THE HIGHLIGHT OF a trip to the vast Shaybah oil field in Saudi Arabia’s “empty quarter” is a stroll at dusk to the top of a range of silky sand dunes. There you can watch the sun set over the pride of the Saudi petroleum industry as a muezzin in the mosque below strikes up a call to prayer. Unfortunately, executives from Saudi Aramco, the state oil company, challenged your correspondent to a running race. By the time he reached the top, he was coughing so badly that he missed the sunset; and the banter drowned out the muezzin. “If only we could turn this sand into silicon for solar panels,” one joked. “We’d be rich.”
Like many petrostates, Saudi Arabia, the world’s biggest oil exporter, is aware that demand for petroleum may one day fall victim to solar panels, electric vehicles, more frugal consumption and so on. But how seriously do the big oil producers take the threat? The answer comes in two parts. The first concerns their response to the recent onslaught of American shale production. The second is about their reaction to the prospect of “peak oil” (the beginning of the end of the world’s addiction to oil) over the next few decades. For now, the former appears to carry far more weight than the latter, even though peak oil may eventually cause what some call “the mother of all oil crises”.
Start with the impact of shale. The galloping rise in American oil production up to 2014 caught many traditional oil producers off guard and contributed to a rapid increase in global oil stocks to unsustainably high levels. The subsequent oil-price crash clobbered oil-producing countries that had been spending lavishly on social programmes. They acted swiftly.
A reeling Saudi Arabia unveiled a plan to sell off 5% of the world’s biggest oil company, Saudi Aramco, to raise $2trn for the country’s public-investment fund. This is part of the kingdom’s so-called Vision 2030 strategy, designed by Mohammad bin Salman, the crown prince, to reduce the country’s dependence on oil and diversify the economy to provide new sorts of jobs for a young population. But in the absence of high oil prices it is unlikely to raise anything like the sums he wants.
In late 2016 OPEC and non-OPEC producers, led by Saudi Arabia and Russia, agreed to curtail production by a combined 1.8m barrels a day (or about 2% of global output) to push up prices. So far the plan has not only worked, it has set the stage for an “axis of love” between Russia’s president, Vladimir Putin, and Prince Mohammad. Despite their support for opposite sides in the Syrian civil war, and despite Russia’s long-standing friendship with Iran, they now talk of developing long-term joint projects, especially involving Russian natural gas.
Whether they are seriously preparing for the longer-term threat—of falling oil demand as the world switches to electric vehicles—is harder to answer. Publicly, leaders of Saudi Arabia and Russia dismiss the risk that demand will collapse. They predict that cars, trucks and planes will still consume growing amounts of fuel into the middle of this century, and that plastics and petrochemicals will still use a lot of oil. But some observers think that concern about peak oil is leading them to hedge their bets and may be one reason the Saudis are selling off part of Aramco.
Drill, habibi, drill
What should petrostates do about output if oil demand ebbs? In theory they should pump as hard as possible now so they can bank the money while they can. But that would set off a battle for market share among producers which would drive down oil prices further. Those with the lowest costs, such as Saudi Arabia, which can produce oil for as little as $6 a barrel, might feel that this is a fight they are bound to win.
However, a paper published in January by Spencer Dale of BP and Bassam Fattouh of the Oxford Institute for Energy Studies casts doubt on this idea. It argues that Middle Eastern oil producers should focus not on the cost of extraction but on the “social cost” of oil: their spending on social commitments such as health care, education and public-sector employment. The authors use the oil price needed to achieve balanced budgets as a rough proxy. This is close to $60 a barrel. Mssrs Dale and Fattouh argue that until such countries can shift their economies away from oil, they will need to cover these social costs. So instead of fighting each other for market share, they will seek to maintain long-term alliances, such as the current OPEC-plus arrangement. Yet in the past such pacts have always unravelled because of cheating on quotas. And investors in Aramco might balk at sacrificing short-term revenues for long-term strategic objectives. So perhaps the Aramco IPO will be the high-water mark of Saudi Arabia’s co
If the producers are not able to control the market, reform will become more urgent. But it will be tough. Saudi Arabia’s Vision 2030 depends almost exclusively on the will of the young crown prince, who has ripped up a long-established model of rule by consensus, with unpredictable consequences. His sense of urgency is not matched by experience, and progress is patchy. Saudi Aramco is taking longer to list than planned.
Other Middle Eastern producers, such as the United Arab Emirates, are also hedging their bets, talking up clean energy but also reaffirming their commitment to using fossil fuels for half their energy needs until at least 2050. Like Saudi Arabia, they are blessed not just with oil but with sun and space, which offer ideal conditions both for large solar-photovoltaic parks, which harvest the sun during daylight hours, and concentrated solar plants, which store the heat generated by the sun in molten salt and release it as electricity at any hour of day or night. But at present Middle Eastern oil producers see renewable energy mainly as a way to use less oil and gas at home so they have more of it available for export. They do not consider clean energy to be an existential threat.
As for Russia, it appears to be even blinder to the prospect of the energy transition. It has given short shrift to renewables. Beyond oil and gas, most of its attention is on nuclear energy. And it is still betting heavily on oil. Partly thanks to global warming, last year it started drilling in the Laptev Sea, in the Arctic Circle, despite low prices and semi-frozen terrain that would put off most Western oil companies.
The wild card for petro-producers is what happens to demand for oil and gas in the developing world, particularly in China. Last year China overtook America to become the world’s largest oil importer, and those imports are forecast to continue growing rapidly for at least a decade. At least for now, China’s energy relationship with the Middle East and Russia is likely to become closer. State companies from all three regions are investing in each other’s assets. Chinese funding has helped Russia finance drilling projects, despite Western sanctions. The same may happen with Iranian gas. Saudi Aramco has invested in a refinery in China’s Fujian province. Russia has offered to sell Arctic gas to Saudi Arabia.
The end of oil will not be linear. If oil prices slump, electric vehicles may look less attractive. Concerns about over-investment in oil may produce unexpected price spikes. But if the producers do not embrace economic reform, they could find themselves in deep trouble very quickly. They need only look at Venezuela to see how rapidly falling oil revenues can force an autocratic state to break its bargain with the people, leading to economic turmoil, social instability and regional tension.