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 February 21, 2012
The Cost of $100 Crude

 Saudi Oil Minister Ali Al-Naimi's statement in mid-January that $100 constitutes a "fair" price for a barrel of crude appears to have been met with uncharacteristic agreement across OPEC member states. In an interview with Austrian newspaper Kurier at the end of the month, OPEC Secretary General Abdalla Salem al-Badri went so far as to declare that "$100 a barrel doesn't hurt the world economy at all." As oil consuming nations struggle to climb out of global recession, does $100 per barrel constitute a reasonable price? Not likely.

At the outset, one might question Mr. Al-Naimi's methodology, given that just one year earlier he cited $75 per barrel as a fair price. And in 2007, when the global economy was seen as comparatively crisis free, he and other Saudi officials targeted the "fair" price of $50 per barrel. Both market demand and levels of oil investments fail to accurately explain the drastic changes in attitude over what constitutes a "fair price." Recession has, at least in the short term, stalled growth projections for global oil demand, and Saudi Aramco's planned investment in upstream and downstream projects over the next five years is down nearly 40 percent from late-1990s levels. Does Saudi Arabia's decision to slow oil infrastructure investment correspond to its changing conception of a "fair" price?

A reevaluation of how to define "fairness" seems a needed corrective during today's economic perils for both exporting and importing countries:

Exporters

Oil producing countries tend to seek maximum revenues from the highest oil price that consumers are willing to pay. However, there are two considerations on the producers' side that should drive down the ideal price. The first consideration is that although oil demand is relatively inelastic in the short-term, it is elastic over long periods of sustained high prices; primary exporters have an interest in preventing a shrinking market marked by either a decline in purchasing power or a secular rise in the viability of substitutions. Earlier this month the IEA cut its global oil demand forecast by 200,000 to 90 million barrels a day, and the long term picture is that efficiency gains and new drilling are going to dramatically change the US oil import picture.

The second consideration is the resource curse aspect of massive petrodollar inflows, which tend to drive the rapid appreciation of property and stock values, as well as the accumulation of nonoil spending deficits underscored by inflated subsidies and public spending commitments. Take Saudi Arabia: against the backdrop of a 30 percent YoY spending increase in 2011, the country's nonoil deficit has spiked to an estimated 80 percent from 20 percent in 2002. When the price of oil starts to decline, however, credit bubbles crash. As the periods of steep declines in real GDP per capita in various Gulf States since the 1980s illustrate, this kind of volatility can damage exporting economies for years.

Importers

Historical evidence points to the fact that high oil prices have preceded every major global recession since OPEC's inception. Weak recovery of a fragile global economy is in nobody's interest, politically or economically. Global growth will decline 13.5 percent YoY in 2012 from 2011. Also, a major indicator of the strain that oil price places on a national economy is the ratio of the country's oil import bill to its GDP. In less developed countries, this ratio jumped from around 4.5 percent in 2010 to an estimated 5.5 percent in 2011. Given that 1 billion people live without access to modern fuel services, an oil price which contributes to a crisis of poverty across the developing world is clearly too high. OPEC nations understand the criticality of the link between poverty and fuel costs, as they themselves subsidize fuel prices for their own populations.

In light of these constraints, then, where does a "fair" price sit? The enormous oil revenues that enable the military spending sprees we have seen recently across the Middle East may signal to onlookers that in terms of the price of oil, OPEC member governments' interests are fundamentally at odds with those of the rest of the world; in some cases, these interests may even be at odds with those of their own populations. The statistics on how many times the products of military purchases have been unleashed on citizens of oil states are telling. Oil states are 94 percent more likely to engage as aggressors in international military conflict than non-oil states; the rate of civil conflict in these states is even higher.

Saudi Arabia does not currently have the capacity to absorb into its economy the nearly $150 billion in off-budget revenues (which rose by nearly 50 percent YoY from the previous year) that the average $100 per barrel light sweet crude in 2011 generated. Besides, the extra income is eliminating instability on neither a regional scale, where conflicts between neighbors are escalating in intensity, nor even on its own shores. In fact, some of OPEC's rising revenues are simply being channeled to bail out failing economies in the MENA region and even potentially in Europe. If higher oil prices that amplify the economic hardships of consuming nations are not contributing to greater security and improved quality of life for the populations of OPEC countries, then to whom is $100 oil "fair?"