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Saudi Arabia Admits Defeat

“God be with the citizens, we are back to the time of poverty,” wrote Saudi Arabian blogger Rayan al-Shamri on Twitter last week. That’s a bit strong, but he and his fellow citizens are certainly no longer living in the time of plenty. Saudi Arabia is cutting back on all fronts.

The wages of government employees accounted for almost half the the Saudi Arabian government’s spending last year: about $120 billion. And the country’s budget deficit, due to the collapse of the oil price, was $98 billion. So you can see why the government would go looking for some economies in the public sector.

About two-thirds of employed Saudi citizens have public sector jobs, many of which require them to do little beyond showing up on a fairly regular basis. It’s the unwritten contract that the absolute monarchy made with its citizens decades ago, when money was not a problem: you keep quiet politically, and we will subsidise your lifestyle handsomely. But the money isn’t there any more.

A royal decree on 23 September announced that government ministers’ salaries would be cut by 20 percent. Lower-ranking civil servants will have their pay frozen and their overtime payments and annual leave capped. Crown Prince Mohammed bin Salman has announced a plan to cut the public sector to only 40 percent of the working population by 2020. (In the United States it’s 7 percent.)

If this policy sounds a little less than drastic, that’s because the Saudi regime doesn’t dare cut harder for fear of a popular backlash. It cannot afford to let the “time of poverty” come back, and citizens who are used to being coddled and subsidised will define anything short of their current living standard as “poverty”.

So if the regime can’t get its budget spending down much, then it had better start getting the oil price back up before it runs out of money entirely and the roof falls in. This requires an about-turn in the market strategy it has followed for the past two years.

The Organisation of Petroleum-Exporting Countries (OPEC) only accounts for 40 percent of the world’s oil exports, which is marginal for a cartel that seeks to control the world oil price. Moreover, some poorer OPEC members regularly pump more oil than their quotas allow. So Saudi Arabia’s traditional role, as OPEC’s biggest member, was to cut production and get the world price back up when there was a glut of oil on the market.

When the oil price collapsed two years ago, however, Saudi Arabia didn’t do that. The regime was worried that the rapid rise in American oil production, mainly due to fracking, would ultimately destroy OPEC’s ability to set the price of oil. Its response was to pump oil flat out and let the price stay low, hoping that this would drive the high-cost US fracking industry out of business.

That was a foredoomed strategy, because the US government would even subsidise its fracking industry, if it had to, rather than give up on the dream of “energy independence” (self-sufficiency in oil production). In the event, that wasn’t necessary: even with the oil price at rock bottom, American oil production actually grew last year – and by now the OPEC producers are facing budgetary disaster.

At the OPEC summit in Algiers last Wednesday, Saudi Arabia publicly abandoned its strategy. OPEC will cut production by 700,000 barrels a day, starting next month. Saudi Arabia, as usual, will take the biggest share in the cuts – and if this round of cuts doesn’t get the price back up, there will presumably be a further round early in the new year.

The Saudis have even agreed that Iran, their great strategic rival in the Gulf region, can increase its production while everybody else in OPEC is cutting. (Iran, frozen out of the market by the American embargo for so long, has been claiming its old OPEC quota back now that the embargo has been lifted, and until last week Saudi Arabia was resisting its demand.)

A number of things are not yet clear about the new strategy. In particular, how to share the pain of production cuts between the OPEC members has not yet been worked out, so the market is not yet persuaded that these cuts are real.

The world oil price jumped 7 percent on first news of the OPEC decision, but is now back down to about the level it was at before the OPEC announcement. OPEC’s promises about cuts have been broken before. But this time they probably will be kept, because a lot of the producers are truly desperate for a higher price.

So, then, three conclusions. One, Saudi Arabia’s ability to set the price of oil, and OPEC’s power in general, is seriously impaired. Two, the oil price is going back up over the next year or so, though probably not beyond $70 or $80 a barrel. And three, that is really a good thing, because we need a higher oil price to drive the shift out of carbon fuels and into renewables.
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To shorten to 725 words, omit paragraphs 3 and 11. (“About…more”; and “The Saudis…demand”)

Oil Downturn

“The market can stay irrational longer than you can stay solvent,” said John Maynard Keynes (or maybe it wasn’t him, but no matter). At any rate, that was the eternal verity the Saudi Arabians were counting on when they decided to let oil production rip – and the oil price collapse – in late 2014.

The Saudi objective was to keep the oil price low enough, long enough, to drive American shale oil producers out of business and preserve the OPEC cartel’s market share. (The Organisation of Petroleum Exporting Countries controls only 30 percent of world oil production, which is already very low for what was meant to be a price-fixing cartel.)

The end of sanctions against Iran and that country’s push to raise production and regain its old market share put further downward pressure on the oil price. So did the slowdown in China’s economy.

High-cost shale-oil producers in the United States are really hurting (US oil production this year will be down by 700,000 barrels a day), but the OPEC producers are hurting too – and it looks like the Saudis just blinked.

On Tuesday Saudi Arabia, Russia, Venezuela and Qatar announced that they would freeze their oil production at the January level. Most other OPEC members are expected to follow suit, and since Saudi Arabia and Russia (not an OPEC member) are the second- and third-largest oil producers in the world, the freeze will affect almost half of the world’s oil production.

That will not be enough to rescue the economies of OPEC countries and Russia from their current crisis. (All their economies are actually shrinking, and Saudi Arabia has gone from a budget surplus amounting to 13 percent of GDP in 2012 to a deficit of 21 percent last year.) Freezing production will not get the oil price back up when the current global production level is at least 2 million barrels a day higher than global demand.

In fact, the oil glut is so great that the world is running out of places to store the excess production. US and European oil storage facilities are full, and people are already talking about buying tankers as floating storage. Since the beginning of this year the oil price, as high as $115 a barrel less than two years ago, has dipped down into the $20s several times.

Not only will the new production freeze not solve this problem; it won’t really even freeze production. If there’s one thing that OPEC members do well, it is to cheat on their production figures and pump more oil than they admit. As for Russia, it broke the last deal it made with OPEC about freezing production, and it will probably do it again.

Ineffective as this deal is, it illustrates the mounting panic in the major oil producers as the prospect of a long period of very low oil prices opens out ahead of them. Saudi Arabia and Russia are edging towards a direct military confrontation in Syria – the Russian air force backs the Assad regime, and the Saudis are talking about sending ground troops to fight it – but the oil price transcends such issues.

So what conclusions may we draw from all this? First, the price of oil will stay down. In the short run it may even go lower: Morgan Stanley analysts say that oil “in the $20s” is possible if China devalues its currency further, and Standard Chartered Bank predicts that prices could hit just $10 a barrel.

The production freeze might allow the oil price to return to the low $40s in the medium term, if Chinese demand does not collapse entirely and if the producers keep their promises. That price would enable most of the fracking operations in the United States to stay in business, but it would still fall far short of balancing the budgets of Russia and Saudi Arabia. They can’t really afford to have a full-scale war over Syria.

Second, OPEC members with large populations and national budgets that depend heavily on oil revenues (more than 75 percent) face the prospect of major civil unrest or even revolution. This includes Nigeria, Algeria, Venezuela and Angola. Iran and non-OPEC member Mexico face lesser political risks, but they are not negligible.

Finally, a prolonged period of low oil and gas prices will hit the whole array of climate-friendly energy and transportation technologies, from wind-farms to electric cars. Energy costs still matter, even if governments can rectify the balance to some extent with carbon pricing and other regulatory measures. But coal, the most polluting of the fossil fuels, still faces early extinction, since its main rival for power generation is ever cheaper gas.

A ruthlessly rational OPEC leadership (i.e. a Saudi Arabia run by competent economists and strategists) would just end the cash hemorrhage and reduce the political risk by cutting production sharply and getting oil prices back up. But the great gamble to break the US frackers by driving them into bankruptcy was not an ownerless, free-floating policy that somehow took root in OPEC soil.

It was a specific strategy that was conceived and promoted by particular powerful individuals, most notably high-ranking Saudi individuals. They would lose a great deal of face if they had to abandon it, so it will be with us for a while yet.
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To shorten to 725 words, omit paragraphs 3, 7 and 8. (“The end…economy”; and “In fact…again”)

How Long Will the Oil Stay Cheap?

I’m in Alberta, the province that produces most of Canada’s oil, and there’s only one question on everybody’s lips. How long will the oil price stay down? It has fallen by more than half in the past nine months – West Texas Intermediate is $48 per barrel today – and further falls are predicted for the coming weeks.

This hits jobs and government revenues hard in big oil-producing centres like Alberta, Texas and the British North Sea, but its effects reach farther than that. “Clean” energy producers are seeing demand for their solar panels and windmills drop as oil gets more competitive. Electric cars, which were expected to make a major market breakthrough this year, are losing out to traditional gas-guzzlers that are now cheap to run again.

Countries that have become too dependent on oil revenues are in deep trouble, like Russia (where the rouble has lost half its value in six months) and Venezuela. Countries like India, which imports most of its oil, are getting a big economic boost from the lower oil price. So how long this goes on matters to a great many people.

The answer may lie in two key numbers. Saudi Arabia has $900 billion in cash reserves, so it can afford to keep the oil price low for at least a couple of years. The “frackers” who have added 4 million barrels/day to US oil production in the past five years (and effectively flooded the market) already owe an estimated $160 billion to the banks.

They will have to borrow a lot more to stay in business while the oil price is low, because almost none of them can make a profit at the current price. Production costs in the oil world are deep, dark secrets, but nobody believes that oil produced by hydraulic fracturing (“fracking”) comes in at less than $60-$70 per barrel.

The real struggle is between the frackers and Saudi Arabia, because the latter is the “swing producer” in OPEC (the Organisation of Petroleum-Exporting Countries), the cartel that has dominated the global oil market for the past fifty years.

All oil exporters want to keep the price high, but Saudi Arabia was the one OPEC member that could and would cut its production sharply for a while when an over-supply of oil in the market was driving prices down. It could afford to do that because it has a relatively small population, very large savings – and a cost of production so low that it can make some profit on its oil at almost any price.

But even the Saudis cannot work miracles. They can aim for maximum production or maximum price; they cannot do both at the same time. Normally they would cut production temporarily to get the price back up. This time they refused to cut production and let the price collapse, despite the anguished pleas of some other OPEC members that need money NOW.

The Saudis are thinking strategically. OPEC only controls about 30 percent of world oil production, which is a very low share for a cartel that seeks to control the price. If fracking continues to expand in the United States, then OPEC’s market share will fall even further. So it has to drive the frackers out of business now.

At first glance the Saudis look like sure winners, because they can live with low prices a lot longer than the deeply indebted frackers can. The banks that have lent the frackers so much money already won’t get it back if the industry implodes in a wave of bankruptcies, but they don’t want to throw good money after bad.

The real wild card here is the US government, which wants the “energy independence” that only more domestic oil production through fracking can provide. Will it let the American fracking industry go under, or will it give it the loan guarantees and direct subsidies that would let it wait the Saudis out?

Stupid question. Of course it will do what is necessary to save the fracking industry. Ideology goes out the window in a case like this: you can get bipartisan support in Washington for protecting a key American industry from “unfair” foreign competition. That will certainly be enough to keep the frackers in the game for another two or three years.

Meanwhile, the OPEC members that depend on oil income to keep large populations well fed and at least marginally content (e.g. Iran, Nigeria and Venezuela) will be facing massive public protest, and possibly even the threat of revolution. Their governments will be putting huge pressure on Saudi Arabia to save them by cutting production and driving the price back up.

It’s impossible to say how this game will end, but it’s pretty easy to say when. Two years ought to do it. Once the outcome is clear, the price of oil will start going back up no matter which side wins, but it will go up relatively slowly. We are unlikely to see $100-a-barrel oil again before 2020 at the earliest.
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To shorten to 725 words, omit paragraphs 9 and 13. (“The Saudis…now”; and “Meanwhile…up”)

Instead of Oil

12 June 2008

Instead of Oil

By Gwynne Dyer

“Today we witness a very great change for hydrocarbons,” said Alexei Miller, head of Russian oil and gas giant Gazprom, last week. “The [oil price is already] very high, and we think it will reach $250 a barrel.” Cue legions of financial journalists fainting and writhing in coils at the news of impending economic Armageddon. So do you think that we’ll see some attempt to move away from dependence on oil now?

Miller is the only CEO of a major oil company who is predicting $250 a barrel oil within eighteen months, because the others remember what happened the last time the oil price peaked like this, in the 1970s. The big consuming countries responded by cutting back on oil use so drastically that the OPEC cartel lost control of the price, which then bumped along below $20 a barrel through the late 80s and 90s.

With oil in the high $130s, we are already seeing a move away from the monster vehicles that became so popular in the United States during the cheap oil years, but 1970s-style conservation is not going to bring the oil price down this time. For every American or German switching to a car with lower fuel consumption, there is a Chinese or Indian first-time car buyer taking up the slack and keeping demand high.

So if the car-driving masses are ever to escape from high fuel prices, they cannot rely on simply cutting demand through conservation. They need an alternative fuel, and the bio-fuels that are now on offer — made from corn (maize, mealies), sugar cane, sugar beets, oil palm or soybeans — simply cannot replace oil. There just isn’t enough land and water to grow bio-fuels and food too.

It would take half the land-mass of the continental United States to grow enough grain to fuel America’s cars and trucks. “Second-generation” bio-fuels that depend on plants like switchgrass and willow are better in terms of not competing with food because they grow quickly on waste ground, but they cannot provide the volume of fuel needed either.

So if we’re going to go on driving cars, but we can’t afford to fuel them from petroleum (and we can’t afford to put all those greenhouse gas emissions in the air either), then what do we do instead?

This is where it gets interesting, because there are two alternative fuels that could theoretically be produced in the volumes required, and that would not add to the carbon dioxide in the atmosphere. One is algae, grown in open ponds on marginal land, or in nutrient-rich sewage farms, or even in completely contained environments in the dark.

Other plants also contain oil, but the great virtue of algae (pond scum, in the vernacular) is that it can double its mass every two hours under ideal circumstances, which means it can be harvested daily. The US Department of Energy estimates that to replace all the petroleum fuel in the country with home-grown algae fuel would require 40,000 sq. km. (15,000 sq. mi.) of land, which is less than one-seventh of the area devoted to growing corn in the United States.

The oil that is produced can be burned as biodiesel, or further refined until it is almost the same as the fuel we put we put in our vehicles today. It needs no special distribution network, works in unmodified engines, and is effectively carbon-neutral. And the biomass that is left after the oil has been extracted can be fed to cattle, or fermented to produce ethanol.

Fuel from algae is not yet ready for prime time, but there are now numerous start-up companies exploring rival ways of growing and processing it, and oil majors like Shell and Chevron are already jumping in as well. The main question is cost, but so long as petroleum stays above $100 a barrel it’s likely that some of these methods will prove competitive.

The other, more radical proposal is to transform carbon dioxide from the problem into part of the solution by combining it with hydrogen to make a synthetic octane fuel suitable for use in vehicles. You get your CO2 from the exhaust gases of coal and gas-fired power plants or just extract it from the air directly (the first prototypes of machines for doing this are now being tested), and you obtain your hydrogen however you like.

Getting hydrogen requires energy, and is only carbon-neutral if the electricity used to split it out of water comes from a non-fossil fuel source like solar, wind or nuclear. But combining the hydrogen with CO2 avoids the huge problems of storage, refrigeration and high pressures connected with using pure hydrogen as a fuel: the synthetic octane can be handled and burned just like conventional fuel.

One or both of these approaches is going to start challenging conventional oil in the market within five to ten years if the price of oil stays high. Security of supply and cost are the big concerns driving this process now, but the ultimate prize is vehicle fuel that does not contribute to global warming. Conventional oil can never offer that advantage, so in the long run it is in big trouble.

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To shorten to 725 words, omit paragraphs 5 and 9. (“It would…either”; and “The oil…ethanol”)