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Only three years ago it was thought that Saudi Arabia - the largest oil exporter and second largest producer in the world - could generate large budget surpluses with oil at $70/barrel. In recent weeks, new estimates state that the country would need oil at $75/barrel just to balance the budget - never mind trying to post a budget surplus.

The country's oil minister has stated that the nation would work to stabilize prices at the $100/barrel level - which is a first. Saudi Arabia has traditionally held the role of OPEC moderate while Iran and Venezuela have been hawks who favor higher oil prices. Saudi Arabia has always balanced its need for oil revenues with the knowledge that if left unchecked, high oil prices have tended to precede recessions.

OPEC and Crude Oil Prices
click to enlarge

The reason for this change in policy would most likely be due to the country's response to the uprisings across the Middle East last year. Fearing unrest, the government of Saudi Arabia has unveiled a huge increase to public spending that totals almost $130 billion. The Saudi commitment to stabilizing oil in the $100/barrel range should serve as a wakeup call for consumers and investors alike.

The reason that Saudi Arabia's budget should matter is that as the nation spends money at a breathtaking clip, it will require higher oil prices to keep its budget from spilling large amounts of red ink. It is thought that, like last year, the nation will end up spending more money than the official budget calls for. Therefore, the world should not look to Saudi Arabia to use its powers of persuasion and size amongst its OPEC peers to reign in oil prices. In fact, the Institute of International Finance estimates that the break-even oil price for Saudi Arabia will move to $110 over the next three years.

Furthermore, as the chart shows, it is not just Saudi Arabia that needs high oil prices to meet its spending commitments. Russia needs prices of over $100/barrel to balance its budget. Together, Saudi Arabia and Russia account for a little over 20% of the world's oil production. Therefore, it would be hard to argue that these two major oil producers would be willing to bring down prices.

One unintended outcome of these budget constraints amongst the oil producing nations is that the longer oil prices stay elevated, the more the energy industry will spend to find new sources of oil. Improvements in drilling technology have allowed oil to be found at ever greater depths in the oceans and allowed parts of North America to become new and significant oil producers. For example, North Dakota now produces over 500,000 barrels daily and its production now surpasses that of OPEC member Ecuador.

For consumers this means that hope at the gas pumps will prove ill advised. For investors, this should mean that continued investment in the oil shale plays in Texas, North Dakota and other parts of North America should continue.

Source: OPEC Spending Putting A Floor Under Oil Prices