The boom years of big oil are over. For decades, the oil industry has fuelled a relentless pursuit of economic growth, but this is changing. Oil demand growth is set to slow before it plateaus in the mid-2030s. Reaching peak oil by 2025 is key to the world having a fighting chance of limiting the global temperature rise to 1.5°C. All this will have massive implications for countries whose economies are almost totally reliant on oil and gas.
“The global energy transition has been exacerbated by Covid-19, which has resulted in dramatic, immediate and long-term changes to the global energy industry,” says Coco Zhang, an energy researcher at Eurasia Group, a political risk consultancy. “Mounting environmental pressures on oil and gas production, the fast deployment of renewable energy, the advancement of climate mitigation technologies, and the exponential growth of government green policies, pose considerable risks to the oil industry, especially oil exporting countries.”
The world has moved from “an age of (perceived) scarcity to an age of abundance” of oil, says BP. Sectors that used to drive our ever-growing thirst for oil are drying up faster than expected. Predicted global demand for electric vehicles was recently upgraded by management consultancy Deloitte from 20 million to 30 million a year by 2030.
Meanwhile, “social pressures and sustainable investing will also weigh on demand for fossil fuels, adding to transition risks facing major producers”, says a recent Fitch Ratings report on the risk of ‘stranded assets’ in oil producer states. Investors face pressure from shareholders to stop backing fossil fuel exploration projects, while the European Investment Bank and the UK government, for example, have announced they will no longer finance international fossil fuel projects. With the US returning to the Paris Agreement, most major economies agree, at least on paper, that fossil fuels must be significantly phased down.
The Covid-19 pandemic – which saw oil demand fall 8.5% in 2020 – has “provided a cautionary vision of the future if ongoing efforts to diversify producer economies do not succeed”, say analysts Ali Al-Saffar and Matthew Van der Beeuren in a recent article for the International Energy Agency (IEA). In the Middle East and North Africa, net oil and gas exporters’ economies shrank by an estimated 6.6% in 2020, versus an average 1% for net importers.
Demand for oil is growing again. The IEA estimated in February that global oil demand would rise to 96.4 million barrels a day by the end of 2021, recovering around 60% of the volume lost in 2020, but evidence of a short-term recovery should not cloud the bigger picture.
“We don’t know for sure when peak oil demand will happen, but the majority of people I speak to and trust say we have already seen global peak demand for oil,” says Valérie Marcel, an associate fellow at UK think tank Chatham House.
Greg Muttitt, senior policy adviser at the International Institute for Sustainable Development (IISD), says “politics has really shifted over the last two or three years” to make decarbonising a priority. The Paris goals require a decline in global consumption of all fossil fuels, even if we cannot make a definite prediction at this stage as to when that will happen, he says.
A turbulent few years
A rapid transition away from fossil fuels, as under the IEA Sustainable Development Scenario, will give the world a fighting chance to limit temperature rise. It could also have a devastating effect on producer nations, many of which rely on oil rents for the vast majority of government income. On the other hand, the impacts of ditching fossil fuels are likely to be less severe than the worst effects of climate change in these countries, which are particularly vulnerable to a warming world.
Volatile oil prices have already left many petrostate governments struggling. In July 2008, oil prices peaked at $145 a barrel before dropping 80% in the following six months. They fluctuated between $80 and $120 from 2010 to 2014, before dropping to under $40 due to booming US shale oil production. In the following years, the price fluctuated between $50 and $80, before crashing to $18 a barrel in April 2020.
No Arab oil producer, except super-wealthy Qatar, could balance its books at the 2020 average oil price of $40. Years of unstable oil receipts have left countries with significant levels of debt – and the problem is not only in the Middle East. Mexico’s national oil company, Pemex, has $30bn in debt repayments due in 2024, while Brazil’s Petrobras has an immense debt of $78.9bn. On a national level, average petrostate government debt increased from 24% of GDP in 2010 to 46% in 2018, says climate think tank the Carbon Tracker Initiative (CTI).
“Some of the poorest oil-dependent countries are in complete turmoil,” says Thijs Van de Graaf, professor of International Politics at Ghent University in Belgium. “Look at Libya, Venezuela, Nigeria or Iraq. This pattern may spread to other petrostates.”
War-fatigued Iraq relies on oil and gas for 89% of its income. The downturn in oil demand has left the country struggling to pay salaries. Iran cut off electricity exports to the country at the start of 2021 after citing non-payment.
Nigeria, which relies on oil and gas income for 45% of government revenue, is in its second recession in five years, both triggered by a depression in oil prices. The World Bank reports that 40% of the country’s population, 83 million people, live below the poverty line.
Venezuela and Libya offer a cautionary tale for what might happen to petrostates. Both are in the midst of political and economic crises that developed in the wake of the deaths of former authoritarian leaders – a political characteristic of producer nations.
In Venezuela, chronic mismanagement of the oil industry and US sanctions have reduced oil output to around a tenth of levels in the early 2000s. GDP has plunged more than three-quarters in the past five years and more than five million people have left the country.
Libya, meanwhile, is ruled by two governments operating in different regions. One shut down the country’s oilfields and terminals for the first nine months of 2020 to put pressure on its UN-backed rival in Tripoli. Oil output fell to less than a sixth of the previous year and economic performance in 2020 was the worst on record, says the World Bank.
Oil is not simply the main export of many petrostates, but “the central factor around which domestic economies and domestic politics have become established”, says Van de Graaf. The clean energy transition “represents an existential threat for many of these countries”.
A difficult path ahead
Decarbonising along the trajectory of the IEA’s Sustainable Development Scenario with a long-term oil price of $40 a barrel could lead to global losses of $13trn over the next two decades compared with a business-as-usual scenario of continually growing oil demand, forecasts the CTI.
These losses will not be felt equally. Low production costs mean revenues are likely to fall less in the Middle East and North Africa than elsewhere. Compared with industry expectations, the CTI predicts revenues will be 40% lower there versus a fall of 50% in Europe, 58% in sub-Saharan Africa, 66% in Latin America and the Caribbean, 57% in Asia and 77% in North America.
However, because petrostates in the Middle East and North Africa tend to be more reliant on fossil fuels than other countries, a 40% decline could nonetheless be devastating. Governments in Azerbaijan, Iraq, Kuwait, Libya, Oman, Saudi Arabia and South Sudan all receive more than 60% of their income from oil and gas.
Deborah Gordon, leader of oil and gas solutions at global energy and climate think tank Rmi, says investors are more likely to back oil extraction in wealthier and more politically stable countries if demand starts to fall.
“It is the smaller petrostates that will particularly struggle,” she says. “Countries that are war-torn, or with non-democratic governance, or a lot of corruption, are probably those that will teeter on the brink if we are successful in reducing our consumption of oil. If you can’t rely on Iraq, Iran or Venezuela, then those marginal barrels will not be consumed in the market. You will double down on Russia and Saudi Arabia instead.”
It can be “hard to understand the scale of the problem” in many petrostates, says the IISD’s Muttitt. “Countries like Nigeria or Angola, with oil exports providing around half of government revenue, are facing dramatic change. Half the salaries of public sector workers – medical staff, teachers, public transport workers and civil servants – come from oil revenues. It is a difficult and precarious situation.”
Ed Parker, head of Fitch’s EMEA Sovereign Rating, believes “high-cost producers will be squeezed out first”. If governments do not strategise to meet future investment trends, oil production infrastructure will be left “stranded”, he warns.
Data suggests Congo, Angola and Iraq are among the countries most at risk from stranded assets. Their economies are heavily reliant on fossil fuels, the profits of which contribute to 52%, 46% and 26% of their economies, respectively. With corrupt governments and unfavourable investment conditions, they also have low economic diversification potential, says Fitch.
The risks facing these countries are exacerbated by a potentially volatile oil market in the coming years. The intergovernmental oil cartel Opec+ has long attempted to control oil production to maintain a relatively valuable price, but “the prospect of being left with unusable reserves will likely make producers less willing to sacrifice near-term volumes to support prices”, says Fitch’s Parker.
“If we are approaching peak oil, countries may feel an individual incentive to pump as much as they can,” says Mike Coffin, a senior analyst at the CTI. “This could lead to a messier energy transition with rock-bottom oil prices.”
Fitch will be “more circumspect in taking forward-looking rating actions” with regard to uncertain future events, Parker adds. The most vulnerable petrostates could find themselves with a lower credit rating and less access to financing, further compounding their fate.
The best solution would be for these economies to develop business interests in other areas. “Fossil fuel exporters’ desire to diversify predates the clean energy transition,” says Parker. “It is something they have been talking about for decades, but is now moving up in prominence.”
Countries that have successfully diversified have generally had no choice, says Muttitt, citing Indonesia and Dubai. “It wasn’t that governments suddenly decided to be a bit less dependent on oil exports; geological resources were depleting and this forced their hand.”
Wealthy gulf states like Oman and Saudi Arabia have begun investing in renewable energy and international tourism. Nigeria is investing heavily in new infrastructure, including several multi-billion dollar railroad projects backed by China and a $1.6bn deep sea port.
“Reframing national oil companies as national energy companies or even national investment companies is a good first step,” adds Coffin. This is essentially what occurred in wealthy Norway when national oil company Statoil merged with hydroelectric firm StatoilHydro to create the huge multinational Equinor in 2007.
Attempts at change by poorer petrostates are hampered by a lack of capital at home and because they are often unattractive to international investors. “Countries with strong governance and business climates are more likely to succeed in the push to diversify,” says Parker.
“If petrostates can no longer produce oil and gas, they won’t have the capital to diversify,” adds Gordon. “The most successful way to diversify is to do so slowly, but if petrostate short-term economic strategies are to ‘get rich quick’, it is hard to shift priorities to long-term economic growth.”
Renewables to the rescue?
In addition to an abundance of cheap oil and gas, the lack of a stable investment climate has also stymied the development of renewables in many petrostates, even if the Middle East and North Africa offer some of the best conditions for solar energy.
“There is a clear pattern where fossil fuel importers generally have higher levels of renewable energy,” says Parker. “Countries where fossil fuels are cheap and plentiful tend to give fossil fuels a much higher weight in electricity generation.”
Marcel at Chatham House adds: “Oil companies are masters of risk. Risk is their business. Renewables want stability, probably because the rates of return aren’t so high.”
Moreover, while renewables can transform the domestic economy of petrostates, it would be difficult to replicate oil export revenues. “Oil is an extremely valuable export commodity,” says Muttitt. “Though it is crucial that petrostates decarbonise, the amount of revenue that can be generated by exporting renewable energy equipment, for instance, would never be on the same scale as oil.”
Some wealthier petrostates are attempting to sustain their fuel producer status by joining the hydrogen party. Saudi Arabia, the world’s largest producer of oil, has announced plans to build a green hydrogen plant powered by 4GW of renewable electricity, with hydrogen output of 650 tonnes a day. Oman has a national hydrogen strategy, with plans for a green hydrogen plant announced in November 2020.
However, hydrogen alone is unlikely to take the place of oil. “Hydrogen exporters are basically selling the conversion process,” says Van der Graaf. “Anyone can harvest solar or wind energy: you are entering a much more competitive market. I don’t imagine it will ever be able to yield the same level of revenues as fossil fuels once did.”
An international just transition
Ultimately, petrostates are likely to need outside support to transition their economies, which, as Coffin says, is in everyone’s interest.
Gordon would like to see “serious study and scenario planning for an oil and gas transition” to meet the demands of a low-carbon future. “We are basically undoing over a century of interdependence between these nations and the global economy,” she says. “Unwinding this tightly integrated, global market needs to be surgical.”
Van der Graaf agrees. “We have had many phase-in plans for renewables, but they have entered the system without necessarily displacing fossil fuels. We need a global plan that understands how to support certain countries and deliver the best energy transition for all.”
In addition to financial aid, “wealthy countries can also offer technical assistance”, says Coffin. “This could be through retraining workers, helping countries design new tax systems or supporting them with the roll out of renewables.”
Different countries will also need to move at different speeds. “For some countries, such as the UK or Norway, the process of transitioning is not so difficult compared to poorer or more oil-dependent countries,” says Muttitt. “Oil only contributes a negligible share of government income, and though there might be lots of jobs in oil and gas, there is also a lot of money to support a just transition. Both these countries – and the US and Canada – should move faster to allow the likes of Angola and Nigeria more time to transition.”