x Abu Dhabi, UAESunday 23 July 2017

Petro states should note oil's power to fell the mighty

History tells us that oil can go down as well as up, and today's petro-states would do well to plan for all eventualities.

Twice in recent times, seemingly impregnable regimes - the shah's Iran and the Soviet Union - have been brought crashing down by slumping oil prices. History tells us that oil can go down as well as up, and today's petro states would do well to plan for all eventualities.

The papers of Brent Scowcroft shed light on an incident in December 1976, when he was the US national security adviser. Under strong American pressure, and concerned about Iran's growing military power, the Saudi oil minister Ahmed Zaki Yamani announced that his country would not increase prices and would boost its production by 3 million barrels per day.

Iran had bet its oil earnings on a swift push for development, aiming to reach Germany's standard of living within a decade. Asadollah Alam, a close adviser to the shah, wrote in his diary, "We have squandered every cent we had only to be checkmated by a single move from Saudi Arabia".

Inflation had already soared; now spending had to be cut sharply and millions were thrown out of work. By late 1978, the revolution had driven the shah into exile. Saudi Arabia replaced Iran as America's indispensable ally in the Gulf.

The Saudis were again the instigators in September 1985. Tiring of their impossible role as Opec's swing producer, they increased output sharply and prices crashed. Yegor Gaidar, later to be Russian prime minister, described vividly how this undermined the stagnant Soviet economy.

The USSR had to borrow heavily from abroad to buy wheat. When protests ignited in eastern Europe in 1989, the western countries conveyed to Mikhail Gorbachev that should the general secretary of the Communist Party use force against the demonstrators, he would not receive the US$100 billion (Dh367.3bn) in loans required to keep his economy afloat. The Soviet empire crumbled and, in August 1991, it ceased to exist.

For several years, oil markets have been following a narrative that Asian demand will continue to grow rapidly, conventional oil supplies are in decline, and hence Opec can effectively defend high - and rising - prices. Several major oil producers are increasingly gambling their economies and foreign policies on this scenario - which is just one possibility.

In Russia, the apparent strength of the Putinist model conceals deep weaknesses of corruption, under-investment and a public-health crisis. Iran's non-oil economy is feeble, racked by inflation and statism, while its petroleum industry limps along. Saudi Arabia is burdened by spending on subsidies, armaments, unproductive job creation, and political and financial support to governments in neighbouring Bahrain, Yemen, Oman and Egypt.

Iraq runs large budget deficits, but progress on postwar reconstruction is dismally slow, while Algeria suffers from high unemployment and a rigid bureaucracy. Venezuela's poor needed the social initiatives championed by Hugo Chavez, the president, but in the process, oil production has been decimated by strikes and neglect, foreign investment has been chased away and the economy undermined by power cuts, inflation and the flight of the middle class.

Saudi Arabia is thought now to need about $83 per barrel to balance its budget - according to an estimate from the Centre for Global Energy Studies. Credit Suisse puts the break-even price for other oil exporters at $85 for Algeria, $100 for Iran and Russia, and $110 for Venezuela. Yemen, a small, declining producer beset by near-civil war, needs $200 per barrel. History indicates that as high as the price of oil rises, these countries spend more.

Exporters' need for oil prices to stay high does not mean they will. What could trigger another oil slump? There are a number of factors, most likely working together. Most serious would be an economic slowdown in China, perhaps triggered by a bursting of its investment-led growth model, identified as a risk by the Dr Doom of economists, Nouriel Roubini.

More efficient vehicles, hybrid and electric cars, and the use of biofuels and natural gas mean that oil demand from the mature developed countries is probably entering a long, slow decline, and per capita use in India and China will never approach western levels.

The current high oil price is due in part to the loss of Libyan supply, which could be reversed relatively quickly. Iraq's grand plans to produce 12 million barrels per day are improbable, but its vast reserves present Saudi Arabia with a viable Opec challenger for the first time since the 1970s.

Despite declines in some mature producing countries, the stunning discoveries in Brazil's "pre-salt" area, oil from US shales and Canadian oil sands, the emergence of new producers in Africa and an intense period of worldwide exploration suggest that non-Opec production can keep growing.

Some oil exporters are fiscally better off than others. Kuwait, the UAE and Qatar can weather lower prices. Saudi Arabia and, to a lesser extent, Russia, Azerbaijan and Kazakhstan, have substantial savings, which will, however, be quickly depleted in a crisis. The others can only hope they do not relive the fate of the shah and the politburo.

Robin Mills is an energy economist based in Dubai, and author of The Myth of the Oil Crisis and Capturing Carbon.