June 03 , 2016
OPEC Sees the End of Oil
A dramatic change is occurring in how the world’s oil producers see the future. For the last two generations oil has been the lifeblood of the global economy. It used to be burned to generate electricity, but that ended in the 1980’s with the first era of high oil prices. Oil continued to power transportation, autos, trucks, ships, and planes till the present. With the rise of China in the last decade, surging demand created the second era of high oil prices. In the last 18 months that has come to an end. Some oil producers have held out the hope that another era of high prices will return, but the most prescient realize that we are at the end.
The carnage in the oil markets have wrecked the oil producers across the globe. The Iraqi Kurds are suffering a major economic downturn, and have trouble paying their civil servants. The rest of Iraq too has suffered from the drop in oil revenue. Lack of money contributed to the weakness of the Iraqi Army that allowed ISIS to seize much of northwestern Iraq. Low oil prices probably played a role in pushing Iran to sign the nuclear deal with the US and its partners. In Saudi Arabia, the economy has weakened and the construction giant the Bin Laden Group just laid off 50,000 workers. Venezuela’s economy has completely collapsed, with even infant formula and toilet paper no longer available. In Russia, the currency lost half its value, and economy has gone into recession.
In the past these eras of low oil prices were felt to be transient, and good times would eventually return. Low prices would stimulate demand and OPEC would agree to cut supply enough to cause a surge in oil prices. The big producers planned in terms of keeping the oil valuable for their grandchildren and not overproduce for short-term profit now. But this time is very different.
The end of oil is coming. Already oil consumption in the advanced industrial economies peaked 10 years ago and has dropped since. Oil demand in the Third World is still rising and will continue to grow for another 10-15 years, but at a slower rate. After that, total global oil demand will start a long drop down to a very minimal level by 2060. This long run decline will keep pressure on oil prices, and we will never see 100 dollar a barrel oil in real terms again.
The obvious factor that is pushing this forward is the revolution in auto transport that is occurring. This revolution is actually two separate events. First is the switch to electric vehicles. All electric vehicles have gone from a novelty product to a mainstream one in the last decade. Tesla Motors is planning to unveil a mid-priced sedan next year, and already have a huge number of pre-orders. Governments are pushing for electric vehicles in a big way. In the US, average gas mileage for new cars is mandated to rise to 54 mpg by 2025. This is a huge jump from current, and can only occur with a massive increase in electric and hybrid vehicles. The hybrid Honda Accord and Toyota Camry both get around 45 mpg, double what the older gasoline powered vehicles got. India has passed legislation requiring that all new cars sold after 2030 be electric vehicles.
The second part of the revolution is the development of driverless cars. Already companies like Google are test-driving driverless vehicles on the road. All the major car companies are trying to develop such cars that are going to totally change how we get around in the future. Because the cars are driverless, there is no need to own one. Most of the time, a personal car sits motionless. A fleet of driverless cars available for immediate use by a smartphone will take away the need for people to own private cars. You will just summon a car when you need one, and when the trip is over the car will be available for the next rider. Driverless cars will be tremendously safer than current autos, with the massive rate of car accidents dropping like a rock and saving thousands of lives a year in the US, and hundreds of thousands around the world. The total number of cars needed for the population will come way down, and the auto industry will shrink. We are probably 15-25 years away from this technology, but it’s coming.
What this means for OPEC is that much of their oil reserves will never get pumped and sold. The Saudis are selling 3 billion barrels a year, but have 250 billion barrels in reserves, good enough for 80 years. Most of that will never be pumped out. The Saudis see this and realize they have nothing to gain from cutting production. The same holds true for the rest of OPEC, which is why the Iranians rejected a production freeze, and there is no plan for any collective action on oil production.
While it makes sense to pump as much as you can now as the future is looking dimmer, the basic economic paradigm of the OPEC nations is now broken. In the past, huge oil profits allowed governments to buy social peace by distributing the oil wealth through the country. The main way to do so was by subsidizing social services such as free health care and education, no taxes on the population, and employing large numbers of people in fake government jobs where they didn’t actually do anything useful. The Saudis and the Gulf States were the biggest practitioners of this. Places like Iran, Iraq, Russia, and Venezuela had too big a population to provide high living standards for everyone, but still even those economies were grossly distorted by oil.
The petrostates must now reform themselves and create real functioning economies. They have 20 or 30 years to do so, so the change is not necessary overnight, but it will be a massive upheaval anyway. The petrostates have shut their populations out of politics in return for high living standards, but when they can no longer provide the latter, they will have to reverse the former. The Saudis have revealed an ambitious reform agenda, which includes creating a massive sovereign wealth fund of 2 trillion dollars so that they can live off investment income. In addition they want to create a real private economic sector and increase women’s participation in the economy. These changes will strain the Saudi social model, perhaps to the breaking point.
