Stranded fossil states are the next traumatic chapter of the great energy shift
By Ambrose Evans-Pritchard, 12-2-2020
We know what a stranded fossil state looks like. It took five years for the halving of oil prices to defund Venezuela’s rentier petro-regime and reduce what used to be Latin America’s richest country to a humanitarian basket case.
Once the downward spiral began, it became self-feeding and unstoppable. The economy has contracted by two thirds. Nearly five million people have left the country since 2018. It is the world’s largest refugee crisis after Syria.
Brent oil prices today far exceed Venezuela’s extraction costs, but that is irrelevant. What matters is the ‘fiscal break-even cost’ needed to sustain the socialist Chavista machine. The International Monetary Fund thinks this is over $200 a barrel. The Orinoco tar sands - the world’s largest crude reserves on paper - produce high-cost dirty crude that will never be viable in the post-Paris era of decarbonisation. They are worthless.
Venezuela is the first to go of RBC Capital’s ‘fragile five’, but several others are heading towards social collapse and sovereign insolvency. Behind them in this grim parade come the big beasts of the Persian Gulf, and arguably Russia since it depends on fossil revenues to cover 60pc of its budget.
The timing of this massive geopolitical upset is subject to hot dispute. Yet there can no longer be any doubt that the twin-pincers of draconian carbon curbs and plummeting renewable costs will sweep away much of the old energy order, and that markets will bring this forward demolition job soon enough with Schumpeterian ferocity.
“The world still looks more or less as it always was, so it is hard for people to believe that tomorrow is going to be completely different. But things are moving incredible speed,” said Professor Alan Riley, a global energy expert at the Atlantic Council.
“Nobody wants to talk about the geopolitical implications because they are too disturbing. Once it starts we are going to face crises in the Middle East and Russia at the same time. We could see several more Syrias,” he said.
Mohammed Barkindo, OPEC’s Nigerian secretary-general, is fully aware of the threat. I was in the room in Davos when he let rip against the virtue flaunters and the green colonialism of his old Western masters, so blithely willing to consign his country to insolvency with scarcely a second thought. “Here in Europe it is about sloganeering but we live with climate change on a daily basis. For us it is double jeopardy, ” he said, shaking with emotion.
Nigeria is caught between the Devil and desert. Fossil fuels are its fiscal and economic lifeblood. Yet the UN warns that the country is at existential risk of desertification and a water crisis in the North, and floods in the South.
Nothing to do with us? The UN also says Nigeria will be the world’s third most-populous country by 2050 with 300 million people, and what are they going to do if they cannot survive in their own country?
Mr Barkindo’s home-state has made heroic efforts to break its oil curse. It has tried to cut the fiscal break-even cost from $130 to $60 since 2017 yet still relies on hydrocarbon revenues for half its national budget. Austerity has eaten into core infrastructure spending, shutting off the only way out of the economic trap. In the meantime, Boko Haram jihadi terrorists and the Delta Avengers do their worst. So spare a thought for the human casualties of the great energy transition.
The protest reflex of Extinction Rebels and the green movement is so ingrained, and the habit of indignation so strong, that their own success escapes their notice. In reality finance have already bowed to their agenda, and technology has already killed fossil fuels, or at least mapped out a path where this is irreversible. All that remains is the mopping up job by dynamic markets.
In that respect Greta groupies and denialist nutters are almost a mirror image, each hurling insults at the other in an obsolete discussion.
My advice to green friends is to accept your victory and learn to be magnanimous. The task henceforth is what to do about a billion stranded losers - because they are most surely coming your way. My question to denialist friends is why buck better, cheaper technology?
We already know that Nigeria, Angola, Algeria, Libya, Iraq, Iran, are near the front of the line for a decarbonisation crisis. What is new is that the IMF has begun to issue warnings at more than sotto voce volume to Saudi Arabia and the Gulf states themselves.
Its latest fiscal report on the region said that the Gulf's $2 trillion wealth cushion will evaporate by 2034 unless states take radical action, end subsidies, and shrink their exorbitant patronage systems. This timetable is based on the benign scenario (depending on your point of view) of the International Energy Agency and the oil establishment that peak crude consumption remains a faraway threat beyond 2040.
But the IMF also warns that the tipping point could hit by 2030 if there is a global carbon tax rising to $50 a tonne by then, cutting real oil prices to $37 and accelerating the process.
The City has already moved a step further. The London-based Principles for Responsible Investment, a $90 trillion alliance of investment funds, thinks the shock will come by the middle of the 2020s, a view informed by its own market antennae. Electric vehicles will displace 70pc of the world’s car fleet by 2040, and coal will disappear from economic life everywhere.
The premise is that awakened societies will force their leaders to switch to all-out war on climate change within five years, leading to an “abrupt, and disorderly” change in the policy regime. This is broadly my conclusion as well.
The orthodoxy in Riyadh is that even if peak oil demand does arrive soon, it will not make a dent on oil prices and might even cause them to rise. Markets will cut off funding for commercial drilling and shrink supply. Gulf states with national oil companies and the lowest cost of production will be the last ones standing in those circumstances, gaining market share and still enjoying fat rents for decades.
Just as likely is the ‘race-to-the-bottom’ scenario. “If you think that your oil is not going to be worth much, you have to get rid of it now,” said Daniel Scholten, a technology professor at Delft University and author of ‘The Geopolitics of Renewables’.
This is happening in Norway. The government plans to drill like never before in the Barents Sea, raising the country’s total oil output by 40pc in the early 2020s. It is the last chance to extract the wealth for the Norewgian Pension Fund before the window slams shut. Game theory dictates that others must follow, while laggards will end up with stranded assets.
Prof Scholten said we are moving quickly to an unrecognisable global order where there are no longer energy importers and exporters. Most countries will be ‘prosumers’, generating their own needs locally, first with solar, wind, and batteries, and in the next phase with such technologies as green hydrogen. Global energy trade will wither on the vine.
“It is going to get really ugly for the petro-states, and soon. What worries me is that the world will stop caring about the Middle East, and we’ll just have failed states everywhere falling apart,” he said.
Russia may avert a crisis because of its strategic depth and because natural gas is deemed a climate ‘bridge fuel’, though how long gas remains safe is no longer clear. Liquid air batteries have begun to undercut gas ‘peaker’ plants for renewable back-up even in Texas, where gas is more or less free right now.
Nor are all Gulf states alike. Abu Dhabi has been riding both brown and green horses for a long time. It hosts the net-zero city of Masdar. Its sovereign wealth fund ADIA invests in cutting-edge renewables. “They are heavily into things like battery technology and it gives them lead in market intelligence. They are prepared for what is coming and are going to endure for longer,” said Helima Croft from RBC.
Whether the Saudis can make the switch is another matter. The House of Saud’s survival is built on an uneasy concordat with Wahhabi clerics and a cradle-to-grave welfare system that it can no longer afford. “The social contract is ‘we give you money, and you keep quiet’” said Prof Scholten.
Prince Mohammad bin Salman makes the right economic noises, leaving aside the rather large matter of his consular etiquette. But is his McKinsey plan to break oil addiction and diversify into everything from car plants, to weapons production, and a robotic half-trillion dollar tourist city on Red Sea called NEON, just a string of castles in the air? And can a capricious police-state dynasty ever reach authentic technology take-off?
The IMF says revenue tithe paid to petro-states by oil consumers in Europe, America, China, and the around the world has collapsed by $1.5 trillion a year since 2014. The richest have yet to tighten their belt accordingly.
The long view is that rentier petro-states are inimical to democracy, political pluralism, and market creativity. They are inherently corrupt. The sooner they are gone, the better it is for the world and above all for their own people.
Getting from A to B is going to be traumatic.
