Fiscal and external breakeven oil prices are broken concepts (and how to fix them)

Estimates of the fiscal and external breakeven oil prices are used to assess the financial vulnerability and sovereign credit risk of oil exporting nations. However, the prevailing treatment of these concepts, pioneered by the IMF, is inconsistent with economic reasoning and provides a misleading signal of financial risk. We show that the prevailing method systematically overstates the fiscal risk facing small producers who take the price as given. We develop a case study with Angola. For larger producers, including members of OPEC+, the error typically overstates financial risk, as in the case of Saudi Arabia, for which we provide a detailed analysis. We explain and correct these misconceptions by developing a proper, robust, and practicable approach that includes closed-form formulas for true fiscal and external breakeven oil prices that are consistent with market equilibrium conditions. The true fiscal (external) breakeven price is determined by the largest demand shock that the government budget (current account) can withstand. Our approach produces not only the true breakeven price but also the size and likelihood of market disruptions that would threaten a country's ability to break even. Based on its projected 2023 budget, Saudi Arabia's true fiscal breakeven price was $7.16/barrel lower than calculated by the prevailing method. To force the country into a public deficit, assuming fixed government expenditures, would have required a negative demand shock greater than 3.5 million barrels/day, the probability of which we estimate to have been less than 2%.