The puzzle of low oil prices
By James Rowe, March 8, 2016
Has the race to beat the carbon bubble already begun?
THE WORLD'S LARGEST PRODUCERS of oil, Saudi Arabia and Russia, agreed to a production freeze in February 2016. This deal holds production at the near-record highs that were reached in January in an effort to stop the plunge in world oil prices. But even if other key producers like Iran and Iraq agree, it won’t address the supply glut that has been driving prices into the ground.
Saudi Arabia could be doing more to orchestrate a production cut, and the Saudis would certainly benefit from a price bounce—the Kingdom ran a budget deficit last year of nearly US$98 billion. So why is the House of Saud content to keep the world swimming in cheap oil?
The motivation for Saudi Arabia’s passive response to the price crunch is the source of much speculation, but the consensus is that the Saudis are working to protect market share—primarily by driving high cost ‘unconventional’ production like US shale oil out of the market. There is a larger force, however, that has not received enough attention in efforts to divine Saudi intentions: the ‘carbon bubble.’
What is the Carbon Bubble?
The carbon bubble refers to the overvaluation of fossil fuel companies and petrostate treasuries given the need to rapidly reduce C02 emissions if catastrophic climate change is to be averted. “Catastrophic” is the technical term for predicted climate change if global warming cannot be limited to at least 2 degrees above its present level.
The International Energy Agency estimates that 60 per cent of known fossil fuels need to stay in the ground to avoid breaching that limit (even more if the 1.5-degree target codified in Paris is used). The earth’s carbon budget (or what can safely be burned) is much smaller than the fossil fuel reserves that are available for extraction and combustion. According to the Carbon Tracker Initiative we have five times more reserves than can be burned.
However, these unburnable reserves are already factored into company share prices and budget projections for petrostates like Saudi Arabia. When policy making catches up with ecological necessity, these reserves will become financially worthless and the carbon bubble will burst. Recent climate policy deals in Alberta and Paris are only the beginning of a tightening policy environment for fossil fuel producers.
Given the massive wealth and influence of fossil fuel companies it would be naive to count on political and economic institutions to legislate for planetary liveability without massive popular pressure. Thankfully that pressure is growing daily. Powerful examples include proliferating divestment campaigns, Indigenous-led resistance to pipeline construction in Canada, and 350.org’s campaign against the Keystone XL pipeline.
The existential threat posed by climate change is giving these activist efforts an urgency that it would be risky to bet against. “We are not defending nature, we are nature defending itself” was a slogan popularized on the streets of Paris during recent United Nations climate negotiations.
In this context of accelerating climate change and mounting popular protest, the hands of legislators are likely to be forced. When legislation aligned with a 1.5-degree world comes into effect, the carbon bubble will drop back down to earth.
Peak demand and the carbon bubble
Traditionally, the Organization of Petroleum Exporting Countries OPEC) has coordinated production levels to stabilize oil prices. But in this case Saudi Arabia, OPEC’s most powerful player, has resisted calls for cuts and has convinced its Persian Gulf allies to do the same (the United Arab Emirates, Kuwait and Qatar). The evidence suggests that the carbon bubble is central to Saudi Arabia’s decision making.
US State Department cables released by WikiLeaks reveal a Saudi regime that is worried about the impact of climate legislation on national income. Eighty percent of the Kingdom’s budget is derived from the petroleum sector, so the prospect of not being able to sell the country’s vast oil reserves due to global emission limits poses a massive economic and political threat to the ruling monarchy.
“Saudi officials are very concerned that a climate change treaty would significantly reduce their income,” wrote the US ambassador to Saudi Arabia in a memo in 2010. As global concern over climate change intensifies, the Saudis have begun factoring in the reality of peak demand.”
In 2013, before oil prices started tumbling, Ali al-Naimi, Saudi Arabia’s petroleum minister, told reporters that “demand will peak way ahead of supply.” In the lead up to climate negotiations in Paris, he acknowledged that “in Saudi Arabia, we recognize that eventually, one of these days, we are not going to need fossil fuels. I don’t know when, in 2040, 2050, or thereafter.”
This admission is aligned with the scientific consensus on climate change. What makes it remarkable is that the comment comes from the oil minister of the world’s preeminent petrostate. The Saudis have snapped out of denial and are actively working to diversify their economy and plan for a post-carbon world. According to Naimi, the Kingdom plans to become a “global power in solar and wind energy.”
Saudi Arabia does not, however, deserve congratulations. Like corporate producers of oil such as Exxon, the Saudis have played a dangerous and obstructionist role in climate negotiations. Saudi Arabia has been a regular winner of the “fossil of the day” award from civil society groups at UN negotiations. The leaked cables from the US State Department reveal frustration over the Saudis’ “schizophrenic” approach to climate change: aggressively pursuing market share in renewable energy while simultaneously blocking international negotiations.
It is in Saudi self-interest to extend the age of oil. Given the ecological necessity of a massive energy transition, however, the Saudis appear to be positioning themselves for the next best option: gobbling up as much of the earth’s remaining carbon budget for themselves before the bubble bursts. Isn’t it better to sell at a lower price than to receive nothing at all from vast unburnable reserves?
Cutting a big slice of carbon pie by keeping oil prices low
The production cost for a barrel of Saudi oil is approximately US$10. ‘Unconventional’ sources like tar sand oil cost approximately US$40 to produce. With oil currently trading at around US$35 per barrel, Saudi Arabia is much better positioned to manage the downturn than unconventional producers. With large financial reserves the Kingdom can sustain short-term losses in revenue. Moreover, Saudi efforts to pursue large budget cuts show a commitment to a low price environment (though popular unrest over austerity budgets may change this calculus).
By keeping prices relatively low and outcompeting higher-cost producers, the Saudis not only protect short-term market share. They also ensure that by the time demand shocks arrive, the Kingdom will have sold what it could while its reserves were still burnable. And if Minister Ali al-Naimi’s surprising vision comes to pass, by midcentury the Saudis will diversify into competitive producers of solar and wind power.
The current downturn in oil prices does not appear to be slowing growth in renewable energy. Increasing cost-competitiveness and the different markets served by renewables have been key buffering factors during the petroleum price crash. In the long run, according to Naimi, solar is “more economic than fossil fuels.”
Government legislation that forces producers to keep fossil fuels in the ground is supposed be the needle that bursts the carbon bubble. The looming threat of that legislation, however, may have been enough to start the bubble’s deflation already. All commentary on Saudi motivations during the current price plunge is speculative, but Saudi Arabia’s concern over peaking demand due to climate change, along with its heavy investments in renewables, points to a strong link between a low oil price and a deflating carbon bubble.
What a deflating carbon bubble means for citizens, governments, and investors
If “peak demand” is a central part of the Saudi calculus, then a big rebound in oil price is unlikely anytime soon. The implications of this prospect are enormous. For example, with persistently low oil prices, regions betting on Liquified Natural Gas (LNG) and shale oil as economic drivers will lose out.
Similarly, new pipelines for transporting Alberta tar sands oil to market (like Energy East) may become unnecessary due to slower growth. The economic argument against unconventional oil and gas development just got supercharged.
On the financial front, low oil prices mean that falling share prices among fossil fuel companies are unlikely to rally over the long term. When the carbon bubble collapses completely these investments will fall still further. By betting on a post-carbon future and initiating the carbon bubble’s deflation, the world’s primary petrostate has fortified the economic case for fossil fuel divestment. Institutional investors like the Rockefellers Brothers Fund that have recently divested their portfolios of fossil fuel companies have already benefitted from the move.
Working to avoid catastrophic climate change can feel hopeless in the face of corporate-funded denial and obstruction. But the collective efforts of activists, climate scientists, and educators appear to have convinced the world’s largest producer of oil that fossil fuels have no future. The post-carbon world is fast emerging from the shell of the old. Those still in denial about this transformation are in danger of becoming fossilized themselves.
James Rowe is an Assistant Professor of Environmental Studies at the University of Victoria in British Columbia in Canada. He is a member of the Corporate Mapping Project, a research alliance investigating the power of the fossil fuel industry in Western Canada. This article was first published by openDemocracy.