hms iron duke

hms iron duke

Thursday, 14 January 2016

The Strategic Implications of Low Oil

Alphen, Netherlands. 14 January. My VW is so old it does not know how to cheat. However, it knows how to drink. Yesterday, I went to my local petrol station to fill up. Here in the Netherlands this normally involves disbursing the GDP of a small South Pacific economy  to sate my car's petrololism. Not any more. For the moment Western consumers are gorging on relatively low petrol prices as Brent Crude this week went below the previously unheard of $30 per barrel. Last year alone Americans spent some 17% less than 2014 on energy, whilst many Europeans benefitted by a 10% reduction. However, not everyone is a winner. So, what are the strategic implications of low oil?

It would be easy to suggest that low oil has shifted the balance in a world that since 1973 has essentially been divided between oil producers and oil consumers. However, OPEC, or rather its dominant member Saudi Arabia, plus the five other oil-producing states of the Gulf Co-operation Council, have prevented such a neat and dangerous division by managing oil production so as not to damage the economies of their main Western customers too much during economic downturns. Indeed, that is why the West turns a blind eye to some of the more 'conservative' views and actions of Riyadh in particular.

Furthermore, with China emerging to drive much of world economic growth since the 2008 crash Beijing's insatiable need for oil for a time sustained the kind of oil prices that made President Putin believe that Russia could again become a nauseating world power. Some people who live on a well-known rock stuck on the end of England even fantasised about independence and a new sovereign wealth fund based on an artificially high oil price.

However, those days are for the moment well and truly over. The massive rise in US shale oil exploitation and China's economic downturn, the increase in production of states like Iraq, and the pending return of Iranian oil onto the official oil market, all suggest more supply than demand for some time to come.

Good news? Not entirely. Several of the world's most precarious states are one-shot petro-economies that rely on the oil price hovering around the $60 per barrel mark simply to survive. They range from a dangerously hydro-carbon dependent and increasingly nationalistic Russia, to a Middle East in which many of the states are built around super-rich but unaccountable elites that use oil wealth to buy off opposition, but who have singularly failed to reform archaic governance practices, or invest in future societal balance.

Beyond the Middle East there are populous, poor and often corrupt states such as Venezuela, Nigeria, and Yemen for which the loss of oil income exacerbates existing profound tensions between rulers and ruled, and between the rich and the millions of poor who live therein. Worse, relatively high oil wealth has fuelled a worst of all worlds imbalance between economies and societies. Whilst there has been enough oil wealth to fund basic health systems that have helped, for example, to reduce infant mortality rates (a good thing), the insecure poor have continued to have large families to hedge against a return to deep poverty.

Critically, if low oil persists precarious states will become fragile states, and in time some may well fail. Indeed, several already have failed, most notably Iraq, Syria and Yemen. Whilst the list of precarious states will also grow and may begin to embrace some of the major Asia-Pacific producers.

In such circumstances the tensions between rulers and ruled will grow and, as none of the states mentioned above can be in any way described as liberal democracies, instability would inevitably lead to conflict. Indeed, an already fragile state structure across the Middle East and North Africa is already in danger of collapse, war, or both. History is all too eloquent about such moments. Prolonged economic downturns generate nationalism, sectarianism, poverty, and of course mass uncontrolled, irregular migrations.

There is another factor to throw into the mix; technology.  Past downturns have been tolerated because oil producers were safe in the assumption that come the good times the petro-dollars would once again flow. To manage boom and bust they would use extensive sovereign wealth funds to ease peaks and troughs in income and/or lived on the returns on the huge investments made in places like London. However, current low oil is also likely to see an historic and pivotal twenty-first century shift towards a low-hydrocarbon global economy. Paradoxically, low oil might see the shift slow but it will remain a future trend.

Therefore, if the danger of state collapse across much of the world's midriff is to be avoided it is vital major producers and consumers come together to consider how petro-economies can be better future proofed against the very different world that is coming. If not, and as usual leaders sacrifice long-term strategy for short-term politics and economics, the shock of a coming collapse in key regions will be rendered even more dangerous than it is now.

Power as always is about the interaction between those with wealth and those not, between winners and losers. Still, it is hard to see any real winners if low oil persists indefinitely.

Julian Lindley-French


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