Fall in oil demand a troubling prospect for region's exporters

Surely the Middle East is the last place that should be worrying about energy security. Yet if a spate of articles last week is correct, the world's premier oil region needs to be concerned about just that - not security of supply but of demand.

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The Financial Times, The New York Times and the energy guru Daniel Yergin, writing in The Washington Post, all argued that North America could be self-sufficient in oil by 2035.

Ed Morse, Citigroup's head of commodities research, forecasts that US oil imports, now 10 million barrels per day (bpd), might drop to 3 million bpd as soon as the early 2020s.

US oil output has already reversed its long decline, thanks to new technologies for drilling horizontally and fracturing "tight" - impermeable - oil-bearing rocks. This new source joins swelling production from Canada's oil sands, and the massive discoveries in Brazil's deepwater "pre-salt".

The rising tide of production will collide with ebbing demand, as slow economic growth, more efficient vehicles and tougher environmental standards all reduce consumption. Oil use in developed countries will probably never regain its 2005 peak. The controversial thesis of North American oil independence is an increasingly realistic prospect - with serious implications for the leading oil exporters.

Oil represents 5 per cent of US GDP, but 40 per cent of Saudi Arabia's - exposing Riyadh to harm from volatile oil prices far more than Washington. In the previous oil slump from 1986 to 1998, Saudi per-capita income fell from level with Switzerland to barely ahead of Mexico - a drop comparable to the US's Great Depression.

China is likely to lead strong Asian growth. But eliminating 7 million bpd of US oil purchases - more than all China's imports today - would inevitably put heavy pressure on prices by 2020.

Opec was already facing the difficult question of how to accommodate Iraq. Although it will not achieve its ambitious 12 million bpd target, Iraq could still overtake Iran by the end of next year and reach a comfortable second to the Saudis by mid-decade. Libya, security permitting, and a possible post-Chávez Venezuela, would also want to produce more.

The scene is thus set for squabbles over a shrinking pie. Opec itself has created this dangerous scenario. Iranian, Iraqi, Venezuelan, Nigerian and Libyan output remained stagnant or dropped over the past decade because of war, insecurity, sanctions and mismanagement. Yet the other leading Opec producers made only cautious, measured increases in capacity.

When prices rose too high, for too long, they unsurprisingly encouraged the frantic scramble for new supplies in Alberta's oil sands, in the Brazilian "pre-salt", and in the shale rocks under North Dakota and south Texas.

These high prices simultaneously slowed the world economy, fuelled worries about energy insecurity, encouraged heavy investment in "green" alternatives, and led to the tightening of US fuel efficiency standards.

Many major oil producers are now worryingly exposed to a fall in oil prices. Ambitious investment plans and increases in state employment and entitlements have raised budgetary break-even points towards US$80 or $90 per barrel.

Iran's shambolic economy is the most vulnerable, yet not just Gulf Opec countries, but also Venezuela and Russia are threatened.

So what should Opec do?

The cautious response is to freeze production levels and try to defend current prices. It appears this is the chosen route so far.

Khalid Al Falih, the chief executive of the state oil corporation Saudi Aramco, announced last month the shelving of plans to increase capacity to 15 million bpd.

Abdalla El Badri, the Opec secretary general, made clear in Dubai in September that Opec's market share, steady at about 40 per cent since 1993, is planned to remain the same as far out as 2035. The danger here is that high prices just encourage more production, and that the shale-oil boom spreads to countries outside North America.

The bold course would be to reverse the policy of the past decade, and aim at a sustained increase in Opec output to cool off prices. This could stymie further development in high-cost "unconventional" and deepwater oil. It might also slow the long slide in oil's market share, which fell from almost half of world energy on the verge of the first oil crisis in 1973 to just a third by last year.

Yet this policy is also far from certain of success. In the North Sea in the 1980s, and with US shale gas in recent years, production kept rising unstoppably despite low prices. Once the basic techniques are mastered, new oil and gas areas can stay competitive by reducing costs and improving technology.

As the US increases its oil independence, so must Middle Eastern producers - with the energetic and imaginative pursuit of reform. That means economic liberalisation and diversification away from oil; an end to energy subsidies; more private-sector growth; and a transition away from the state as employer of first resort.

*Robin Mills is the head of consulting at Manaar Energy, and the author of The Myth of the Oil Crisis and Capturing Carbon