Valdai Club

As oil price continues to fall with Brent trading below $40 per barrel, concerns are growing that energy exporting countries may face disastrous economic and political consequences, while alternative energy projects may be abandoned.

In an interview with www.Valdaiclub.com, Urban Rusnák, Secretary General of the Energy Charter, explained the economics of the current slump, its global implications and suggested solutions to the seemingly imminent crisis.

The oil market has been moving towards significant oversupply for some time – at least since shortly after the global financial-economic crisis in 2008-09, when the shale revolution in the US started to have global impact. At the time, we were at the back end of an era of high oil prices which itself started at around the time of the US invasion of Iraq (although the oil price started rising gradually more due to spiraling growth-driven demand in Asia, rather than conflict in Iraq). The financial-economic crisis of 2008-09 was not quite ‘the straw that broke the camel’s back’ in terms of an oil price decline, since that decline proved to be relatively short lived.

The shale revolution, however, was a game changer and its impact on the international oil market has proven to be multiple. First, the US, which ranked with China as the world’s largest oil importer, started to import a lot less oil. The US, while not yet quite energy independent, imports around half as much oil today as it did five years ago. This creates a strong perception in the market that there is a lot less demand for oil at the global level. Second, not only is the US importing much less oil today than it was yesterday, but the market also appears to have bought – be it rumor or reality – the idea that the American government embargo on US oil exports, which has been in place since the so called ‘oil shocks’ of the early 1970s, will soon be lifted.

US oil majors are building up a ‘head of steam’ in order to see the end of the embargo: they stand to win a lot. The market is interpreting this as a signal that even more oil will become available. In fact the US is already exporting some (special forms of light) oil and it only takes a small action on the part of the White House to annul the embargo altogether.

An even bigger factor hammering down the oil price, however, is the lack of any united action from OPEC in order to cut production. There was some hope that OPEC countries, led by Saudi Arabia, would take a decision leading to production cuts at their recent meeting in Vienna. Word had it that the Saudi Kingdom was seeking to build solidarity within the Cartel in order to see output cut and thus send a signal of shortage (of oil) to the market. This did not happen, however, and OPEC production targets remain at well over 30 million barrels per day.

In fact, this November was one of OPEC’s highest production months on record, with oil output nearing some 32 million barrels per day, underscored by soaring production in the Saudi Kingdom, Iraq and other OPEC members. This has been the order of the day in recent years: expanded production from OPEC has flooded the market. Add to this the fact that the US has upped production so significantly, Iranian oil may soon come on to the market in increased volumes due to the likelihood of an easing of sanctions, and the market simply perceives that there is far more oil supply out there than it can handle. Add also the fact that China’s economy has cooled given the recent real estate downturn and it is no surprise that the world’s leading media outlets run headlines such as ‘$37 dollar oil now lower than during the financial crisis (in 2008)’.

In the short run, import dependent oil consuming countries will benefit from the current slump in oil prices. Their national champions will spend much less (of the state budget on) buying oil on the international markets. In the Middle East, for example, ‘oil poor’ countries like Jordan will see substantial budget relief with oil running at less than 40 (dollars per barrel). The problem here though is that we may lose momentum in our battle against climate change mitigation, as countries may ease back into an addiction on fossil fuels. Countries like Jordan, which have invested heavily into renewable energy/energy efficiency technologies during the era of the high oil price, may feel less obliged to deepen their efforts in this direction if the market signifies a new era of cheap oil. This is (chronically cheap and overabundant oil), after all, something we have not really seen since the 1990s.

Of course, low oil prices can cause political and social unrest in energy exporting countries. We have yet to see this happen in the key OPEC members or in other major oil producers, such as Russia. The Saudi Kingdom has been spending heavily to prop up its social sector (some refer to it as the ‘social contract’ between the state and the people), to the point where the IMF has sent various warnings to Riyadh about the speed with which it is depleting its (hard currency and fiscal) reserves.

While many analysts seem to agree that the Saudi Kingdom has saved ‘enough for a rainy day’, and that it has been maintaining a policy of high output in order to defend its market share (at the expense of US shale oil producers), some experts are now suggesting that continued depletion (of reserves) at this rate of knots risks social unrest (in Saudi Arabia). It is of course very difficult to judge as to ‘how deep Saudi pockets’ really are, how long Riyadh can continue with the policy of maintaining production at such high levels of output. I guess many of us feel that the present course cannot continue indefinitely, although I cannot say that there are signs of unrest around the corner (in the Kingdom).

In Venezuela, on the other hand, we have seen a resounding parliamentary elections victory for the opposition, reportedly due to overly high inflation and economic mismanagement (if the international press is something to go by). Venezuela derives the overriding bulk of its hard currency earnings from oil exports and I would think that it is fair to say that the decline in the oil price has had an impact on the government’s ability to maintain living standards. We have not seen major unrest in Venezuela, which is probably due to the strength of the country’s democratic institutions, but the resounding victory to the opposition does imply that living standards in the country have been falling.

Many experts point out that cheap oil will work against the development of non-fossil fuel (or alternative) energy projects in both energy consuming, as well as energy producing countries. This particularly applies to the energy consumers, as implied by the case of Jordan, as cited above. That said, shale projects in the US are likely to continue for the time being, particularly those being developed by the SME (energy) sector. We are receiving reports of the resilience of US shale gas and oil producers, who adapt their production models to lower growth curves underscored by falling oil prices.

Environmental groups will likely pick up on their campaign that the transition to ‘greener energy’ should not lose momentum in wake of falling oil prices, particularly in Europe. And they are likely to succeed to a good degree: we are no longer living in the 1970s and 80s when there was much less social and political awareness about the nefarious impact of carbon emissions on the environment. This is, after all, the era of Paris COP 21 and the significance of the world climate deal adopted just days ago may be every bit the game changer that the Iran deal on nuclear purports to become. Thus in Europe, and beyond, efforts aiming to move us towards fossil fuel reduction and to spur other forms of alternative energies will continue in earnest.

The big question for me is whether this will also be the case in the big Arab oil producing countries in the Gulf. Gulf state economies have been advocating economic diversification away from their oil-dominated economies for many years. They have built industrial cities in the desert, which are creating jobs, contributing to national GDP and can hence no longer be considered as ‘white elephants’ – as they were sometimes referred to after the first oil booms in the 1960s and 70s. The question is whether the big solar and other renewable energy projects will remain on course for realization, or whether Gulf policy makers will see their time more consumed by debating as to how best put some impetus back into the oil price.

In a situation of low prices it is crystal clear for me that we need to strengthen the consumer-producer dialogue at the global level, something I have always been saying, whether at OPEC meetings or at the International Energy Agency. Low oil prices in sustained form are just as unhealthy for the global economy as is the opposite situation of chronically high oil prices. I recall the balmy months of the summer of 2008, when the oil price topped 150 (dollars per barrel) and analysts were forecasting 200 (dollars per barrel), trade unions, farmers and transport groups marched in protest in towns across Europe. Now you are asking me about the prospect of unrest and falling living standards in oil producing countries as the price falls below forty. Neither situation is good for the world as we know it.

In this context, while there are plenty of multilateral energy security organizations out there (including OPEC and the IEA, as well as the Riyadh-based International Energy Forum), most of these organizations tend to be solidarity-driven in that they predominantly represent either energy consumers or producers. They do not tend to unite both. In this context the Energy Charter, which is well known in Russia, can certainly help, despite Russia’s sovereign decision to take a minimalist position towards the organization. The Energy Charter has more than 50 member states, all bound by the Energy Charter Treaty on investment protection, and the Charter Process brings together another 30+ observer countries. This is close to half the United Nations.

There are numerous energy consuming, producing and transiting states that have a seat at the table in our working groups and ministerial forums of the Energy Charter Process. Furthermore, our new political declaration on the International Energy Charter, which was adopted at a Ministerial Summit in May of this year, has led to active engagement in the Charter Process by major energy states at the global level, ranging from the USA, to China and Iran, as well a host of future energy success stories in Africa (particularly in east Africa). While there is nothing compulsory about the Charter Process, if more than 80 countries of the world cooperating internationally on energy is not enough to stimulate producer-consumer dialogue in order to minimize price volatility and reduce geopolitical risks, then I don’t know if we will ever get there.