A simple break-even oil price: real life is more complicated than that

A simple number that apparently explains everything is always welcome to economists, politicians and commentators. The break-even oil price has taken on that status, illuminating countries’ budgets, OPEC policy and economic diversification efforts. But real life is more complicated.

The concept is straightforward enough. For nations which rely mostly on petroleum exports to fund their spending, what level of oil price allows them to run a balanced budget? Or, at what oil price would they have a balanced current account, that is, not returning an external payment deficit or surplus?

IMF estimates

The International Monetary Fund provides estimates. Brent crude, the main international benchmark, closed last week at $73.87 per barrel. In the Middle East and North Africa for 2024, budget break-evens range from Qatar’s $43 per barrel and the UAE’s $57, to $126 in Bahrain and Algeria. For the external balance, the UAE is best-placed at $36, while Iraq stands at $85.

The two are measuring different things, but are clearly related. High government spending will tend to suck in more imports and weaken the external balance. If a government runs deficits, it has to plug the gap by taking on debt or selling state assets.

If the country is in external deficit, it must borrow from abroad, draw down its foreign currency reserves, sell assets to foreigners, or attract more outside investment. This may put the domestic currency under pressure. If the exchange rate is fixed versus the dollar or other international currencies, as those in the GCC and Iraq are, it may come under pressure, forcing capital controls or devaluation.

Of course, a country does not collapse just because it runs a deficit. France has not recorded a budget surplus since 1974. The concern is, though, that oil exporters’ reliance on a single, volatile, finite resource makes them uniquely vulnerable.

Classical view of deficits

The classical view is that oil producers are depleting a fixed asset in the ground – their hydrocarbons – and should be converting that into other productive assets, not spending it on consumption. This is a concern for countries such as Oman, Bahrain and Algeria. Even in these cases, exploiting unconventional resources can extend production for decades.

For the biggest oil states, though, this idea of oil’s “running out” is not really true. Their hydrocarbon reserves are so large, production costs so low, and their output policies quite conservative, that they will not be depleted in a reasonable policy horizon.

The problem is more that oil and gas will eventually become obsolete – replaced by renewable or other energy sources, or by different user technologies such as electric vehicles. This may be in combination with climate policies that restrict the use of hydrocarbons or impose heavy charges.

Level of oil prices

The level of oil prices is clearly crucial. The International Energy Agency’s latest energy outlook foresees “more ample – or even surplus – supplies of oil and natural gas…implies downward pressure on prices”, says its Executive Director, Fatih Birol.

So observations that Saudi Arabia “needs” an oil price of, say, $90 per barrel does not mean that Riyadh will target such a price, or that it can achieve it, or that a certain price would deliver its budgetary needs – since cutting production too far to raise prices might reduce revenues overall.

The direction of travel says more than the specific break-even price. Iraq, for instance, has seen both budget and external break-evens soar since 2021. And not all spending is on the books. Oman has shifted debt to state-controlled corporate entities, while a Bloomberg estimate suggested that Saudi Arabia’s budget break-even of $96 per barrel, calculated by the IMF, swells to $112 per barrel when including the commitments of the Public Investment Fund.

Bahrain’s economy is quite diversified, with 85 per cent of GDP from non-hydrocarbon extraction, but its government budget is not, with 64 per cent coming from oil revenues. So the challenge is how to rebalance taxation appropriately towards the non-oil part of the economy, without harming competitiveness, triggering discontent, or hurting lower-income citizens.

The level of debt is also important: Saudi Arabia’s has grown from about 3% of gross domestic product (GDP) in the 2010s to 25% now, but that is still low compared to many developed countries with debt burdens exceeding 100% of GDP. It is forecast to remain below 35% by 2027. The large sovereign wealth funds in countries such as Qatar and the UAE are both a buffer against periods of lower oil prices, and a repository of funds for strategic investments in new economic sectors at home and abroad.

Non-oil sector growth

Growth of the non-oil sector broadens the potential tax base. Saudi non-oil budget revenues have more than doubled since 2016, mostly because of value-added tax (VAT), introduced at 5% in 2018 and raised to 15% from July 2020. Corporate and income taxes are also making a slow appearance in the Gulf Cooperation Council (GCC) states.

On the side of the external balance, foreign direct investment inflows into Saudi Arabia last year have just been revised up to 2.4% of GDP, making progress towards the Vision 2030 target of 5.7%.

Nevertheless, there remains a long way to go. A significant part of the “non-oil” economy in the big oil producers really represents taxation or dividends from activities financed by government oil revenues.

To illustrate the size of the task of economic diversification, if the planned city of Neom in Saudi Arabia’s north-west were to reach a GDP equal to Dubai’s today, that would still only amount to about 10% of the total Saudi economy currently. That would certainly be a very major contribution, but not transformational.

And the GCC countries face the challenge of competition – focusing in rather similar areas such as tourism, aviation, logistics and financial services.

There are many complexities and decision points on these paths. Running deficits today to finance economic transformation tomorrow is a good policy, if pursued well. Major oil exporters’ OPEC policy is not driven solely by the need to limit a deficit in the budget or external payments. Rather the opposite: in many countries, budgets tend to rise or fall to follow the oil price. So while break-even prices are an interesting and informative statistic, analysts should be cautious to take them seriously, but not literally.

• Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis