The market gasped in reaction to this news, and then the tumble began. The price of oil dropped $6—or 8 percent—in the twenty-four hours after the meeting adjourned to hit a new yearly low of $71 a barrel. It went south from there. Finally, the abundance of energy resources emerging on the global scene over the past several years was beginning to be reflected in the price. Many expected the drop to be temporary, but the price kept sliding.
Just as surprising to many, the comparatively high-cost tight oil resources that the United States had recently brought online did not come to a quick halt as prices plunged. Moreover, Saudi Arabia, as well as Iraq, further increased their already high levels of production, in an effort to gain more market share. Over 2015, the price collapsed even further. The world welcomed the new year of 2016 with the shock of $28 oil, a price not seen since 2003. According to an analyst at one U.S. bank, the downturn had become “deeper and longer than each of the five oil-price crashes since 1970.”
Figure 1.7: The Price of Oil, July 2014–January 2016 (dollars per barrel)
This graph shows the price of oil—specifically the benchmark price called “West Texas Intermediate.”
Source: Energy Information Administration, http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=rwtc&f=D.
OPEC’s action—or rather inaction—fueled endless conspiracy theories. Russian president Vladimir Putin publicly mused, “We all see the lowering of the oil price. There’s lots of talk about what’s causing it. Could it be the agreement between the U.S. and Saudi Arabia to punish Iran and affect the economies of Russia and Venezuela? It could.” Iranian president Hassan Rouhani was only a bit more circumspect in pinning the blame for the price drop on the United States; speaking to his cabinet in December 2014, he asserted, “The main reason for [the oil price plunge] is [a] political conspiracy by certain countries against the interest of the region and the Islamic world. . . . Iran and people of the region will not forget such . . . treachery against the interests of the Muslim world.” Even states on the margins of the fray chimed in. Bolivian president Evo Morales, for example, declared, “The reduction in oil prices was provoked by the U.S. as an attack on the economies of Venezuela and Russia. In the face of such economic and political attacks, the nations must be united.” Such conspiracies also raged in the Western world. Writing for the magazine Foreign Policy, Columbia University professor Andrew Scott Cooper mused, “Riyadh’s real hope . . . is that escalated production will force [Iranian president] Rouhani’s government to implement an austerity budget that will ultimately stoke underlying social unrest and once again push people into the streets.”
When analyzing OPEC’s and particularly Saudi Arabia’s policy shift at the end of 2014, these individuals all made the common error of confusing correlation with cause. Saudi Arabia’s oil policy did in fact hurt the finances of its adversaries, but that does not mean such an outcome was the prime motivation of Saudi action at that time. Saudi behavior could also be explained by economic theory. If Saudi Arabia were to act as the “dominant firm” that many analysts have suggested it was in the oil marketplace, economic rationality would lead it not to cut production in this energy environment. Instead, it would cause the kingdom to increase production “in order to drive the fringe firms out of the market,” which in this case were shale companies, and “later return to monopolist pricing.” Geopolitical benefits would be the frosting, not the cake itself. “If in the process, you [shave] 30% off Iran’s income, fine. If in the process, you shave 30% off Russia’s income, fine,” a senior Arab official involved in the negotiations told the Wall Street Journal.
Moreover, those wishing to explain the Saudi decision primarily in terms of geopolitics need to account for the timing of the 2014 action. The Saudi government has been locked in a fervent competition with Iran for decades, a rivalry that has reached a crescendo in the last decade. The kingdom has vehemently opposed Iran’s efforts to expand its regional influence and its pursuit of nuclear weapons. Riyadh supported international efforts to create economic pressure on Tehran in the hopes of deterring it from its nuclear program. If the Saudi government were willing to endure a price dive in order to put greater pressure on Iran, why would it have waited until the end of 2014, when the contours of a deal it found objectionable between Tehran and the United States and its allies were already clear? Had the Saudis been interested and willing to use an oil weapon against Iran, the optimal moment would have been several years earlier, before the Obama administration had made key concessions to Tehran in order to begin negotiations. When, during a visit to Saudi Arabia, I asked my Saudi interlocutors about why the kingdom did not adopt this approach in 2012, my suggestions were rebuffed with claims that Riyadh could not afford such a strategy. Pointing to a fiscal breakeven price that had risen by 13 percent between just 2010 and 2012, and a more dubious regional and political environment, Saudi officials lamented they could not survive a period of low prices. At the time, with oil prices high and looking sustainable, the Saudis seemed unwilling to risk losing control of the oil market, even in pursuit of a goal so central to their interests.
Al-Naimi’s satisfaction after the November 27, 2014, OPEC meeting seemed palpable, but it was not until later that the minister described the logic in plain words: “In a situation like this, it is difficult, if not impossible for the kingdom or OPEC to take any action that may result in lower market share and higher quotas from others, at a time when it is difficult to control prices.” Talking to Middle East Economic Survey in December 2014, al-Naimi revealed, “It is not in the interest of OPEC producers to cut their production, whatever the price is. . . . If I reduce, what happens to my market share? The price will go up and the Russians, the Brazilians, U.S. shale [tight oil] producers will take my share. . . . Whether [the price] goes down to $20, $40, $50, $60, it is irrelevant.”
Al-Naimi’s determination was certainly tested. Prices remained historically low for more than two years after this meeting. The enduring financial hardship eventually spurred Saudi Arabia—and the bulk of OPEC countries and eleven non-OPEC countries—to cut production in early 2017 in an effort to rebalance the market and bolster the price.
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Matt Simmons died before he could see the outcome of the bet he made with John Tierney about the oil price. Had he lived a few months longer, he would have seen his office pay out the $5,000 plus interest he owed Tierney, given that the oil price did not exceed $200 by the end of 2010. Tierney, having placed faith in the driving power of human ingenuity and innovation, won the bet. Although victorious, Tierney—like most others—probably had no idea in 2010 how these two forces were going to affect the oil price and more in a few short years. It seems unlikely that even George Mitchell anticipated the change that he was going to help catalyze.
Although Mitchell had plenty of ambitious goals—such as developing a new resource extraction technique, building his company, and changing America’s energy balance—they were relatively close to home. But the unconventional boom he helped launch had even bigger and more widespread impacts. It altered geopolitics in ways Mitchell couldn’t have foreseen when he walked around wildcatters’ graveyard six decades earlier. These unconventional resources were perhaps the single largest factor in changing the calculations of OPEC and convincing the cartel to shift strategies. In the absence of U.S. tight oil production, OPEC would have almost certainly been discussing how to temper rising prices at the end of 2014, rather than stem declining ones. Not only would the price environment have been different without the added supply of U.S. tight oil, but the tools at OPEC’s disposal and the logic behind its actions would have varied as well. The new energy abundance not only shaped OPEC’s historical decision in November 2014. As will be discussed, it has more generally challenged OPEC’s ability to successfully manage the oil market as it did during its strongest periods over the past decades.
The combination of technological advances and political decisions is not only the key to understanding
the recent past, but is also vital to interpreting and anticipating what is happening today and what will happen tomorrow in the world of both energy and geopolitics. Moreover, as explored in the next two chapters, technology and politics have affected much more than simply the price of oil and gas. They have altered the structure of markets in profound and lasting ways. It is these changes, as well as price levels, that we will take into account as we explore the nexus between energy and geopolitics in the United States, Europe, Russia, China, and the Middle East throughout subsequent sections of this book.
TWO
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The New Oil Order
The March 6, 1999, cover of the Economist portrayed two oil-soaked workers struggling to control a gushing oil well. Superimposed over the dark-brown geyser were three words: “Drowning in Oil.” For two years, the price of oil had scraped rock bottom, under $30 in 2017 dollars. Despite the dramatic cover, the Economist still cautioned that oil’s “abundant flow might be too easily taken for granted today. Normality could last a while; but it is unwise to assume that it will endure for ever.” As the magazine predicted, OPEC subsequently got its act together and curtailed production, demand grew, and the market gradually became tighter over the coming years. Once prices rose, investment into building new capacity resumed, and a new cycle was under way.
There is some debate over whether the 2014 price plunge is just a new performance of the same Broadway show, or if—as this book contends—there is something fundamentally different at work this time. For the sake of simplicity, let’s consider two groups with different views.
The first group sees today’s oil market essentially as resembling a version of earlier boom-and-bust cycles—and expects tomorrow to look similarly familiar. Its members do have some strong facts and arguments on their side. The 2014–2016 price plunge did cause companies to curtail investment in exploration and production on a massive scale. In 2015 and 2016, for the first time in thirty years, investment declined for two consecutive years; in both years investment in oil and natural gas declined by a quarter. The reduced investment will temper oil supply growth in coming years. This anemic new supply growth is particularly problematic in the face of the “decline rates” of existing fields. Although decline rates vary field by field, on average, a conventional oil field loses 5 to 7 percent of production every year. Proponents of this view tend to think that demand for oil will continue to grow positively and close to the recent average. Eventually, growing demand will outstrip lethargic supply growth. Tight oil will respond to higher prices, but will not be sufficient to fill the gap between supply and demand, leading to a price hike in 2018–2020, which will be needed to incentivize further investment in higher cost resources, such as deep water fields and oil sands. Looking out over the longer term to 2040, many of the same observers predict that oil markets then will resemble those of previous decades: the production of tight oil will be exhausted and continued demand for the oil will further boost the reliance of the world on Middle Eastern resources.
The second group believes that more change has occurred in the oil space in the last several years and expects more change to lie ahead. Proponents in this group see the parameters of a new oil order emerging. They do not necessarily rule out a price spike in the years from 2018 to 2020 due to the curtailed investment in the years prior. Yet, they do not see it as inevitable or even probable, as they have greater confidence in tight oil rising to meet the growing demand and also can imagine some of the OPEC countries being in a position to increase capacity in the face of rising prices to meet increased demand. Looking beyond 2020, this group places greater emphasis on tight oil’s transformative impact. Advocates of this view see tight oil as seriously diminishing the power of OPEC, leaving the market open to greater fluctuations in prices. They also see tight oil as responding relatively quickly to changes in price, thereby shaving the peaks and troughs off the increased volatility and bringing any disconnects between supply and demand into balance more rapidly. This group also has greater confidence that technology will continue to increase supply, both by making more oil of all kinds available to produce at lower prices and by decreasing decline rates of fields. And it is more likely to perceive that technology—in the form of efficiency or possibly even the greater electrification of transportation—will also chip away at oil demand growth over time. The net result is, looking out to the longer term, this group does not see a return of the oil markets to earlier norms. Except for the occasional geopolitical disruption, the long trend is one of more flush oil markets, with supply finding balance with demand at moderate (although not rock bottom) prices for the foreseeable future.
While appreciating that one cannot entirely dismiss the possibility of an old oil order comeback, this book squarely associates itself with the second group—those who see the emergence of the broad contours of a new order in which the traditional boom-and-bust cycle of the old oil market will be at least greatly muted.
Lower prices are the most noticeable result of this new oil order, but they are not the only dimension of it. Other characteristics are as important as, and arguably more interesting than, the question of price. For the next decade or longer, the world will feel less influence of two phenomena—scarcity and cartel-like organizations—that have long shaped oil markets and have had major geopolitical consequences. In the new oil order, peak oil will no longer drive decisions of governments, businesses, and individuals as it has in the past. Moreover, in this era—despite the OPEC agreement to cut production made at the end of 2016—OPEC is a greatly diminished force. Instead, the market—rather than OPEC or any other institution—will play a greater role as a balancer of oil supply and demand.
A Reprieve from Peak Oil
On March 8, 1956, Marion King Hubbert, a geophysicist with a reputation for stoking controversy, was sitting on the stage at the regional meeting of the American Petroleum Institute, when he was signaled to leave the platform to take an urgent call. A public relations manager at his employer, Shell Oil, wanted to make one last appeal to Hubbert to tone down the “sensational parts” of the speech he planned to deliver to the members of the country’s powerful oil industry association. Hubbert was not easily cowed. He hung up, returned to the stage and proceeded to present his paper, “Nuclear Energy and the Fossil Fuels.”
Drawing on a paper laden with equations and graphs, Hubbert argued that there was a finite amount of oil and gas in the world. Given that it had taken 500 million years of geological pressure to turn plants and animals into fossil fuels, it stood to reason that these resources would eventually be exhausted long before they could be replenished. He introduced an idea now known as the Hubbert curve, postulating that the production of such a finite resource would resemble a bell curve, exponentially increasing up to a peak and declining afterward. Based on this theory and his own calculations of how much oil remained in the earth, Hubbert predicted that American oil production would reach a “peak” between 1965 and 1970 and then begin to decline until the resource was depleted; the world would follow suit around the year 2000.
Hubbert’s thesis was not popular—critics in the oil industry challenged his assumptions, his math, and his methodology. Morgan Davis, the head of Humble Oil, the largest producer of U.S. oil at the time, reportedly tasked people to attend Hubbert’s every presentation to publicly refute his theory. Kenneth Deffeyes, a longtime friend and colleague of Hubbert’s from the Shell research lab, explained that some of the negative reaction to Hubbert’s theory was emotional. He noted, “The oil business was highly profitable, and many did not want to hear the party would soon be over. A deeper reason was that there had been many false prophets before. . . . They had cried ‘wolf’ . . . and the industry actually grew instead of drying up.”
Despite this barrage of criticism, Hubbert’s prediction at least appeared to come true. Crude oil production in the United States did seem to top off in November 1970 at 10 mnb/d and then em
bark on a slow steady decline. Even after this apparent validation of Hubbert’s peak, however, debates continued over its applicability to the rest of the world. For decades, the salience of “peak oil” would wax and wane. Inevitably, whenever oil prices began to climb, consumers and producers around the world would bite their fingernails, wondering if the world was finally about to face the peak on Hubbert’s curve. In 2005, U.S. EIA director Guy Caruso gave a talk in which he chronicled thirty-six times between 1972 and 2004 when various sources had predicted peak oil. When prices declined, the fretting over peak oil would subside but not vanish. In fact, the notion that the world would eventually run out of oil sparked serious inquiries, such as the 2005 U.S. government–funded study Peaking of World Oil Production: Impacts, Mitigation, and Risk Management (also known as the Hirsch Report). In 2010, a think tank associated with the German military also conducted a similar analysis, concluding that peak oil could in some instances lead to open conflict and might even jeopardize the foundations of democracy. Peak oil has even made multiple appearances in the realm of popular culture; it has been the inspiration for a bevy of fantasy novels and sci-fi films such as Blade Runner and Mad Max, movies in which the human race confronts a grim future without oil.
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