By Pierre Noël, IISS Senior Fellow for Economic and Energy Security
In the October–November 2016 issue of Survival, I defended what was then the minority view among oil commentators: that shale oil was posing an existential challenge to Saudi Arabia. In ‘The New Oil Regime’, I explored the dynamic interaction between Saudi/Organization of Petroleum Exporting Countries (OPEC) oil policy, Saudi economic modernisation and the US shale industry. I concluded that the oil-price collapse that began in June 2014 was not just a correction typical of commodity markets, but rather marked the start of a new era.
This thesis seemed to have been weakened by Saudi-led OPEC production cuts, which helped prop up the oil price. What has been happening since the cuts, however, is exactly what I described in the article: OPEC restored the oil price to a level at which shale production grows steadily. As was the case before the oil-price crash of 2014, US shale-production growth is back at a level where it covers most of global demand growth. Saudi Arabia may be losing its battle with shale, and could eventually face both lower production and lower prices, its crude having simply been replaced by US shale oil.
A recent article in the Financial Times shows that what was once the minority opinion is now conventional wisdom.
The policy dilemma that I identified in the paper is now openly discussed in the press, and was alluded to in an economic break-out session at the 2017 IISS Manama Dialogue. Saudi leaders need to convince their population that the good times are over in order to change expectations and break with rentier-state practices; in the meantime, however, they need steady oil revenues to alleviate the short-term pain of structural reforms. This is very difficult.
The flip side of the new situation brought about by the US shale-oil revolution is that the market has become very reliant on it. At some point the growth of shale will slow down, perhaps dramatically. This could be gradual or brutal, and could come naturally or because of regulatory intervention – perhaps after Donald Trump leaves office. There seems to be little question that the gradual electrification of transport will, eventually, drastically reduce the global demand for oil, but the timing is uncertain. In the meantime, a lot could go wrong on the supply side, as illustrated by the slow-motion collapse of Venezuela into chaos and continued security risks in the Gulf. If the ‘new oil regime’ poses an existential challenge to Saudi Arabia, it still leaves the rest of us to cope with economic-security risks.