Top Economist: OPEC Is Preparing for ‘Long-Term Type of War’
The research chief of Abu Dhabi’s $750 billion investment fund believes the oil cartel will keep pumping, even though prices are low and there’s already too much of the stuff.
American oil producers are reeling thanks to a continued fall in oil prices. Countries such as Iran, Iraq, Russia, and Venezuela are struggling to pay for basic services and desperately want to see oil prices rise again; even rich countries in the Middle East are feeling the pain and tightening their belts.
The culprit? OPEC, led by Saudi Arabia, which made the radical decision last year to keep pumping oil into a market that was already glutted. On Friday, OPEC will meet again to decide whether to double down on its strategy or to cut production and try to nudge oil prices back up. The implications are huge: If OPEC buckles, it would throw a lifeline to beleaguered oil producers in Texas and North Dakota, not to mention Russia. But if OPEC stays the course, oil prices will likely stay depressed for another year.
Ahead of the meeting, Foreign Policy sat down on the sidelines of the Atlantic Council’s Energy and Economic summit in Istanbul with Christof Rühl, 56, the former chief economist at the World Bank in Russia and Brazil and for the oil giant BP. He now heads research at the Abu Dhabi Investment Authority, whose $750 billion in assets make it one of the world’s largest sovereign wealth funds. Below is an edited and condensed transcript of the interview.
Foreign Policy: Is OPEC finally ready to blink, or is the U.S. energy boom about to finally run out of steam?
Christof Rühl: Let’s look at how we got here. The beginning of 2011 to the summer of 2014 was the period with the highest oil prices ever and the period with the most stable oil prices ever. People assumed that was a stable situation, and it wasn’t.
You had this enormous growth in shale production — the biggest organic increase in oil production ever — but it was neutralized almost barrel-for-barrel by supply disruptions in the Middle East and North Africa. You had the Libyan civil war, Syria, Yemen, South Sudan. You had supply disruptions escalating way beyond historic levels and the new supplies almost matching them.
So it was always clear that the system would fall off a cliff. And then in 2014, a little bit more production came back online, from Libya, from Nigeria, from Russia, and prices started coming down. Then there was the OPEC meeting [in late November 2014], where everybody expected OPEC to cut production and restore the natural order.
OPEC’s dilemma was really difficult: Do you cut production or not cut? If you cut, you bring prices back up; that means shale production in the United States continues to grow unabated and OPEC loses market share and loses revenue. If you don’t cut, prices come crashing down and you lose the revenues directly. It was a dilemma because in both cases it would lose revenues. The difference was, not cutting production also had the possibility of limiting shale production and maintaining market share. Economically speaking, that was the rational choice.
FP: So where is the inflection point for oil prices?
CR: The first question, and an absolutely crucial one, is how flexible will shale production be on the way back up? No one knows the answer to that because it hasn’t been tested; it’s never happened before.
The second factor is global demand. Demand growth has been much stronger than expected. That’s partially a price reaction, but there’s a funny substory about China.
When China had the wobbles in the summer, everyone was saying, ‘Oh my God, there goes commodity and oil markets.’ Not true. China has these wobbles because [it is] rebalancing the economy away from overexposure to the industrial sector toward more domestic consumption.
If China is successful at rebalancing, [it] will shift more money toward household consumption. Diesel demand is dependent on economic growth because it’s used for heavy trucking and trains and industry. But gasoline consumption is income-dependent; people earn more money, they drive more. In China, diesel consumption went down, because economic growth went down, but gasoline consumption grew. In other words, these doomsday notions about China collapsing, and oil demand with it, are not true.
And then there’s the question of whether OPEC will blink. My sense is this was a deliberate, strategic decision [to keep pumping despite falling prices], and there is no reason, no indication, that they will blink anytime soon. It’s a long-term game for them, and I don’t see them blinking anytime soon.
FP: But there’s increasing fiscal pressure. The Iraqs, Irans, the Venezuelas are in dire straits. Even the richer OPEC countries are taking drastic steps. Gulf states are trimming civil service salaries, fuel subsidies are being cut back, the Saudis are running deficits. Aren’t low oil prices hitting the rich countries even harder than it appeared a few months ago?
CR: But you could understand the same reactions as preparations for a long-term type of war. That’s what you do early on; you try to clean up the system, make yourself lean.
FP: But how sustainable are these low prices? Beyond just shale in the U.S., it’s terrible news for oil companies looking in the Arctic, in deepwater, in more expensive locations. These could be the first back-to-back years with reductions in oil industry capital expenditure.
CR: The first thing to be cut is the long-term investment of private oil companies. These kinds of cuts show up seven to 10 years later, because that’s how long it takes to build a deepwater platform. This is the old, classical cycle. You have low prices, you cut expenditures, 10 years later you don’t have enough capacity, prices go up, and 10 years later prices crash again. The shale dimension has just added another cycle to it. It’s like having a short cycle inside a long cycle.
OPEC has not forgotten that there is this long cycle as well. If this goes on for two, three, four years, there will be a lack of capacity in conventional oil, making it quite possible for shale to grow without Saudi Arabia losing money. From OPEC’s perspective, or from Saudi Arabia’s, you want to stabilize your market share; if you kill some conventional sources, it’s just the same as killing shale. So will OPEC blink? Probably not. Not in the next two years.
FP: In the past, cheap oil used to spur economic growth. Why didn’t that happen this time?
CR: Four reasons. First, the oil price is not the only relative price that has changed: We also have the huge increase in the dollar. Now, there’s a very simple story when oil prices go down: All exporters lose, and all importers win.
But if you look at the dollar, you can get a much more colorful picture. For example, both India and China win from lower oil prices. But India wins from a higher dollar because it has a flexible exchange rate; China loses from a higher dollar because it doesn’t. Same for the producer side. Russia and Saudi Arabia both lose from lower oil prices, because they get less dollar revenues. But in Russia, you have a flexible ruble exchange rate, so with fewer dollars [the Russians] can translate it into just as many rubles as before for domestic expenditure — they’re not even running a fiscal deficit.
Second, you have this age of deleveraging. The whole theory is based on consumers of oil reaping a windfall, going shopping for a big new TV set, but if you’re busy repaying your credit card, of course, that is blunted.
The third one: All these estimates are based on experiences from the 1980s and 1990s. But now, one thing that has changed is that large importers are becoming large producers themselves. Suppose you’re sitting in Florida and your gas bill falls by half. You’re glad to go out and buy the famous TV. But then you learn that your nephew has just lost his job in the shale industry somewhere, and he may come knock on your door tomorrow. Probably you buy a smaller TV.
And fourth, there has been an amazing improvement in energy efficiency generally and in oil efficiency in particular. Since 1980, oil imports in the U.S. have gone up by 12 percent, but the economy has grown 150 percent — so if you do the numbers, the oil intensity, the amount of oil per dollar of GDP, is down about 60 percent. Same order of magnitude in Europe and in Asia and in China. So that means oil has just become much less important.
Energy intensity is falling everywhere in the world, with one exception: the Middle East. And there’s a related, and important, point with the Saudis. They use up to a million barrels of oil a day for electricity generation in the summer. But that’s over now, with winter coming.
So one point to watch is: What do they do with these million barrels? They could take this million, not produce it, and not worsen the general oil glut. Or they could take the million and export it, making the glut even larger. So that’s an indicator of how radical-minded they are.
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