How do oil producers balance their books?

The prices at which the governments of oil-producing countries balance their budgets – known as fiscal break-even prices – are looked at closely as one important metric by which to assess a state’s fiscal vulnerability to oil price swings. In theory at least, if the break-even price is higher than the market price, the budget cannot be balanced.

For Opec nations such as Saudi Arabia, Iran, Iraq and Kuwait, fluctuations of their break-even prices are also an indication as to what is the desired oil price for the cartel overall. This may give oil-market watchers a sense of these countries’ appetite to raise and lower production to influence prices.

For example, the recent drop in the price of oil has spurred chatter about whether Opec nations will make cuts to supply in defence of higher oil prices.

Break-even oil prices are created through a complicated combination of the following variables: oil production costs, population size, domestic demand for petroleum products, how much the country produces and exports, royalties and taxes, exchange rates, non-oil revenue as well as government expenses.

Their range gives us a sense of each country’s fiscal strength. While stronger economies such as Saudi Arabia and Kuwait have lower break evens, weaker nations such as Iran and Venezuela have much higher ones.

Although the break-even price can reflect the strength of an economy, a higher break-even price in a low market price environment does not necessarily equate to serious financial strain. There are a number of measures countries can implement if prices fall below the theoretical break-even.

Foreign exchange reserves – Saudi Arabia has a $750bn war chest – and sovereign wealth funds can provide a useful financial buffer. Nations with low public debt can also borrow more. Finally, governments can raise domestic oil prices to increase their revenues. This is not to say that oil exporters will not feel the pressure of lower oil prices at all.

But break-even prices should not be interpreted on their own to understand what actions a country may take in response to lower market prices. Governments are often opaque on the details, making it difficult to assess what a country’s realised revenues are, how this money is being spent and how vulnerable it is to price plunges.

In the context of Opec, the extent to which a country is able to cut production is unclear. As a result, it is tough to draw a direct link between what break-even prices show and how the cartel will respond to price movements.