What is going on in the oil industry?
The price of oil has cratered. In 2012 it was over $120 a barrel. Today, 2016, it is at $42 a barrel, and this is an improvement from January and February of this year when it went under $30 a barrel.
Previously, when the price of oil fell, OPEC would meet, they’d agree to cut the output, and the constrained supply would ensure the price would rise once more. Why isn’t that happening now?
Most commentators are putting it down to the fact that Iran, who were under sanctions until very recently, understandably don’t want to cut production, and with Iran not cutting back, Saudi Arabia won’t either.
However, there’s another thesis which I think is more likely, and if true, oil prices will remain low for the foreseeable future. That thesis states that Saudi Arabia has realised that we are at the end of the Oil Age, and that a large percentage of the world’s fossil fuel resources will have to remain in the ground. With this in mind, it makes sense for Saudi Arabia to make sure they can extract, and monetise as much of their fossil fuel resources, as possible, while they still can.
What is the evidence for this?
First off, consider that last Friday 170+ countries signed the Paris Climate Accord whose aim to to limit global warming to 1.5-2C. Now that we have an upper limit on the temperature increase we are willing to accept, we also know how much CO2 we need to put into the atmosphere to achieve this amount of warming. It comes in at 1,100Gt CO2 [PDF] (1Gt = 1 gigaton = 1 billion tons).
On the other hand, the total proven reserves of the fossil fuel companies, and countries comes to 3,300Gt CO2. Notice the problem? 70-80% of the world’s proven reserves of fossil fuels will have to stay in the ground if we are to keep global warming below 2C.
Now Saudi Arabia has known about this issue for quite some time. As far back as the year 2000, Sheikh Yamani famously predicted that
Thirty years from now there will be a huge amount of oil – and no buyers. Oil will be left in the ground. The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.
In fairness Sheikh Yamani’s reasoning didn’t have to do with climate change, but better drilling and exploration technologies, but still it has come to pass, and in this scenario Saudi Arabia has to race to produce as much oil as it can, no matter what the price, so as little Saudi oil as possible is left in the ground. Consequently Saudi Arabia is now producing somewhere between 10.3m-11m barrels per day – an historic high.
And then at last week’s OPEC meeting in Doha to try to stabilise oil production, Saudi Arabia scuppered the talks, ensuring no freezing of oil outputs. This has the added advantage of squeezing the other producers, few of whom can produce oil at the same low cost as Saudi Arabia.
On the demand side, the International Energy Agency (IEA) has admitted that for 2016 global demand trends are not as positive as they were. The IEA is counting on demand from developing countries where India recently announced that it is going to install 100GW of solar by 2022 (in large part because solar is now cheaper in India than coal), while China is aiming to increase its installed solar by over 100GW by 2020.
And if news of the 400,000 orders for the Tesla Model 3 are anything to go by, there is no love amongst consumers for fossil fuel spewing vehicles.
Then yesterday comes the announcement that the Saudi cabinet approved a set of reforms aimed at moving the country away from its dependence on oil profits. They have seen the writing on the wall, and so while on the one hand they are going all out to maximise the amount of oil they can extract and sell, they are at the same time setting up a sovereign wealth fund of $2tn to ensure they, in the words of Deputy Crown Prince Mohammed bin Salman
can live without oil by 2020
So, with Saudi Arabia diversifying away from oil revenues, and unlikely to reduce output any time soon, there is no obvious reason why oil prices will ever rise again. And Sheikh Yamani’s prediction about a huge amount of oil being left in the ground will come to pass.
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