The Brave New World of Ample Oil

In the oil universe, the September 14^th attack on Saudi Aramco’s oil facilities is comparable to the 9/11 attacks on the twin towers in New York City. Yet, the taking out of half of the Kingdom’s oil output led not to an oil shock but a whimper.

Barely two weeks after the brazen attack, oil headlines were once again dominated by fears of over-supply and falling prices amidst a slowing global economy. Following an initial 20% intra-day price surge after the attack, the benchmark Brent crude oil price quickly retraced its steps back down to pre-attack levels.

The US oil production surge benefits
Asia

The shift from a perceived world of
oil scarcity to abundance has been brought about in an astonishingly short
period of time by the advent of the “fracking” revolution in the US. This
combines horizontal drilling and hydraulically-fracturing shale rock with
high-pressure liquids to extract “unconventional” oil and gas. In the past
decade, US crude oil production more than doubled. By mid-2019, US production was rated at over
12 million b/d, surpassing Russian and Saudi
Arabian output as the world’s largest.

Academic studies suggest that global
oil prices would have been higher by $10 to $50 per barrel higher if there had
not been a fracking boom in the US. Given the scales involved, even with
conservative estimates on the price impact, the US upsurge in unconventional
oil production has probably led to the
biggest transfer of wealth in history. Largely at the
cost of reduced oil revenues to OPEC and Russia, benefits have primarily flowed
to the world’s largest oil markets in the US, China, India, Japan and South
Korea as well as the US unconventional oil producers.

From what was previously expected to
be an inevitable growing dependence on Middle Eastern supplies, Asian oil
refiners are now spoilt for choice. With Europe’s long-declining oil demand
trends, crude oil exports from the Russian Far East, West Africa and Latin
America to Asian markets compete with the traditional large exporters of the
Middle East. While the majority of Asian crude imports are still sourced in the
Middle East, prices are set at the margin by competing crudes from other
regions including the US.

Middle East imperatives for economic
reform

While the US fracking revolution has
benefited Asia’s crude oil importers, it has burdened the Middle East oil
producers. The Gulf states had built up extensive welfare states utilizing
massive oil revenues to support social security, health, education and
government employment programs. The social upheavals since the Arab Spring in
2010 led the Gulf states to further expand the social support programs to
maintain their implicit social contracts with their citizens.

In 2015, the fiscal break-even oil
price for Saudi Arabia – that is the oil price at which the government budget
is balanced — was estimated by the IMF to be
$94.25/barrel while the reference “OPEC basket
price” had plummeted to $49.50/barrel. The situation since has generally been
one of increased
government spending, low economic growth and recurring budget deficits.

The Gulf Arab states are reaching
their limits of tolerance to declining oil export revenues. Low oil prices make
the imperative of economic reforms and industrial diversification a central
concern for the Gulf “rentier” oil states. The risks of a collapse in the
social contract between the ruling regimes and their peoples in the Gulf region
may be remote for now. The spectre of growing populations, unemployed youth and
persistent budget deficits, however, will increasingly concentrate the minds of
its planners and palace advisers.

Oil geopolitics upended

Ever since the historic meeting of
Saudi Arabia’s King Abdul Aziz (Ibn Saud) with US President Franklin D.
Roosevelt on a warship cruiser in the Suez Canal in 1945, the quid pro
quo of the strategic relations between the two nations has been clear:
while the Saudis assured the Western world access to its oil exports, the US
served as the security umbrella for the Kingdom. With its new-found
unconventional oil and gas resources, the US is no more the energy supplicant
in this relationship. Saudi Arabia and other Middle East oil producers still constitute
the world’s major source of low-cost conventional oil reserves. However, their
overwhelming dominance is no longer a defining feature of global oil markets.

In the age of US-led oil abundance, conventional notions of geopolitical risk and perceptions of energy security have been upended. By effectively making the US the “swing” producer in global oil markets, the fracking revolution has weakened the ability of OPEC and Russia to support crude oil prices by restraining output. It may be argued that US strategic interests in the Middle East might wane along with the decline in its energy imports from that region. But it would be a mistake to make too much of America’s reduced dependence on Middle Eastern oil. Containing Islamic terrorism, mitigating the threat of nuclear proliferation and supporting Israel’s defence needs in a volatile region remain strategic foreign policy imperatives.