It’s a race to failure between rogue states and global oil output

Saudi Arabia is the classic example of how striking oil can be a blessing and a curse. An item in Forbes earlier in the month, “Saudi Arabia's House Of Cards”, peels back the veneer. It cites an open letter to Saudi royals allegedly written by dissident prince Turki bin Abdul Aziz Al Saud, a prominent exile in Cairo. In this the prince supposedly states the government is no longer able to contain grassroots discontent, and that his fellow royals would be advised to flee before the masses "cut off our heads in streets". (A June 14 edict by the Saudi Press Agency claims the prince told them this letter was “fabricated by enemy parties wishing to spread confusion and excitement” - which seems, as far as I can tell, to be an implicit warning to the domestic media that reporting on the item will result in a rather swift visit from Saudi security forces.)

The Forbes article quotes from Matthew Simmons’ peak oil classic, Twilight in the Desert, with questions of just how much longer the highly secretive state can go on as the world’s major oil producer considering “no major new energy fields have been found in Saudi Arabia since the 1970s, and the chances of such discoveries are now, in Simmons' words, ‘remote’”. But, stark as this may be, it’s followed by the sucker punch: Saudi Arabia doesn’t have to run out of oil to face collapse, “thanks to the country's ballooning entitlement class”. It states:

The actual size of the Saudi royal family is subject to some debate, but informed estimates a few years ago placed the number at more than 30,000 members, with some 4,000 princes each afforded a luxurious monthly stipend of tens of thousands of dollars apiece. And because of officially sanctioned polygamy, their ranks are swelling exponentially, projected to reach 60,000 or more by 2020. Needless to say, their allowances, and the attendant extravagant indulgences, are possible solely because of Saudi petrodollars. All of which has prompted an insatiable appetite for ever greater production and consumption of the Kingdom's lifeblood.

Meanwhile, life is getting tougher for “an impoverished underclass” - essentially, everyone else outside the royal elite. It states: “Since the oil boom of the 1970s, per capita income in Saudi Arabia has constricted precipitously, falling from $28,000 in the early 1980s to below $7,000 in 2001.”

According to a separate Bloomberg item, “Saudi Arabian inflation accelerated to a 13-month high in June as housing and food costs increased in the largest Arab economy”.

The Saudi government cannot afford for the global economy to slip further, cutting both the volume of its own oil exports and prices per barrel. Theirs is a very expensive place to run.

The geopolitical implications of all this are staggering. Saudi Arabia, which has been accused of having a greater involvement in the 9-11 attacks than most realise and has shown subsequent “indirect troublemaking in Iraq and Afghanistan,” has long been a source of regional instability. But that will be nothing as to the turmoil that will unfold from any domestic upheaval, such as an Iranian-style revolution (upheaval in that country, in 1979, caused the second energy crisis of the decade, mitigated somewhat by the Saudis increasing output). Groups like al-Qaeda have long been “highly critical of and violently opposed to western influence within the country”, especially its close relations with the US, and are reportedly working to bring about revolt.

What, then, would an Islamic revolution in Saudi Arabia mean to the oil consuming world? In the immediate term, supply would cease, due to the domestic turmoil. And beyond that, there’s every reason to believe the new government would be less inclined to export so much oil to the West. This is, in effect, the nuclear option. As far as the rest of the world is concerned, there is not enough alternative oil to go around; right now a Saudi oil embargo would bring the economies of many Western nations to a grinding halt. It’s all due to diminishing surplus production capacity.

A June Bloomberg report, Oil Price Swings to Worsen as Spare OPEC Capacity Shrinks: Energy Markets, stated that “OPEC’s shrinking spare production capacity increases traders’ concern about supply shortages”. This states that output of non-OPEC oil is unable to keep up with global demand, putting more and more importance on OPEC’s ever dwindling spare capacity. It states:

OPEC, supplier of 40 percent of the world’s oil, pumped 29.4 million barrels a day in May, with capacity of another 5.5 million barrels idled, according to data compiled by Bloomberg. The group’s spare capacity was as low as about 2 million barrels a day in July 2008, when oil prices peaked, before tumbling as the global recession crimped energy consumption.

Spare production capacity will drop as supplies from outside the group fail to keep up with demand, according to the IEA. The agency estimates world oil usage will rise 6.4 percent by 2015 to 91.93 million barrels a day, while output, excluding OPEC crude, will increase 3.7 percent. That means the world will need more of the group’s oil to meet demand.

This seems to be saying that, as world energy demand creeps up - earlier last week China was confirmed as the world's biggest energy consumer, burning more energy than the US - the key figure to watch is OPEC’s surplus capacity. To which I’d add that, to all intents, the term diminishing spare production capacity can be used interchangeably with peak oil. If OPEC’s surplus cannot meet demand, we will surely have passed the tip of Hubbert’s peak, and find ourselves on the downslope - which is when the market turmoil and recession sets in.

But things could get difficult a lot sooner than that. It doesn’t require the physical limits of the Earth’s oil to have been reached - reserves are now low enough that domestic turmoil at any one of the major oil producers will have the same unfortunate results to most of the world. As Bloomberg states:

Saudi Arabia accounts for almost 60 percent of OPEC’s spare capacity, according to Bloomberg estimates. The country is investing as much as $30 billion on new supplies over the next five years to keep a minimum 1.5 million to 2 million barrels-a-day of spare capacity, Oil Minister Ali al-Naimi said in a May 18 interview with consultant Petroleum Policy Intelligence.

“Markets are sensitive to when OPEC spare capacity starts getting down toward 3 million barrels a day,” according to Wittner of Societe Generale. Should supplies be disrupted from a producer such as Iran or Nigeria “there would not be much left after that,” he said.

Reading between the lines, it’s all a delicate balancing act. The rogue states that produce oil are now key players in this geopolitical game. At the same time, we are relying more and more on OPEC output, as this is where the world’s largest accessible reserves are. And OPEC output is more and more dependent on Saudi reserves. Even without some calamity befalling global basket cases like Nigeria or Venezuela, we are desperately reliant on two distinctly plausible possibilities not happening: Saudi output dropping, or the Saudi economy being plunged into chaos for some internal economic or political reason.

It’s a race to failure. But, then, that’s the reality of betting everything on a non-renewable source.