Oil prices have been dropping dramatically over the past few months. The shift is generally attributed to an increase in global oil output after the emergence of new players in unconventional oil production — namely, shale oil in the United States and tar sands in Canada — and a sluggish global economy.
Producers might have limited control over the second factor, but they can make adjustments to the first. But last week OPEC, led by its most influential state, Saudi Arabia, decided to maintain current levels of production. The decision was strongly opposed by other members, including Iran and Venezuela, and led to an almost immediate price drop.
While the decision not to try to force prices back up through cutting supply may seem counterintuitive, maintaining oil production levels is a good long-term strategy. The decision puts pressure on U.S. shale oil extraction, which can’t produce as cheaply as conventional petroleum production.
Estimates on the break-even price of shale oil vary, with most sources agreeing that production is still economically feasible at current prices. What low prices do, however, is discourage investment in new drilling sites that would further erode OPEC’s global market share (currently about 40 percent). Meanwhile, other oil sources, such as deep-water drilling and tar sands, are left even less attractive to potential investors.
This appears positive for the Gulf in the long term. A decision to induce higher global prices by cutting production would likely have resulted in budget surpluses for OPEC members and all the benefits that come with it. But these short-term gains would encourage more global investment in unconventional oil extraction. Furthermore, higher oil prices would encourage research in renewable technology, hastening the gradual but inevitable shift toward alternative energy use around the world.
This shift, while necessary for the sustainability of our planet, will certainly put great pressure on the economies of oil-exporting states. Not driving up oil prices also supports greater global economic growth, which would result in growing global energy demand, benefiting exporters.
The decision for certain OPEC members, namely Saudi Arabia and its Gulf allies, to oppose decreasing production may be motivated geopolitically by the desire to reduce the immediate fiscal revenue for Russia and Iran. Both countries are longtime supporters of Bashar al-Assad’s regime, while Saudi Arabia is backing Syrian opposition movements. Since long before the outbreak of civil war in Syria, Saudi Arabia has regarded Iran as its primary regional rival and likely views any financial pressure on the Iranian government as a victory, especially in light of the possible rapprochement between Tehran and the West over Iran’s nuclear program.
Despite the potential geopolitical gains, the sense of growing anxiety that typically follows long stretches of low oil prices is beginning to set in once again in many Gulf countries. While it is true that Gulf states have much less to lose with low oil prices than countries such as Iran, Iraq, Venezuela and Russia, fears of a budget deficit in some Gulf states, namely Saudi Arabia, may put pressure on governments to reduce spending and cut back on social programs.
This is particularly worrying to those that regard such programs as at the heart of the rentier social contract that exists between Gulf citizens and their governments — an acceptance of the political status quo by the citizenry in exchange for a comprehensive government patronage system funded by oil revenues. Ironically, however, this shift may be good for the Gulf, particularly over the long haul. While global demand for oil is projected to continue increasing for several decades as economic development and growth continue in developing countries, it is likely that OPEC’s share of the world energy market will diminish at faster rates over time because of more fracking in the U.S., continued increases in natural gas consumption and the growth and affordability of renewable energy.
Gradual yet manageable declines in the global oil market will force the Gulf states to acclimate to this reality and to set in place policies that will modify their citizens’ acceptance of a more realistic social contract, in which amenities and subsidies are at least partly reduced. Low oil prices create incentives to finally implement policies that would lay the groundwork for more sustainable and diversified economies. Investments in renewable technology and infrastructure for domestic use that would free up greater amounts of oil for export could finally be regarded as feasible on a grand scale in these countries.
Already in Kuwait, subsidies for diesel, kerosene and aviation fuel have been eliminated. But other heavily subsidized commodities, such water and electricity, remain unchanged for the time being. These policies need to be altered. And there is no better time to make these changes than when oil prices are low. Today’s conditions could foster the sense of urgency necessary to curb consumption and reckless spending, promote efficiency and drive sustainable development.
If low petroleum prices are part of a permanent trend, better for the Gulf states to make the painful yet necessary structural reforms sooner on their own terms rather than have those changes imposed on them later. The entire region would benefit if policymakers have enough vision to reshape oil economies for the 21st century.