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Friday’s meeting of the Organization of Oil Producing Countries (OPEC) marks the one-year anniversary of the group’s now infamous decision to sit still as oil prices collapsed. The plunge, which took crude prices from a June 2014 high of $112 per barrel to an August 2015 low of $47 per barrel, set off wide speculation about which countries might face political instability or geopolitical pressure as their oil revenues ran dry. Central to much of that discussion was the concept of a break-even oil price—the price of oil at which an exporting country would be able to balance its budget. Breach the break even, the theory went, and all hell might break loose; governments of oil exporting countries would be forced to slash spending, crank up taxes, and even default on their debt, all sharply raising the risk of social and political unrest.
A year later, little of this has come to pass. Oil exporters no doubt face large new challenges. But even as oil prices have remained far below the break-even points of many oil-exporting countries, oil-dependent regimes from Saudi Arabia to Russia have weathered the storm fairly well. Why were analysts so wrong?
My Council on Foreign Relations colleague Blake Clayton and I recently concluded a study on the use and abuse of fiscal break-even prices in geopolitical analysis. Our findings help explain why the geopolitical results of the oil price plunge have so wildly defied expectations.
Perhaps the biggest blind spot in break-even analysis is countries’ fiscal reserves—the cash or other savings stored up in good times that provide a buffer in leaner ones. Those reserves are a significant factor in the economic health of wealthier Gulf countries, particularly Saudi Arabia. For 2015, the International Monetary Fund estimated that the kingdom’s fiscal-even oil price was $106.50 per barrel. With oil now less than half that, Saudi Arabia is running a deficit. But the country also has approximately $647 billion in the bank. In fact, it could run its current deficit for roughly four more years and still be in the black—and, even then, might be able to borrow money to sustain deficits even longer. That is just what Riyadh did that after the 1986 oil price crash, relying on savings and international borrowing to finance deficits in 16 out of 20 years between 1986 and 2005.
Fiscal break-even prices are also moving targets. They are particularly apt to shift when oil market conditions are tough. According to the most recent IMF estimate, Kuwait’s fiscal break-even oil price will fall from $57 per barrel in 2014—above the average price of oil this year—to $47 per barrel in 2015. That is low enough for Kuwait to still post a budgetary surplus for this calendar year, despite currently running a deficit. The lower fiscal break even was achieved through modest policy adjustments in response to market developments. Those steps, including cutting energy subsidies, were not politically toxic.
Flexible exchange rates provide another buffer. Russia is a recent example. Between June 2014 and January 2015, global oil prices dropped 57 percent, but the ruble (itself under pressure from the oil price plunge) also fell precipitously. As a result, the fall in dollar-denominated oil prices translated into a much smaller decline in Russia’s ruble-denominated oil revenues. It therefore damaged Moscow’s budgetary balance much less than expected (since most state expenses are set in rubles).
And then there is the opacity and uncertainty of break-even estimates themselves. Our study systemically examined the IMF’s estimates to date, the first of which were published in 2008. Although experts widely and rightly agree that the IMF’s figures are among the best available estimates, we found that even these predictions change dramatically over time. Predictions made a year in advance of a given fiscal year were often as much as 20 percent higher or lower than break-even figures calculated in retrospect. For example, from May 2013 to October 2015, the IMF’s estimate of Iran’s 2014 fiscal break-even price dropped from $143 to $94.20. Such variation is the result of many factors, often beyond the control of the teams that estimate the figures, including changes in oil production and exports, government spending surprises, changes in non-oil revenue sources, and unexpected sovereign wealth fund returns. But those who publish fiscal break-even oil prices rarely highlight these uncertainties. As a result, analysts treat the estimates as far more reliable than they actually are.
To be sure, fiscal break-even oil prices have a place in geopolitical analysis. Budget deficits often have political ramifications, even when they don’t prompt radical policy change or bankruptcy, because they can signal weakness to geopolitical rivals and provide ammunition to a ruling government’s domestic opponents. The pitfalls that our study outlines, however, make it clear that break evens alone are insufficient. They must be complemented with a broader suite of indicators that provide a more comprehensive sense of oil producers’ fiscal positions.
More broadly, failure to correctly anticipate the geopolitical implications of the oil price collapse points to the dangers of oversimplifying economics for the purposes of geopolitical argument. Economics and geopolitics are increasingly intertwined. Simple analytical tools such as fiscal break evens can provide great value if they help translate economic insights into a form that makes them useful to non-economists who are grappling with national security questions. But when the simplifications go too far, or are used carelessly, they induce false confidence rather than actually strengthen analysts’ hands. As the OPEC meets this week to kick off year two of what appears to be a new era for oil, security strategists grappling with its consequences would be wise to keep that lesson in mind.