Twilight of the Petrostate

Image: An offshore oil rig at sunset. Pete Markham, CC BY-SA 2.0.

The age of oil rents is over. A political and geopolitical revolution is on its way.

About twenty countries around the world are dependent on a single number: the price of oil. Some, primarily Persian Gulf states, live entirely off their oil and gas wealth. They rely on crude oil, natural gas and petroleum products for 50 percent of their Gross Domestic Product and for 70-plus percent of their budget revenue. Some 15 countries generate more than 50 percent of their export earnings from oil, gas and petroleum product sales.

Oil-producing countries have been living a dream. In recent decades, most oil-producing countries saw their per-capita GDP not only expand but show a rate of growth above the global average. In other words, they were getting rich faster than the rest of the world. In terms of dollar-denominated GDP per capita, as crude prices peaked in 2011 Russia and Kazakhstan outstripped Malaysia and Turkey; Saudi Arabia and Equatorial Guinea nearly overtook South Korea; Kuwait shot ahead of Great Britain, while Qatar rose to rank as one of the three richest nations. The new generation of the petrostates' political elite has come to look on oil rent as a means to achieve all its goals. And yet, many experts will call the oil windfall a curse, not a blessing. A prosperity that is due to the sheer accident of owning large mineral resources rather than to technological prowess, investment and hard work has its downsides, including the degradation of political systems, the throttling of competition and the proliferation of populist fiscal policies.

An awakening from this dream is now inevitable. The future holds challenges for those countries that have cast their lot with the global oil market. There is little doubt that oil's transformation into an ordinary, non-rent-generating commodity is going to change the world.

The Invisible Hand against the Petroleum Leviathan

Over the course of human history many rent-generating commodities capable of enriching their owners have turned into ordinary products. Pricing becomes determined by production costs rather than scarcity value. The readiest example is land, which has seen the rent component of its price steadily decline over millennia and has thus gradually ceased to be the main cause of armed conflicts. Other cases include furs, which generated rent for Russia into the eighteenth century, and natural rubber, which fed the Amazon boom in the early 1900s.

Inevitably, technological progress reduced the scarcity value for many commodities. A rent-generating commodity could also suffer a fall in demand when a less expensive substitute of similar quality comes to the market. The story of natural and synthetic rubber is a prime example.

Another common scenario was when supply increased, such as when previously inaccessible deposits were brought on line or new resource-rich areas were discovered. This was how the exploration and settlement of North America decimated Russia's rent from the fur trade.

Oil is now subject to just such pressures from both demand and supply.

The weakening in oil demand has more to do with technological progress than with the slowdown in China’s economy, which has been the main growth driver for the world economy and oil consumption in the recent decades.

Indeed, economic growth and oil consumption have become more and more disconnected. Over the last fifteen years, average oil-consumption-to-GDP elasticity has been about 0.7 for China and even less for developed countries. A striking example is the U.S. where from 1980-2014 real GDP grew by 150 percent and oil consumption edged up only 11 percent. This is because modern economic growth is increasingly driven by more energy-efficient sectors. Even lower prices fail to boost oil's appeal to consumers who stand to gain more from improving energy efficiency than from saving on oil costs.

Moreover, huge investment has been made in alternative energy, natural gas and electric vehicle R&D. While not all this investment is viable at low crude prices, nonoil solutions in transport, energy and petrochemistry are sufficient to rein in oil-demand growth. These solutions are constantly becoming more efficient and competitive. This means that a business that only yesterday relied on government subsidies to survive will need no state money to make a profit tomorrow, even in a cheap-oil environment.

The supply side has changed even more dramatically. Although much more oil was pumped in 2014 than in 2007, the proven-reserves-to-production ratio increased from forty-nine to fifty-five years over that period. The advent of accessible shale oil alone added 50 percent to proven U.S. reserves. And this was not all “tough oil,” which can be economically recovered only at very high prices. At the start of the current oil market downturn, Moody's estimated that more than half of U.S. shale oil producers would stay profitable at $51/bbl. In the last year, this figure has become much lower. Unremitting competition-induced innovation has enhanced productivity and reduced costs. In fact, production costs at most shale oil wells eventually are likely to decline to $10–12/bbl (in current prices) due to technological breakthroughs.

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