In recent months a great deal of debate has taken place about the way in which oil exporting economies have been affected by the price drop of the barrel of oil. Few details appeared, however, about the actual effects on the incomes of the states whose budgets depend largely on oil exports.
In order to explain the phenomena I will use two examples which I consider to have a greater relevance for us: Russia and Saudi Arabia. I will also talk a bit about Romania, in order to explain why the price drop had little to no effect in our country.
Most of the time, when the media reports a drop in the price of the barrel it does so in a way that gives hope to people that gas prices will drop significantly. That happens because it rarely takes into account the production cost of the barrel, limiting to simply weighting its price against the price at the pump.
What is the production cost?
In short, the production cost is the combined cost of exploration and extraction. This cost compounds a very high proportion of the total price that consumers pay at the pump. To it are added taxes imposed by the government, transit fees and refining costs.
Which factors influence the production cost?
- Demand and production – even though the trend on the long run is that of a lower oil consumption, for now at least there is plenty of demand. Therefore, we can rule out this factor from the start;
- Geography – this is probably the most important factor since it infleunces the weather and often it’s also a determining element for the occurence of conflicts or of political instability. In principle though, the closer the oil is to the Poles, the higher the production costs will be;
- The geological structure – the soil composition is also very important. The more difficult the process of exploration and extraction, the higher the production cost will be;
- The weather – the colder it is, the more difficult the exploration process is. The same applies to the extraction process;
- Political stability & conflict – something that the Romanian political class still refuses to understand is that a stable political environment is essential for the proper conduct of business.
The Russian Federation
According to the US Energy Information Administration Russia is the second largest natural gas producer and the third largest producer of oil in the world. As impressive as that may sound, in reality though 52% of its budget revenues depend on the exports of energy resources. And over 70% of the exported resources consist of oil and gas – of which 80% oil –. In total, 30% of the total state budget is supported by oil exports. By 2014 Russia earned about $440 billion dollars from the export of energy.
In the language of the common man this translates into underdevelopment. Until the escalation of the Ukrainian crisis, until the enforcement of economic sanctions and the decrease in the price per barrel, this underdevelopment did not have very visible effects on the Russian economy. On the contrary, the perception of Russia was one of a continuously asertive state with a growing force not just in its sphere of influence, but also in Europe.
In 2011 Russia was earning $100- $110 per barrel, which in turn contributed significantly to the Krelmin’s coffers and to the formation of a financial reserve of about $500 billion – now it has about $400 billion -. The $100- $110 price per Russian barrel was much higher than the barrel of Saudi barrel for example. The difference between the two can be explained by the higher expenses that Russian operators support with the process of exploration, extraction and with taxes.
In 2013, a more or less private operator from the $100 it gained per barrel around $71 covered the exploration and extraction processes, but especially on taxes. Taxes represented almost 2/3 of this amount. At the end the operators remained with about $22- $24, with which to pay wages, rents and whatever debts they had. It was only after that that then registered their profit.
With the barrel having reached $45 the Russians now find it difficult to balance their budget revenues. For that to be possible the price per barrel should be of at least $100. So Russia is in a very delicate situation because it means that the oil they produce is sold mostly at a loss. In November 2014 they did lower a part of their taxes, but this measure is not sufficient to solve the problem.
Given this context, it is surprising that, although their main source of income has almost completely disappeared, the Kremlin recently reduced the budgets of all economic sectors, but not to the military sector as well. On the contrary, that one was enlarged, despite the economic problems that they currently have and despite the fact that the future does not look very promising either. This decision clearly shows a trend on behalf of Russia, which no doubt will translate in improved military capabilities and very likely, in more aggressive actions. From this regard the Russian Federation is repeating the experience of the Soviet Union. The result became visible in 1991.
Saudi Arabia holds 16% of the world’s proven oil reserves, it’s the largest oil exporter and it has the largest crude oil production capacity in the world. Approximately 89% of the state budget comes from oil exports, thus the dependence rate on energy exports is significantly higher than that of Russia. When the barrel was sold at around $106 the Saudis were able to create a budget of nearly $740 billion.
At a price of $45 per barrel the calculation for Saudi Arabia is simple: according to some sources the production costs of the Saudi oil is somewhere around $16 – according to other sources, it might even be around $6- $7 -. The reasons why the production cost are so low are related to geography, to the way in which the resources are distributed, but also due to the higher temperatures. If we are to take into consideration the figure of $16 than we can conclude that the Saudis still have a profit of about $28 per barrel. This may not be enough to cover all the expenses of the state, such as the education subsidies, the low price of energy, the palace budget, the expenses of the royals and many other expenses for which it is estimated that a price of $86 per barrel would be needed.
That does not mean that Saudi Arabia will go bankrupt just because it no longer earns $106 per barrel, only that it will be harder for them to finance all the overt and covert activities in which they are involved both externally, as well as internally.
Romania has the forth oil reserve in Europe – somewhere around 600 million barrels of oil –. It also produces some surplus oil – which it exports -, but that does not bring a substantial revenue to the state budget.
It is interesting to note that in Romania the production costs for one barrel of oil are unknown. Or, to put it another way: it is not publicly known. It’s most certainly known by the operators, but there is nothing that forces them to make that information public. If however, we are to speculate a bit by taking into account what we do know, such as the geographical location, the remaining reserves, the refining capacity and the production costs in countries similarly located, then we could assume that the production cost is somewhere between $30-$40. To this price, if we add taxes and the corporate greed then we can understand why the gasoline prices have remained high in Romania, regardless if the price per barrel is $45 or $110.
It’s highly unlikely that the oil prices will reach the level where they were before…at least not too soon. For Russia this means a long and painful effort to support its own economic backwardness, which it never wanted to leave behind. For Saudi Arabia it means mostly the same thing, although it will probably not be affected as Russia due to the very low production cost of its oil. Romania could gain from all this more from a geopolitical perspective than from an economic one. That’s because an economically weakened Russia for Romania means (or it should mean) a greater internal security and a greater ability to project power – especially soft power – outside its borders. And I am particarly referring to the Republic of Moldova.