world’s largest oil consumer and the world’s largest oil-producer, is not dependent on oil exports because of the US’ diversified industry.
Saudi Arabia and Russia, as the world’s second-largest and third-largest oil-producers, have state-owned oil and gas companies. The formation of the breakeven price for a national oil company is similar to that of an international oil company, where several factors contribute to a company’s profitability. The difference between national and international oil companies is that national oil companies do not always seek cost-effectiveness as their strategic positioning is largely influenced by domestic governmental policies. National oil companies, under the same conditions, usually have a higher Individual Breakeven Price than private oil companies. There is a misleading assumption that national oil companies have the same breakeven price as an oil-exporting country as an entity, which is incorrect.
Governments of countries with a high dependence on oil exports require a different breakeven price than that of state-controlled national oil companies. Governments have individual costs to cover based on the sectoral allocation of funds defined by their annual budget. The government expects a certain amount of tax revenues from the oil industry based on a certain oil price. The budget balanced breakeven price of a country is the Fiscal Breakeven Price. Usually, National Breakeven Prices tend to be higher than the breakeven prices of national companies. This is the case for Saudi Arabia, which has an estimated breakeven price of $72-$84 ppb to maintain its fiscal balance, while its national company, Aramco has a breakeven price of $42 ppb. The difference, while significant, is standard. Russia’s Fiscal Breakeven Price is lower than Saudi Arabia’s, at $42 ppb, but the breakeven price for Russia’s national oil company, Rosneft, is somewhat higher at $50 ppb. Because of the comparatively high Technical Breakeven Prices in Russia, it becomes increasingly difficult for Russian oil companies to explore new oil fields. This explains Russian oil companies’ high Individual Breakeven Prices.
Oil-producing countries have options to mitigate lower oil prices that exceed their Fiscal Breakeven Prices. For example, a country may create reserve funds during periods when oil prices remain well above the Fiscal Breakeven Price as a buffer when prices decrease. Poorly governed countries of so-called Petrostates allow the Fiscal Breakeven Price to climb whenever oil prices are high, leaving little room for financial reserves to rise. Oil exporting countries could limit budgetary spending during periods of low oil prices or tie their domestic currency to the oil price. Russia began reducing its Fiscal Breakeven Price following the 2014 oil price plunge through budget cuts and currency devaluation. The drawback, despite a stable budget, is that the Ruble’s devaluation led to an economic decline in 2015 and 2016. The oil price drop in 2020 could cause a similar situation. However, the international economic sanctions imposed on Russia in 2014, due to Russia’s annexation of Crimea, spurred the economic decline. The coronavirus pandemic will have a similar or more devastating impact on Russia’s economy. The options for low-oil-price-mitigation for oil-producing countries come with political risk. The devaluation of the currency leads to economic hardships for the population, which in turn puts pressure on the government. The creation of a reserve fund instead, creates a low risk of political instability.
The Fiscal Breakeven Price also does not necessarily reflect the breakeven price of oil companies to develop new wells. For example, the Technical Breakeven Price for new Russian onshore oil wells averages at $59 ppb, while the average breakeven price for offshore oil in the Russian Arctic is at $75 ppb. Russian Individual Breakeven Prices for existing wells can be as low as $20 ppb. This indicates that a Fiscal Breakeven Price of a country might not depict a trustworthy number or it might indicate that the fiscal breakeven price will grow in the future.
Saudi Arabia has long been able to influence global oil prices through oil production cuts initiated through OPEC, where Saudi Arabia is the leading member. Saudi Arabia uses its financial reserve fund to mitigate low global oil prices and maintains its high Fiscal Breakeven Price. Production cuts have enabled Saudi Arabia to balance its budget either through a higher oil price or through a higher export rate. Since the US and Russia have become major oil-producers, the price-determining influence of OPEC has been significantly marginalized.
The calculation of the Fiscal Breakeven Price can be opaque or misleading. It is almost impossible to track a country’s revenues from oil production as there are many revenue sources including many forms of oil taxation. Separately, state-owned oil companies often contribute to non-budgetary social spending and investment without which the breakeven price for a balanced budget could be even higher. Finally, the Fiscal Breakeven Price does not reflect the economic significance of a currency devaluation, as the case of Russia illustrates, but highlights a country’s volatility to oil prices to a lesser degree.
The calculation of the External Breakeven Price can provide a better understanding of a country’s dependence on oil prices. The External Breakeven Price is calculated by the difference of the country’s oil export revenues and its non-oil import deficit, divided by its oil export volumes annually. Given the simplicity of its calculation, the External Breakeven Price provides little insight into a country’s fiscal and budgetary policies but offers a coherent reference value for breakeven prices of oil-dependent countries. For example, the External Breakeven price for Saudi Arabia, calculated by the International Monetary Fund (IMF), was at $47 ppb in 2018. The IMF’s projected 2020 External Breakeven Price for Saudi Arabia is $55 ppb. The IMF’s projected Fiscal Breakeven Price of 2020 for Saudi Arabia is $84 ppb. The reason for Saudi Arabia’s significant difference of $29 ppb between the Fiscal and the External Breakeven Price is the country’s continued reduction on imports after the 2014 oil price plunge. Conversely, Russia’s Fiscal Breakeven Price and External Breakeven Price, however, were very similar between $42 and $40 ppb in 2016 (data after 2016 is unavailable). Russian currency devaluation has led to a decrease in imports which has helped to maintain the External Breakeven Price at a consistently lower level.
Can Breakeven Prices Explain the Current Oil Price Crisis?
There are many ways to consider OPEC+’s failure to curb oil production, why the three leading oil-producers staged a price war, and why the coronavirus pandemic has devolved into an oil price crisis. One method for considering this situation is through analysis of the breakeven prices.
The story of the oil price crisis reads somewhat like the story of Wolfgang Goethe’s Sorcerer’s Apprentice: We cannot get rid of the low oil prices that we called for.
The economic crisis resulting from the coronavirus pandemic brought down oil demand to a level that cannot be influenced by any oil-producer. In other words, the pandemic has turned the oil price war to an oil price crisis.
It is debatable if Saudi Arabia and Russia have taken the ongoing dire economic situation into their calculations when they decided to discontinue oil production cuts. However, the sharp decline of oil prices brought OPEC members and non-OPEC oil-producing countries back to the table and reach an agreement on output cuts. Regardless of the ability of OPEC+ to increase oil prices, the current oil price crisis provides an opportunity to demonstrate how important the knowledge of the breakeven is to assess market behavior.
Since 2014, the three major oil-producers have been battling for market share. OPEC+ was able to curb the market share of US shale oil with indications that US shale oil could not sustain the battle for the longer term. In early 2020, Russia opted to leave OPEC+ which allowed for an oversupply on the oil market. Saudi Arabia intended to maintain the OPEC+ regime to control global oil prices, suiting the Kingdom’s goals. Although Saudi Arabia and Russia follow the same goal to curb the development of US shale oil production, Russia pursued a different strategy. Russia has tried to push US shale oil-producers into bankruptcy by increasing output, thus leading to oil prices that would be too low for shale oil-producers to survive. This strategy, if achieved, would lead to oil prices closer to pre-2014 levels. Russia’s oil and gas industry has been hit hard by US-imposed economic sanctions. Moscow perceives these sanctions as a tit-for-tat attempt by the US to strangle their industry or industries. The decision of the US government to sanction Rosneft, Russia’s national oil company, over its business involvement in Venezuela, was likely the final trigger for Moscow to leave OPEC+. Saudi Arabia, as a reaction to Russia’s exit, increased its oil production, which eventually triggered the crash of oil prices. It was the only option for US shale oil-producers to maintain the highest output level to survive. The US government refuses to intervene in the domestic oil industry with imposed production quotas.
A closer look at the breakeven prices of the parties involved provides a clear understanding of how long the oil price war can continue and which country will be best positioned to turn the outcome into its fortune. At first glance, Saudi Arabia’s Fiscal Breakeven Price of $84 ppb is the highest in this scenario when compared to Russia’s price at $45 ppb and around $46 ppb for US shale oil. Saudi Arabia’s prospects appear the worst. Russia would have the advantage because of its lower Fiscal Breakeven Price. The difference of the External Breakeven Price between Saudi Arabia ($55 ppb) and Russia ($45 ppb) is not as far off as the Fiscal Breakeven Price. Additionally, Saudi Arabia’s national oil company, Aramco, has the advantage that it has a far lower breakeven price for existing wells at $26 ppb. Saudi existing wells are likely to be sustainable longer than Russian and US shale oil existing wells. The Technical Breakeven Price for existing wells in the Middle East can be as low as $11 ppb.
It is important to note that Russia and Saudi Arabia currently have similar low oil production costs, although Russia’s low production costs are based on the already devalued currency. The development of new Russian wells requires a breakeven price of at least $50 ppb. Saudi Arabia requires a breakeven price of $42 ppb for new wells. These numbers suggest a fairly equal and challenging environment for both countries. The options to mitigate low oil prices for Saudi Arabia and Russia, the expenditure of financial reserves, devaluation of domestic currencies, or budget cuts will eventually have negative political and geopolitical consequences.
The situation of the US shale oil industry is different. Although the current Regional Breakeven Price for US shale oil of $46 to $48 ppb is comparable to the Fiscal Breakeven Price of Russia, shale oil-producers do not have the financial reserves to sustain a longer period of low oil prices. Most shale oil-producers were already indebted before the current economic crisis began. The low Regional Breakeven Price for existing shale oil wells of $26 ppb is not comparable to equally low breakeven prices of Saudi Arabia and Russia. Shale oil wells usually do not offer high oil reserves and deplete sooner than conventional oil wells in the Middle East or Western Siberia. The only way to mitigate low oil prices for shale oil-producers is to acquire as much oil storage capacity as possible and wait for oil prices to rise. The advantage of US shale oil is that longer periods of low oil prices drive competition, innovation, and efficiency. If a shale oil-producer goes bankrupt, another one will grow more efficiently. Shale oil-producers have already shown flexibility to increase oil production on short notice, whenever global oil prices increase.
Within this oil price war scenario, there is the risk to compare apples with pears. The breakeven prices of countries follow a different system than breakeven prices for private companies, as in this case of the US shale oil industry. While companies go bankrupt, countries dependent on oil production face political turmoil. The preparedness, pressure, and measures by governments to reduce those risks are more intense and sweeping in these countries than in private companies. However, the current oil price threatens the entire US shale oil industry. In the worst case, a dire socio-economic impact could jeopardize some segments of the population where the shale industry is located. This is likely part of the US government’s motivation to assist in finding a political solution. The interest of all parties in stopping the oil price war has dramatically increased because of the pandemic. The pandemic and the resulting economic recession will certainly negatively affect global oil demand for months, if not years, accelerating the pressure on future oil prices.
Recommendations and Guidelines: Using Breakeven Oil Prices
Knowledge of the breakeven oil price is a useful factor to predict the economic health, profitability, and prosperity of a company, the industry, or even a country. The interpretation of breakeven prices though has to be approached with care. Here is a guideline on how to use breakeven prices and the types of breakeven prices for oil analysis.
- Always scrutinize the sources of reported breakeven prices. This is the case for all breakeven prices, but specifically for Individual and International Company Breakeven Prices and Fiscal Breakeven Prices. Companies and governments sometimes have the interest to sugarcoat or misrepresent their numbers to gain investment.
- Calculated breakeven prices should state which type of breakeven price they intend to present. Individual and International Company Breakeven Prices may relate to existing oil wells only, where the crucial investment for the development of new wells are excluded. It is also possible that the Fiscal Breakeven Prices for countries do not include all government revenues and spending. In this case, it is essential to analyze an oil-producing country’s fiscal and economic policies before interpreting its breakeven price. Technical Breakeven Prices often show an average breakeven price for a certain region or type of extraction. This does not include the efficiency of single oil companies nor the opportunity to extract oil to lower than average breakeven prices. For example, Saudi Arabian onshore breakeven prices can vary considerably, between $20 and $60 ppb, while US shale breakeven prices only vary between $46 and $52 ppb.
- Do not compare different types of breakeven prices par for par. There are only a few types of breakeven prices that can be compared without the interpretation of their occurrence and ramifications. The External Breakeven Price for oil-producing countries is the one breakeven price that is specifically designed to be similar. Also, the Regional Breakeven Price of US shale oil is comparable to a high degree because it reflects a localized industry. The Technical Breakeven Price is comparable as well as it reflects the technological expenditures in certain geographic areas. The International Company Breakeven Price, as well as the Individual Breakeven Price for national oil companies, cannot be directly compared as other factors influence the performance of each company. These breakeven prices provide a reliable indicator of the profitability of a company.
The breakeven price provides one of the most useful tools for investors and geopolitical analysts. For the investor, the breakeven price of a company provides profitability information. This is true for small oil businesses in the US shale oil industry. For international companies, the breakeven price represents only one variable amongst other factors. Some of these other factors include proven oil reserves, investments in new wells and technologies and broad positioning in all industries of energy and petrochemicals production. The rule of thumb dictates that the lower the oil price, the more important a company’s breakeven price. The knowledge of the breakeven price along with all types of breakeven prices, as well as the breakeven price for major oil-producers provides a good indicator for the real global price for oil.
For the political analyst, the Fiscal and External Breakeven Price is an important tool to assess the political stability of a country. The high Fiscal or External Breakeven Price is a reliable indicator of high dependence on oil revenues and low political maturity of a country. More importantly, in times of low oil prices, the breakeven price for a country indicates the likelihood of a government being overthrown, the possibility of a civil war or even the possibility of international conflicts.