Elias Hinckley for The Energy Collective:
Saudi Arabia’s decision not to cut oil production, despite crashing prices, marks the beginning of an incredibly important change. There are near-term and obvious implications for oil markets and global economies. More important is the acknowledgement, demonstrated by the action of world’s most important oil producer, of the beginning of the end of the most prosperous period in human history – the age of oil.
In 2000, Sheikh Yamani, former oil minister of Saudi Arabia, gave an interview in which he said:
“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.”
Fourteen years later, while Americans were eating or sleeping off their Thanksgiving meals, the twelve members of the Organization of Oil Producing Countries (OPEC) failed to reach an agreement to cut production below the 30 million barrel per day target that was set in 2011. This followed strenuous lobbying efforts by some of largest oil producing non-OPEC nations in the weeks leading up to the meeting. This group even went so far as to make the highly unusual offer of agreeing to their own production cuts.
The ramifications of this decision across the globe, not just in energy markets, but politically, are already having consequences for the global landscape. Lost in the effort to understand the vast implications is an even more important signal sent by Saudi Arabia, the owner of more than 16% of the world’s proved oil reserves, about its view of the future of fossil fuels.
Since its formal creation in 1960 the members of OPEC, and specifically Saudi Arabia (and in reality the Kingdom’s control over global oil markets is much larger than that 16% of reserves implies as its more than 260 billion barrels are among the easiest and cheapest to extract and before enhanced recovery techniques accounted for a much larger share of global reserves) have used excess oil production capacity to influence crude prices. The primary role of OPEC has been to support price stability. There are notable exceptions – like the 1973-1974 oil embargo and a period of excess supply that undermined prices and crippled the Soviet Union in the 1980s (though whether this was a defined strategy or serendipity remains in some question), but at its core the role of OPEC has been to control oil prices. As recent events show, OPEC’s role as the controller of crude oil pricing is coming to an abrupt end.
In acting as global swing producer, OPEC relied has heavily on Saudi Arabia, which can influence global prices by increasing or decreasing production to expand or reduce available global supply. Saudi Arabia can do this not only because it controls an enormous portion of global reserves and production capacity, but does so with crude oil that is stunningly inexpensive to produce compared to the current global market. A change, however, has occurred in Saudi Arabia’s fundamental strategic approach to the global oil market. And this new approach – to refuse to curtail production to support global prices – not only undermines OPECs pricing power, but also removes a vital subsidy for global oil producers provided by the Saudi’s longtime commitment to price support.
Understanding Why
The widely held conventional theory is that the Saudis want to shake the weak production out of the market. This strategy would undermine the economic viability of a meaningful amount of global production. The theory assumes that this can be done in some kind of orderly bring-down of prices where the Saudis can find an ideal price below the production cost of this marginal oil production but still high enough to maintain significant profits for the Kingdom while this market correction plays out. The assumption is that following the correction there will be a return to business as usual along with higher prices, but with Saudi Arabia commanding a relatively larger share of that market. An alternative rationale is that Saudi Arabia is fighting an economic war with oil; a strategy designed to economically and in turn politically cripple rival producers Iran and Russia because the governments of these countries that depend on oil exports cannot withstand sustained low prices and will be significantly weakened.
While there may be some truth to both of these theories, the real motivation lies somewhere closer to Sheikh Yamani’s 2000 prediction. Saudi Arabia has embarked on an absolute quest for dominant market share in the global oil market. The near-term cost of grabbing that market share is immense, with the Saudis sacrificing potentially hundreds of billions of dollars if low prices persist. In a world of endless consumption, this risk would be hard to justify merely in exchange for a temporary expansion of global market share – the current lost revenue would take years to recover with a marginally higher share of global supply.
But in a world where a producer sees the end of its market on the horizon, then every barrel sold at a profit is more valuable than a barrel that will never be sold. Current Saudi oil minister Ali al-Naimi had this to say about production cuts in late December: “it is not in the interest of OPEC to cut their production whatever the price is,” adding that even if prices fell to $20 “it is irrelevant.” Implied, if not explicitly stated, is that Saudi Arabia wants its oil out of the ground, regardless of how thin its profit margin per barrel becomes.
Saudi Arabia is seeing a new and massively changing energy landscape. The U.S. and China have agreed to bilateral carbon reduction targets. 2014 is now officially the hottest year recorded in human history, a record set almost impossibly without the presence of El Nino. And on January 7 a report released in Nature lays bare the fossil fuel climate change equation by concluding that to achieve anything better than a 50/50 shot at keeping global warming under 2 degrees centigrade (the most widely accepted threshold for avoiding catastrophic climate change) 82% of fossil reserves must remain in the ground. That report puts hard numbers on the percentages of fossil fuels that must “stay in the ground” and calls for 38% of proven Mideast oil reserves to never to be pumped from the ground. That 38% represents some 260 billion barrels of oil – worth tens of trillions of dollars – much of that not held in Saudi reserves.
All of these threats to oil use are occurring against a backdrop where the acceleration of costs-effective alternative technologies expands the potential of viable alternatives to our current fossil fuel-based energy economy. Yamani’s prediction no longer seems a fantasy where no one outside of science fiction writers could envision an alternative to the age of oil, but rather a stunningly prescient analysis of the future risk to the value the largest oil reserve on the planet by a man who once managed that reserve.
Saudi Arabia no longer needs OPEC. Global action on carbon dioxide emissions is gaining global acceptance and technological advances are creating foreseeable and viable alternatives to the world’s oil dependence. Saudi Arabia has come to the stark realization, as Yamani foretold, that it is a race to produce, regardless of price, so that it will not be leaving its oil in the ground. The Kingdom has effectively open the valve on the carbon asset bubble and jumped to be the first to start the race to the end of the age of hydrocarbons by playing its one great advantage – a cost of production so low that it can sell its crude faster and hoping not to find itself at the end of the age of oil holding vast worthless unburnable reserves.
The end of the age of oil, of course, remains many years off (and almost certainly well beyond Yamani’s timeline of 2030), but to Saudi Arabia, that end is clearly not so far away that the owner of the largest, most accessible crude resource is willing to continue to subsidize higher prices for other producers at the risk of leaving its own oil untapped one day in the future.
Collateral Fallout
Much has been made of the catastrophic economic consequences to Russia, Iran, Venezuela and other oil exporting nations caused by these low oil prices, as well as, the profound damage to their economies and impending political turmoil. Meanwhile in the U.S., there has been endless analysis of the impact (or lack of impact) on the nation’s resurgent oil production and speculation about the price at which U.S. production will begin to decline.
Less well documented is the impact on access to capital for drilling operations (and given the disastrous economics of North American coal, perhaps fossil fuel extraction broadly). Drilling for oil requires huge amounts of capital with a significant appetite for risk, as both production uncertainty and market volatility can undermine the value of investments. In the current production boom, market volatility was wildly underpriced. When combined with pent up appetite for yield due to persistently low interest rates, capital, including tremendous amounts of high-yield debt, has flooded into oil companies. As low crude prices persist there will be substantial losses by investors. This will cause volatility in crude oil markets to be re-priced, and access to low cost capital will disappear for all but a select group of oil production investments.
OPEC will continue to meet and hold itself out as a cartel that can control the oil markets, but that time has passed. The cartel was dependent upon Saudi Arabia to use its outsized swing position to control spare capacity in the market. With the Saudis no longer interested in that role, the influence of the cartel is gone. It would be no surprise at all to see Saudi Arabia actually increase production (though how much additional output is readily available is unclear) as prices stabilize and begin to climb later this year because excess capacity will be shed from the market and global economic growth will accelerate.
The direct oil markets impact and the geopolitical fallout will likely be the defining headlines of 2015, but there is a much much bigger story unfolding: the carbon asset bubble is deflating. The value of effectively every asset class on Earth is influenced by the assumption that a fossil fuel-based economy will persist for so long that any potential for future change to asset values can be ignored. That assumption is wrong. The global industrial economy operates on an assumption of available and relatively inexpensive energy, either in the form of electricity or liquid fuels. If the form, availability of, or cost of, those energy sources changes it will fundamentally change the cost to use and produce virtually every other asset on Earth. And that will necessarily change the value of every one of those assets. There will be both positive and negative impacts, and understanding this change, in both scope and speed, will provide insight on one of the largest wealth shifts ever experienced.
The owner of the most valuable fossil fuel reserve on Earth just started discounting for a future without fossil fuels. While they would never state this reasoning publicly, their actions speak on their behalf. And that changes everything.
From USA Today – Saudi Prince says we will never see $100 a barrel oil again.
http://www.usatoday.com/story/money/columnist/bartiromo/2015/01/11/bartiromo-saudi-prince-alwaleed-oil-100-barrel/21484911/
A very interesting article. The Saudi rulers have always been a very strong partner and ally (at least business partner) of the U.S, but lately China are becoming much more involved in the Gulf states especially in oil business partnerships, and of course it is also in China’s interest to keep the price low. I hope this reflects reality and the end of the oil age is indeed in sight, and we will see the Keeling curve stabilize and droop. A more pessimistic view from Author McKenzie Funk:
“Arctic drilling is not part of the conversation now, but the future is long, and it’s still, in terms of conventional oil deposits — not fracking or anything — it’s still the biggest thing out there. And the ice is still melting. So this isn’t the last time we’re going to see Arctic oil. It’s maybe a temporary drop.”
http://www.salon.com/2015/01/11/why_arctic_drilling_is_a_disaster_waiting_to_happen/
Jason Box and I will be attending the Economist magazine’s Arctic Summit in March. I will report on impacts of collapsing oil prices on arctic plans.
Here is the original article:
http://www.telegraph.co.uk/news/uknews/1344832/Sheikh-Yamani-predicts-price-crash-as-age-of-oil-ends.html
In it (from 2000), Sheikh Yamani predicts: 1) a near-term ‘crash’ is oil prices from the contemporary price of $30, 2) the ‘huge’ oil finds in Africa, Yemen, the Caspian, and Iraq will be the reason for the price crash, 3) hydrogen fuel cell technology will be the reason why oil demand will go down, and 4) the U.S. will convert to fuel cells completely by 2010. Wrong, wrong, wrong, wrong. This is “stunningly prescient analysis”?
The article also relies on the Saudis having the full effect on the current drop in prices, which is just one small factor compared to several MUCH larger factors – overproduction in the U.S. and declining demand in Asia and weak demand in the West being the largest.
It also ignores the fact that Saudi Arabia itself can’t maintain the oil prices staying around $50 for long. They can easily break even at that level on production, but their national spending requires prices around $90 to $100 (they have to keep their population from rioting like many other Middle Eastern countries by providing high levels of governmental support):
http://www.slate.com/blogs/moneybox/2014/12/11/oil_falls_below_60_a_barrel_who_s_in_trouble.html
The basic premise is that Saudi Arabia isn’t cutting production because they want to sell it while they can, fearing a future where oil demand goes to zero. Even if they cut their level of production, as they have done historically in the past on occasion, the amount cut would be less than a percent of world production, and it would be far less than a one percent of their total reserves even if they kept the lower production level for a year. Additionally, there are many other uses for oil besides ground transport. Oil demand won’t just end, even with a startlingly fast ramp up in alternative transport tech.
There is one decent paragraph:
“Less well documented is the impact on access to capital for drilling operations (and given the disastrous economics of North American coal, perhaps fossil fuel extraction broadly). Drilling for oil requires huge amounts of capital with a significant appetite for risk, as both production uncertainty and market volatility can undermine the value of investments. In the current production boom, market volatility was wildly underpriced. When combined with pent up appetite for yield due to persistently low interest rates, capital, including tremendous amounts of high-yield debt, has flooded into oil companies. As low crude prices persist there will be substantial losses by investors. This will cause volatility in crude oil markets to be re-priced, and access to low cost capital will disappear for all but a select group of oil production investments.”
However, it’s overstated. Financing for higher cost oil won’t disappear. It will reduce during times of lower oil prices and increase during times of high oil prices – just like it’s always done in the past.
The author’s second to last paragraph has some kernels of truth, however, the author is also personally invested in seeing that transfer of wealth go from others to him. From his bio:
“Elias Hinckley is a strategic advisor on energy finance and energy policy to investors, energy companies and governments”
Finally, why we should take anything a Saudi minister says as truth?
The article is wishful thinking posing as analysis. I don’t want a future of heavy fossil carbon use either, but the status quo isn’t going to prevent it. We have to work towards it, actively and aggressively – not rely on the power of markets and very tenuous conjecture of Saudi Arabia, of all places.
There is another theory which goes as follows:
“Central Intelligence Agency director John Brennan’s long familiarity with Saudi Arabia, owing to the time he spent there as the CIA station chief in Riyadh in the 1990s and his knowledge of Saudi oil operations, has paid off. Petroleum industry insiders claim that Brennan’s agents inside Saudi Aramco convinced the firm’s management and the Saudi Oil Ministry to begin fracking operations in order to stimulate production in Saudi Arabia’s oldest oil fields. The Saudis, who are not known for their hands-on knowledge of their nation’s own oil industry, agreed to what became an oil pricing catastrophe which would not only affect Saudi Arabia but oil producing nations around the world from Russia and Venezuela to Nigeria and Indonesia.
By pumping high-pressure salt water into older wells, some at a depth of three to six thousand feet, an inordinate amount of pressure was built up. The CIA’s oil industry implants knew what would occur when the fracking operations began. Due to the dangerously high water pressure, the Saudis were forced continuously pump oil until the pressure became equalized. That process is continuing. If the Saudis ceased pumping oil, they would permanently lose the wells to salt water contamination. In the current “pump it or lose it” situation, the Saudis are forced to pump at a rate that may take up to five years before they can slow down production rates to pre-glut levels.”
I have no idea about the accuracy of this, though it does tie in with reports from quite some time back that Saudi’s were having to pump sea water into some of their main fields to ‘maintain pressure’.
Can anyone with oil knowledge comment?
Having worked in Middle Eastern oil fields for many years and having some knowledge of reservoir simulation techniques and Saudi Aramco, I can assure you they are not that naive, and their staff are far more professional than your stated view.
What’s the source?
The Saudis aren’t fracking. That’s a mistake that makes the quote a bit dodgy. It’s a totally different technique than what they are doing. They are salt water pumping, though, and it’s possible that salt water contamination could prevent them from dramatically lowering their production levels, but good luck confirming that one. Additionally, the Saudis have dropped production a bit several times the past decade:
http://en.wikipedia.org/wiki/Oil_reserves_in_Saudi_Arabia#mediaviewer/File:Saudi_Oil_Production.png
BTW, here’s another recent prediction from Saudi Arabia:
http://www.usatoday.com/story/money/columnist/bartiromo/2015/01/11/bartiromo-saudi-prince-alwaleed-oil-100-barrel/21484911/
The basic premise of this article – that the Saudis are desperate to pump their oil now and sell it because soon demand for oil will dry up – is rubbish. Any slackening of demand in developed countries due to solar, wind, economic collapse, etc, will be more than made up for by demand from developing countries. Lower prices will increase consumption, and discourage use of non-fossil fuel alternatives.
If the Saudis are indeed overpumping to drive oil prices down, they are probably doing it in pursuit of some secret political agenda which we peons are not privileged enough to know about. Conspiracy theories abound…like the USA wants to bring down Russia with Saudi help and thus turns a blind eye to Saudi-backed terrorism. But that’s only a conspiracy theory – I can’t call up Obama or the Saudi leadership and ask them to confirm that. I’m just speculating what’s going on behind the smoke and mirrors, and so are you.
Anyway, if I were you, I wouldn’t uncork that bottle of champagne just yet to celebrate the end of fossil fuels.
I’ll add a conspiracy theory that I haven’t seen elsewhere. No way to prove it, of course, and I’m not saying I believe it, even though it’s crossed my mind. The theory is that $50 oil is another economic stimulus attempt by the banks.
Commodity pricing IS affected by supply/demand, but it’s also at the whim of the markets. There isn’t a great supply/demand reason why gold jumps up and down so much:
http://upload.wikimedia.org/wikipedia/commons/e/e3/Gold_price_in_USD.png
It’s still gold, and it stays at a relatively stable supply and demand. It’s mostly what Wall Street thinks at the time as to its desirability. It rises during times of stress and lowers during times of stability. It’s mostly about perception. What does the market ‘feel’ about it, instead of what it actually is. I sometimes wonder if oil isn’t affected in similar ways, although probably not at the same level as gold.
Anyway, governments and the federal banks have tried QE, they’ve tried government bail outs, they’ve tried public spending, they’ve lowered interest rates to the point where they’re even trying negative interest rates in some places:
http://www.bloombergview.com/quicktake/negative-interest-rates
Insanity. And yet, the economies are still stalling. What’s left? Maybe lower oil prices to boost growth?
It’s okay to stall fracking in that case for the U.S. That oil is still there, and it won’t unduly harm the U.S. economy. The only ones really hurt are places like Russia, Iran, and Venezuela, and we don’t have the best relationship with them. Saudi Arabia can weather it for a while, as they have enough in the bank to cover it for a few years.
Gold went into a bubble mostly because of the QE program. People thought injecting billions/trillions into the ‘economy’ was going to significantly diminish the value of the paper dollar. Investing article after investing article showed correlation graphs between fiat in circulation and the price of gold. It was just another investor mania.
The problem was that QE wasn’t causing much inflation. The trillions weren’t going into the general economy. They were going into a black hole, so that banks could clear their worthless mortgage backed derivatives off their books. Also gold doesn’t really have an inherent value, other than that of its use in electronic circuits and maybe jewelry….
Amen!
Interesting. I wonder if the intentions of the Saudis really matter here– they are responding to a market-share challenge in an oversupply situation by lowering prices; if this works, it will take some more expensive sources off the market over the coming months. But if demand growth continues to be slow, low prices may persist, with a long-term impact on high-cost oil exploration and development. The longer-term question (as I see it) is whether this will lead to a demand response that drives prices up and enables a return to BAU in the tar sands and other high-priced sources. My hope is that new low-carbon sources are competitive enough to satisfy renewed growth in energy demand…
Interestingly I have noticed the US president haven’t been very vocal about this new oil price landscape, and a part of me feel this is partly because the low oil price is also good for pressuring Putin into re-thinking his annexation strategy. It surely will be interesting to see how 2015 pans out for Russia’s economy – although this low oil price is surely affecting all exporters now (below $50 today).
Here in Norway there are now close to 10.000 jobs lost in the oil business since the price drop, and the part where i live, in the west its said that 1/3rd of all jobs are either directly or indirectly employed through the oil businesses. So this could be a pretty serious problem if the price stays low throughout 2015 (it very likely will affect my work place as well).
Interestingly, we now have a right-ish government (still left of anything Obama can do) that has been very vocal about Norway having to use more of our oil profits for all kinds of things, only to get a serious reality check about our dependence on fossil fuel for running the economy. It’s about time though, as it was getting pretty “lazy” over here. The question on many lips now here is what Norway is going to live from when the oil era is ending, which everybody knew was going to happen anyway.
I often leave comments on any oil discovery news post with the facts that Norway produce half the amount of oil we did 10 years ago, and will produce half of what we do today in 10 years time.
http://crudeoilpeak.info/global-peak/norway-peak-oil
Saudi Arabia has already stated it’s position as favoring continuation of a market share, rather than withhold production. If you think that oil is disappearing from our landscape and economy, how do you think operator our cars, buses, and trucks, with solar panels or wind mills? Methyl hydrate deposits are in strong supply off up almost every coast, ensuring 1000 years of petroleum assets.
= Drilling for oil requires huge amounts of capital with a significant appetite for risk, as both production uncertainty and market volatility can undermine the value of investments. In the current production boom, market volatility was wildly underpriced. When combined with pent up appetite for yield due to persistently low interest rates, capital, including tremendous amounts of high-yield debt, has flooded into oil companies.=
Paradoxically, companies will get into situations where all they want to do is pay the interest expense of their debt and will open the floodgates even further to help pay this expense: if they can’t get it by margin, they’ll get it by volume, in other words.
Also, re-fracking is going to come online, where they use 1 drill kit to drill multiple wells. This cuts their break-even down to $30/barrel. So American fracking ain’t done yet.
Also, US drillers can’t cooperatively agree to ‘cut-back’ without violating anti-trust laws.
Also, a lot of those middle eastern countries can’t take low prices for long, as it cuts into their government tax revenue, and they’ll start running deficits.