The Pandemic Depression
The Global Economy Will Never Be the Same
Last year, it was nearly impossible to miss headlines proclaiming the United States’ coming energy windfall. According to the U.S. International Energy Agency’s latest forecast, thanks to booming output from shale gas formations, the United States will be nearly energy self-sufficient by 2015, surpassing both Russia and Saudi Arabia in energy production. All this might seem like bad news for Saudi Arabia, which could see its regional and economic influence wane and its decades-long economic boom come to an end.
But the shale oil bonanza in the United States is actually a good thing for Riyadh. Over the last few decades, oil markets have experienced sharp price fluctuations, particularly with growing demand for oil in the emerging Asian economies. Oil is Saudi Arabia’s main source of revenue, so any price swings create big risks for the kingdom. Unpredictable oil prices and a collapse in revenues in the 1980s and 1990s made Saudi Arabia particularly wary of uncertainty. Over the next few years, the increase in energy production in far-flung locations and diverse sources, including from shale, will help mitigate those swings. Eventually, increased supply will also help create stable new price floor for oil, which is now estimated to cost around $80 per barrel.
At the same time, Saudi Arabia has little reason to worry about its position as the world’s supplier of last resort. Historically, Saudi Arabia has maintained more than half of the world’s spare capacity, even if markets did not put it to use all the time. In the future, too, its more than two million barrels of oil reserves will prove crucial whenever a supply crisis erupts. Markets that have traditionally relied on Saudi Arabia will continue to do so; and no other country is likely to be able to ramp up production capacity enough to amass such a large reserve, especially since more than a few of them have outsized domestic demand that they will struggle to meet.
Since demand for oil is set to grow, Riyadh does not see U.S. shale oil production as competition. Asia’s demand for oil will soar over the next two decades. According to the Energy Information Agency, from 2010 to 2040, demand from countries that are not members of the Organization for Economic Cooperation and Development will increase by 19.3 million barrels. And between 2011 and 2030, China alone will increase its oil consumption by as much as 66 percent and India by more than 100 percent. Further, according to the U.S. Department of Energy, it will take decades for the United States to achieve total energy independence -- if it ever does. Because of all that, the demand for Saudi energy exports is set to grow.
In the longer term, of course, the United States is not the only country that is looking to ramp up unconventional gas production. For now, though, the conditions that supported the United States’ shale boom are missing in Europe and Asia. Outside of North America, national governments retain most mineral rights, which discourages private-sector involvement and entrepreneurship. In general, these countries also levy heavier taxes on oil and gas profits than does the United States, which holds back new research and production. And access to the water needed to mine unconventional gas is a concern for all. But with enough time, the proper policies, and new technologies, scores of other countries could experience gas booms of their own. China has the largest known shale gas reserves, estimated at 1,115 trillion cubic feet. Argentina, at 802 trillion cubic feet, comes next. In terms of shale oil, Russia tops the list with about 75 billion barrels. Australia, Poland, and Algeria also have huge reserves. Luckily for Saudi Arabia, all this extra production is a long way off and, before it comes online, demand will continue to climb.
Of course, that does not mean that Riyadh has nothing to fear. Namely, it worries that Iraqi, Libyan, and Iranian oil production will swing upward, and that those countries will increase the amount of oil they supply to global markets. That will drive prices down as the kingdom’s domestic appetite for oil continues to grow, limiting the amount the country has for export.
Iraqi output in particular is soaring. The country is on track to produce some three million barrels a day on average this year -- its highest sustained level in two decades. Baghdad intends to raise crude output to nine million barrels a day and export capacity to 7.5 million barrels a day by 2020. Libya could potentially ramp up production as well. Although its oil output is still being held hostage to political unrest, the government has planned to produce around 1.2 million barrels over the medium term. Finally, sanctions-crippled Iran could resume exports at some point. Because a final deal on Iran’s nuclear program is still a ways off, Iranian crude output is unlikely to reach its pre-2012 level of 3.6 million barrels per day in the near future. The country will have a hard time overcoming existing sanctions and technical hurdles to restarting production. But if the West does eventually lift all of the sanctions, Iranian oil will flood the market. It is for this reason that Western oil companies have already started courting Iran, and vice versa.
Additional oil supply from Iraq, Iran, and Libya could change the world’s energy map. The export capacity of these countries would be of a different order of magnitude from that of the United States. As Iran and Iraq, two of OPEC’s founding members, increase production, other members of the organization will have to curtail their own production to maintain quotas. Saudi Arabia would be the most likely candidate. Moreover, geopolitical differences and regional grievances make the effect of a marginal barrel of oil from Iran and Iraq more unpredictable in the eyes of Riyadh than additional oil supplies from the United States.
Even more worrying for Saudi Arabia is the country’s growing domestic consumption of oil, which is currently estimated to be 24 percent of its total annual production. The kingdom uses oil and its derivatives for about half of its electricity production, which, at peak rates, is growing by about seven percent a year. By the late 2020s, Saudi Arabia will consume more oil than it exports. Domestic energy prices are heavily subsidized, which dampens the efficient allocation of resources. They weigh on the government’s budget and encourage capital-intensive industries to the detriment of employment-intensive activities. If consumption continues apace, Saudi Arabia could eat all of its extra oil capacity and, consequently, lose its role as oil-market bulwark.
The situation will become even more dangerous as a larger global energy supply puts downward pressure on prices. It is no secret that the oil market is the main source of political risk for Saudi Arabia. But for now, large buffers provide ample fiscal breathing room. Saudi Arabia’s foreign assets are about the size of its 2013 GDP -- $745 billion -- and its public-debt-to-GDP ratio is among the world’s lowest -- 2.6 percent. The country can withstand any price shock that is not sustained over long periods (but even the short dive in oil prices in 2009 to $33 per barrel was uncomfortable). And Riyadh is mindful of the direction of oil prices. Not long ago, the break-even price for Saudi Arabia’s finances was $40 per barrel; today, it is around $90 per barrel, assuming production at 9.5 million barrels per day.
The world is in the middle of a shale oil revolution, and exuberant commentary about the United States’ looming oil independence has become increasingly common. It is easy to go from mindless jabbering about oil scarcity and peak oil to chatter about oil plenty. The truth lies somewhere in the middle. Hydraulic fracturing is revolutionizing the energy map in North America and has the potential to do the same elsewhere if governments offer the right incentives. Riyadh does not stand to lose much, but it cannot brush aside the possibility that Iraq, Iran, and Libya will become much bigger suppliers. For Saudi Arabia, domestic energy consumption is the only variable it can control. It needs to get that right to maintain its role as a stabilizing force in global oil markets. Though Saudi Arabia’s position remains strong, nothing lasts forever.