(Bloomberg Opinion) -- One of the world’s largest energy companies says the era of oil demand growth is dead; a key OPEC producer flouts supply cuts that have rebalanced the crude market; the country with the largest reserves turns pipelines into scrap to upgrade crumbling refineries.
The three events aren’t unconnected. The future of declining oil demand forecast in BP Plc’s latest energy outlook is one in which lower-cost exporters may opt to quietly flood the market, as the United Arab Emirates now appears to be doing. That will drive out production from higher-cost nations in brutal fashion. Those that aren’t able to diversify in time face economic collapse, not unlike the one now forcing Venezuela to cannibalize its own infrastructure to keep the barrels flowing.
To see why, it’s worth looking at how oil producers might hope to make money in a world where crude demand falls by half or more over the next 30 years, as two of BP’s latest scenarios predict. The trick is (in theory) simple: As long as supply drops faster than demand, prices should remain high enough to make a profit, especially for those with the lowest production costs.
The difficult part is coordinating such a reduction in a market where even Saudi Arabia accounts for only 13% or so of production. For the past 60 years, the best answer has been the Organization of the Petroleum Exporting Countries, which groups nations together accounting for about 42% of oil production, or 61% if all 23 members of the expanded OPEC+ body are included.
Still, there have always been deep splits between OPEC’s wealthier, more oil-rich states in the Gulf and its less developed, more populous members in Africa and elsewhere, as my colleague Julian Lee has written.
Those divisions are likely to get deeper once we pass peak demand. The only period in history when oil demand has fallen on a sustained basis — the glut of the early 1980s — caused an economic depression in the Gulf and ructions within OPEC. It ended in a flood of supply from Saudi Arabia that ultimately contributed to the break-up of the Soviet Union, the 1990-1991 Gulf War, Algeria’s civil war and the rise of al-Qaeda. All that turmoil was the consequence of a roughly five-year decline in crude consumption. Imagine the disruption that would result from an oil recession lasting three decades or more.
Set against that backdrop, the largely self-inflicted collapse of the Venezuelan state has been grimly helpful for lower-cost producers like the UAE. A decade ago, the two countries were both producing roughly 3 million barrels of crude a day. Despite production costs that were just $7.65 a barrel in 2016 (the last time it filed accounts), output by Petroleos de Venezuela SA has since fallen about 90% owing to years of under-investment, corruption, debt, sanctions and an exodus of staff. That’s helped tighten the oil market without all the agonizing diplomacy of an OPEC cuts agreement.
This cycle of gluts, lower prices and production declines is how commodity markets typically weather swings in consumption and output. Higher-cost producers shut down operations rather than run them at a loss. More importantly, their future projects get cancelled, reducing long-term supplies to levels more consistent with demand. Lower-cost peers may suffer a squeeze on revenues, but they’ll ultimately survive to prosper through the next cycle.
In oil-market terms, that means pain for countries like Algeria, Azerbaijan, Iran and Kazakhstan, which are in effect high-cost producers thanks to the prices they need to balance their budgets and current accounts. It also means brutal writedowns like those taken or flagged by independent oil companies like Total SA, Exxon Mobil Corp. and Royal Dutch Shell Plc as it’s become clear that higher-cost wells may never go into production. BP’s own promise to cut output by 40% by 2030 is only the most prominent example of this hard economic reality.
Even if the major oil-exporting countries don’t head down a path as grim as that trodden by Venezuela, the consequences could be harsh. Historically, the South American nation has had a far more diverse economy than most OPEC countries, barring Nigeria and occasional members Indonesia and Ecuador. The corruption and mismanagement of Venezuela under Presidents Hugo Chavez and Nicolas Maduro may seem unique — but you’d scan the list of OPEC members in vain for models of good democratic governance.
For decades now, the major oil exporters have talked about shifting their economies away from dependence on crude. Their efforts have fallen far short of what’s needed. Chemical industries tied to petroleum feedstocks; metal smelters dependent on gas-fired power; real estate and finance sectors valued on the basis of oil-derived cash flows; hundreds of thousands of government jobs sucking at the same teat. None represent more than a cosmetic diversification.
The capitulation of independent oil producers to a future of weaker demand should be a wake-up call to governments. If BP and Shell find it harder to survive in a world after crude, life will be even tougher for Saudi Arabia and the UAE.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
David Fickling is a Bloomberg Opinion columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.
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