Is a crash in oil prices in the offing, and what would it mean for the Middle East?
In the West, 'energy crisis' conjures images of firebrand political leaders such as Hugo Chávez and Ayatollah Khomeini, families shivering in the dark, soaring petrol prices, and endless queues of cars waiting to fill up.
For oil-dependent economies, though, oil shocks come in reverse - the economic stagnation and political tensions brought by slumping prices. Such busts helped bring down the Shah of Iran, contributed to the collapse of the Soviet Union, and encouraged Saddam Hussein to invade Kuwait.
Is a crash in oil prices in the offing? And what would it mean for the Middle East?
Certainly the next decade looks tougher for oil-exporting countries than the last.
Developed economies' oil use will probably never repeat its 2005 peak, and is in long-term decline. Consumption will be kept down by ageing populations and a slow and painful recovery from the economic crisis. Transport use, the largest component of demand, is under pressure from growing efficiency under the influence of high prices, the US's tightening of mileage standards, environmental concerns and the gradual emergence of hybrid and electric vehicles.
The oil price surge last decade was driven by emerging economies, above all China, which overtook the US as the world's largest car market early in 2010. No doubt their growth will continue, but there are signs of over-heating in China, India and Brazil, and 'Dr Doom' Nouriel Roubini believes China has over-invested and is due for a crash. Due to its one-child policy, China will run into increasingly stiff demographic headwinds as its population ages, and even a slowdown in its breakneck growth to say, a still respectable six per cent annually, would take a bite out of oil demand.
On the supply side, non-Opec production is holding up better than many expected, stimulated by high prices and technological advances. The breakthrough in the USA in producing gas from shale rocks, via horizontal drilling and high-pressure hydraulic fracturing, has now spread to oil. Led by the Bakken Shale of North Dakota, shale oil output could reach 1.5-2.5 million barrels a day (b/d), larger than pre-war Libya.
Canada's oil sands continue to expand steadily, despite environmental opposition. And Brazil's massive deep offshore 'pre-salt' finds are now starting to come into production. Even in the apparently mature North Sea, Norway's production decline will be eased by its recent discovery of a one billion barrel field, one of the ten largest ever found in the country.
Saudi Arabia will also face new competition within Opec. With the fall of Tripoli, Libya will return, even if only gradually, and Angolan production still has room to rise. With president Chávez suffering from cancer, Venezuela may change course after the 2012 elections, investing in the heavy oil of the Orinoco Belt, recently certified as the world's largest reserves.
Most importantly, of course, is the vast potential of Iraq. No analyst believes it will reach the targeted 12 million bpd by 2017, and even Iraqi oil minister Abdul Karim Luaibi has backtracked from this recently - logistical and security challenges are too steep. But if Iraq got halfway to its goal, this would soak up more than half of global demand growth.
Saudi Arabia can defend prices by cutting production. But it faces a dilemma: apart from its Gulf allies Kuwait and the United Arab Emirates, most Opec members have tended to over-produce their quotas. A severe crisis might bring them back into line, but probably only for a short period. Then Saudi Arabia would be left absorbing most of the burden of defending an unrealistic price, as in the 1980s, when it came perilously close to exporting nothing at all.
This prediction of a decade of weaker prices depends, of course, on relative stability within the Middle East. One lesson of the Iranian Revolution, the Iran-Iraq War and the Iraqi invasion of Kuwait is that oil markets are, as George Soros might put it, reflexive. That is, political events trigger volatility in oil prices that then has a further effect on the oil producing states. The economic strains of low prices might induce renewed violence in Iraq or an uprising in a significant producer such as Algeria. Or, for instance, military conflict involving Iran might upset Gulf oil exports.
Even in the absence of such upheaval, a weaker oil market will strongly influence the course of Middle East political change in several ways.
In Libya and Iraq in particular, oil prices and recovery in production will determine how much money the government has to spend on the rebuilding of the country - and pose the difficult challenges of fair allocation, corruption and patronage.
Energy-poor states, such as Jordan, will be in the opposite situation - the country's import bill has soared in recent years, exacerbated by repeated attacks on its gas pipeline from Egypt. Lower oil prices could give welcome relief. But Jordan, Lebanon, Egypt and others will be hit by falls in remittances and investment from the Gulf.
And for modest hydrocarbon producers such as Egypt, Syria, Tunisia and Yemen, lower oil prices reduce revenue available to the government, but may also ease the burden of energy subsidies, and the high food prices that were a major contributor to inflation and revolution.
Two of the region's big geopolitical players may have less money to pursue their goals. Iran has taken a counter-revolutionary role in Syria, with a reported gift of $6 billion to Bashar Al Assad; Saudi Arabia likewise in Bahrain, Jordan and Oman, where it will meet the lion's share of more than $20 billion of Gulf Co-operation Council (GCC) aid. Yet both have historically tended to prioritise foreign policy objectives over spending money at home.
In recent years, all the major oil producers have allowed state spending to swell, increasing the break-even oil price required to balance their budgets. Even the head of the budget committee described Kuwait's expansionary spending plans in July as "crazy".
Saudi Arabia's break-even price, at $55 per barrel during the 2008 crash, is now around $85 per barrel, and forecast to increase to an improbable $320 by 2030. Though the current position is relatively comfortable, three intersecting trends identified by Saudi investment bank Jadwa threaten its long-term fiscal security.
In a weak and more competitive oil market, Riyadh will have to accept lower oil production, prices or both.
Soaring domestic consumption, fuelled by subsidies that fixed prices at $3 per barrel for power generation and $0.60 per gallon of gasoline, cuts into exports. The kingdom now burns up to 1.2 million barrels of oil per day to supply summer air-conditioning.
And domestic spending, flat since the last oil boom, has been rising by 10 per cent or more annually, boosted by King Abdullah's $130 billion of largesse, announced in February and March to head off discontent.
There is no immediate danger while oil prices remain high. The kingdom has virtually no debt and $562 billion of foreign assets.
But the experience of the last oil price cycle is likely to recur: under the strain of low oil prices, $180 billion of assets in 1980 had become $176 billion of debt by the end of 2002. This time, Jadwa foresees that the budget will be in deficit from 2014, the Saudi Arabian Monetary Authority will have drawn down its foreign assets by 2024 and, by 2030, Riyadh will be staggering under a severe debt load.
But the most vulnerable to a fall in oil prices is Iran. Since it enacted a radical subsidies reform package last December, its fiscal position is much improved, with a break-even oil price similar to Saudi Arabia's. But it does not have Saudi Arabia's massive savings. And unlike Iraq, its oil production, hampered by mismanagement and international sanctions, is slowly declining. Non-oil growth is feeble, with industries struggling under higher fuel bills, inflation over 20 per cent and unemployment high.
In the short term, Iran's squabbling political factions have always managed to hang together when the system is seriously threatened. The regime is likely to become yet more militarised and repressive. But under the strain of low oil prices and threadbare ideology, it might well experience a similar fate to the USSR's.
Iran has little opportunity to manage this situation within Opec. Its arch-enemy, Saudi Arabia, will not make things easy, while Iraq is likely to demand a quota at least at parity with Iran at around four million b/d. With no spare production capacity of its own, Iran cannot retaliate.
It may therefore seek to undermine Iraqi production by using its political influence there. Iran's eminence noir Qassem Suleimani, head of the elite Qods Force of the Sepah (Revolutionary Guard), already skilfully uses Iraqi clients to keep the vital Basra area in foment.
Of course, events in Saudi Arabia, Iran, Iraq and the rest of the region will have a further effect on energy prices which, though they may be lower, will still be volatile and unpredictable.
The MENA countries are thus faced with short- and long-term challenges more difficult than those of the last decade. People's expectations are higher, yet money is likely to be tighter. New governments in Egypt, Tunisia, Libya and elsewhere will be tested. And the GCC states will learn how successful their efforts to build diversified economies have truly been. The Middle East needs skilful policies to ensure that a fall in oil prices does not become a crisis.<
Robin M. Mills is a Dubai-based energy economist, and author of The Myth of the Oil Crisis and Capturing Carbon.
© The Gulf 2011
