Implications Of Our Global Nationalized Oil Market
A lot of people are excited these days about the growing diversification of the international energy sector. The potential (arguments for which often overlook the misleading promises) of American or North American energy independence has had people excited for over three years now, and for many the excitement grew with the now-famous International Energy Agency (IEA) prediction that the US would become the world’s largest oil producer by 2020. Missed among the frenzy, however, is a growing reality that the diversification of the market is likely to lead to increasingly distorted markets: just as a group of states monopolizes the oil market, the collection of state-owned oil companies is nearing almost total control of global oil and gas reserves.
Oil is priced on a single global market that requires US military protection to function property, so de-linking US oil prices from the global price and de-linking American involvement in the Middle East are impossible feats no matter how much we produce at home. The global market is run by a cartel called the Organization of the Petroleum Exporting Countries (OPEC), which distorts energy markets and wreaks havoc on the global economy by conspiring to mitigate market forces, regulating their collective production which represents about 40% of globally traded oil. The US hates to need these countries because of the costs they impose on us due to our reliance (and that of the global economy) on oil. Greater US oil production and, indirectly, natural gas production, is exciting because it means we may be able to wean ourselves off OPEC’s oil. Unfortunately, however, we cannot wean ourselves off OPEC’s impact.
While fracking or horizontal drilling sit excitingly at the center of the diversifying energy sector, a spoiling force is lurking: global oil and gas are increasingly controlled by national oil companies (NOCs). In the 1970s, NOCs controlled less than 10% of global oil and gas reserves. It was the “Seven Sisters,” a group of seven integrated oil companies (IOCs) (non-nationalized companies), who controlled 85% of the global total at that time. By 2012, however, NOCs were controlling as much as 90% (estimates vary, but most fall in the 80-90% range). Only four of the Seven Sisters remain, and on the list of the biggest 25 oil companies today none cracks the top three. In fact, only 6 IOCs crack the top 25. Since 2006, oil production by the five largest IOCs (the “supermajors”) has actually decreased by 2%.
The story of this transformation is a fascinating one, and it will be detailed to great length in a separate piece. IOCs have become disadvantaged in nearly every aspect of their industry, from reduced access to resources to lesser access to more expensive debt to more regulations. The result is that it is hard to look beyond the medium term when analyzing the state of IOCs – they very well may not have long-term prospects. The process of moving from an IOC to an NOC-dominated market has been largely the result of the power of governments to set up their NOCs for success, itself a decision based on economic needs and desire for greater power on the world stage.
This dramatic shift will be very problematic for the US and the global economies. NOCs first and foremost serve the needs of their parent countries, who use their role as energy producers to steer the global market towards an equilibrium that meets their political and economic needs.
The price of oil has been de-linked from the standard supply and demand components since the 1973-1974 oil embargo when the member states of OPEC decided, really for the first time, to wield their collective power. Although at the time the decision to cut production was based on the desire to punish the West for its support of Israel, the two lessons they learned were first that they could not afford to not sell to the West, and second that by conspiring they could essentially determine the world oil price. This realization meant a dramatic increase in revenues going directly to the state governments, helping them consolidate their domestic and international power. Oil prices have yet to re-linked with supply and demand, and oil price volatility, one of the most destructive economic forces in the world, is one byproduct of the disconnects between supply and demand.
In more fundamental economic terms, the closer states can keep revenues the more control they will have over the market, and the more adventurous their governments can be at home and abroad. While OPEC has for decades controlled supply and therefore heavily influenced prices, a good chunk of the revenues were sent outside the country. This is decreasingly the case as producing countries consolidate their production among their NOCs and NOSCs.
As energy wealth concentrates among the producing states with NOCs, these countries will further consolidate their control over supply and minimize the amount of players competing in the market. Further, while relations between many oil producing states are far from perfect, state-to-state relations among the oil producers, as seen with OPEC, can be good enough to cause trouble for the market. As NOCs take over control of oil and gas production and reserves worldwide, they do so merely as extensions of their parent governments and become those governments’ “people on the inside.”
This consolidation of oil under governmental banners means that the effects of oil price shocks are more likely to be passed on to consumers. Many of the oil exporting governments who rely on oil revenue to run their countries require an increasingly high fiscal breakeven point for oil, some of which are pressing up against today’s market price. A positive price shock would push up prices, giving states reprieve. However, positive shocks tend to have a medium turn negative effect on demand and eventually price, and these states cannot afford to lose money on their oil.
The volatile nature of the oil market means the ability for states relying on oil revenues to plan long-term is very limited, and it has stunted the economic growth in those places where energy is the main source of revenue. This drives up the cost of government, and as the cost of running oil producing countries gets passed on to the consumer in the oil importing country, production costs increase and output becomes restricted in those places. Knock-on effects include employment levels, the trade balance, inflation, public accounts, stock market prices, and exchange rates. Meanwhile, household spending shifts to accommodate greater expenditure on gasoline, cutting the amount people can save, invest, or spend on other consumer goods.
Oil producers try to avoid negative price shocks for a fairly obvious reason: a cut in production means lost revenue. For that reason, the only real threat of such a shock comes from political events, natural disasters, and the like, an obvious example being the loss of Libyan oil in 2011 during the international intervention. When these events occur, producers with spare capacity (namely Saudi Arabia) pump more to keep the market afloat. However, as NOCs direct more oil revenue to the home government, the incentives to cause negative shocks elsewhere grow. In this sense, security stability is threatened by the growth of NOCs.
Based on our experience with OPEC, the fledging state of the IOCs, and the growing scope and reach of the NOCs, the countries with the best chances of being empowered by the trends are likely to perpetuate the distorted nature of the global oil market and perhaps exacerbate it. This would strain the global economy and raise the risk of political and economic instability across the world.
Unfortunately for the economically and politically liberal part of the world, the list of the largest NOCs suggests trouble. Among the top-twenty-five are NOCs from Saudi Arabia, Russia, Iran, Venezuela, and China. Common characteristics of these states include a propensity for protectionist and anti-competition measures that aim to self-serve with little regard for the effects to the global system. This includes not just economics, but also geopolitics. The next set of countries are those whose dedication and contribution to the global public good are suspect: Kuwait, the emirate of Abu Dhabi, Algeria, Iraq, Qatar, Nigeria, and Malaysia. The remaining two, Mexico and Brazil, can safely be considered “on our side.”
The motivation (and for some, the need) to produce will be there for the NOCs and their parent countries, and therefore the market will maintain a decent level of supply diversification, at least in terms of today’s market. It will therefore be around the policy margins where countries with NOCs will take actions that will harm consumers (and especially the large importers), whether intentional or otherwise.
A cautionary tale is the decision the Saudis have made for nearly four decades to under-invest in production. As a result, Saudi production has not risen in a meaningful way since the 1970s. This has been an active choice the Saudis have made to ensure supply remains tight and, therefore, prices remain at a level above the Saudi fiscal breakeven price, which is growing quickly to scary levels. It is also a decision influenced by the desire to maintain an influential position in the community of nations for the indefinite future.
The Saudis own 20% of the world’s proven reserves, the largest of any country, but they produce less than 13% of world supply. No other country comes close to the magnitude of that reserve to production ratio, and it gives them the flexibility to not only have perhaps the most influential position in the global energy market, but also the ability to complicate energy efforts of many other countries. The projection that the US would out-produce the Saudis by 2020 distracts from the fact that America’s reserves constitute just 2% of the global total. If the Saudis decided to become serious about even a fraction of their untapped reserves, the economic incentives may no longer line up for the US to achieve the top spot for those five years, or even reach that position at all.
Another example in the making is China. If you’re a Sinophobe, China’s globally expanding control of oil and gas is scary. China’s international presence is viewed with great suspicion because many feel the country’s government is self-serving in ways that seriously harm the rest of the world. Depending on the extent to which this is true, the increasing presence of Chinese NOCs in foreign countries add a very influential policy tool to the Chinese toolbox.
Similarly, the spoiler reputation Russia is earning as an actor in the international community is a cause for concern in the context of the country’s energy power (it is the third largest supplier of oil in the global market). Russia’s NOCs’ production has grown as their championing by the federal government has reached new heights on the increasingly important revenue they generate for the state (and the oligarchs). Russia’s suppressive domestic policy and obstructive foreign policy are largely funded by this revenue, and so long as Russia keeps churning out oil the country will continue to be able to pursue that role many feel harms the good of the world.
The repercussions of an NOC-dominant energy market are, to be fair, far from determined. The ideas put forth in this piece, however, suggest that we have much to lose from their growing dominance: from an economic perspective they perpetuate the government monopolies that distort markets and raise costs for business and households, and from a foreign policy perspective they complicate relations while empowering some troubling actors. There is little that can be done to confront these issues by the US or other oil-importing countries except for one very big move: ending our reliance on oil. So long as our economy runs on the commodity, we are beholden to the movements of the oil market, which are guided by the producers and suppliers. And given the way these two groups are merging, we need to take on that challenge immediately and pursue it aggressively.