CHAPTER 3, G. OPECalypse Now and the World Economy

• Jurisdiction: United States

G. OPECalypse Now and the World Economy

ABI Journal

June 2019

J. Michael Issa¹

GlassRatner Advisory & Capital Group LLC

Irvine, Calif.

Since 2014, the price of crude oil has suffered a major drop of approximately 60 percent from its peak of $111.80 and currently hovers around $60. This has created a financial crisis for most Organization of the Petroleum Exporting Countries (OPEC) members and other oil-producing countries. The OPEC struggle can potentially impact the world economy.

All but two OPEC member nations are on a collision course with financial ruin. Budget deficits as a percentage of GDP are generally double-digit, levels that are clearly unsustainable. Cash and investment reserves are being depleted, and sovereign debt is being incurred to delay the day of reckoning. The total sovereign debt of OPEC is approaching the level of subprime mortgage debt that rocked the world on its economic axis in 2008.

The current crude futures curve strongly suggests that crude prices will not increase to a level that will allow Saudi Arabia and others to balance their budgets. Most major energy executives now accept that "peak demand" is a reality and that that inflection point will be reached in the next decade, confirming that the shape of the crude futures curve is well-founded. For a variety of reasons, including peak demand and increasing concerns about hydrocarbon emissions, the sun is beginning to set on crude's domination of the world's energy supplies. This ultimate financial demise of OPEC has the potential to significantly impact the world's economy.

World's Reliance on OPEC Oil

To analyze the impact of the oil industry on the world's economy, one must first review the supply-and-de-mand metrics of oil and the role that OPEC plays in this arena. OPEC's oil production accounts for approximately 44 percent of the oil production of the world.

Theoretically, one would assume that OPEC should then have the ability to dictate oil prices by thoughtfully controlling the supply of oil, which has largely been true in the past. Events of the last decade have shown that this assumption is no longer viable. Output cuts have been extended a number of times, but the impact of these cuts has been minimal as oil prices are continuing to hover in the $60 range, dipping as low as $35.64 in 2016. There are several reasons for this:

• Over the last decade, the U.S. has nearly doubled its domestic production of crude by exploiting the development of shale oil. The increase of U.S. crude production over the last 10 years totals more than 6.7 million barrels per day² and is more than the total daily production for Iran. U.S. shale production is projected to increase in the future as technological advances and economies of scale continue to lower the cost of production.³ The U.S. is now a net exporter of crude for the first time in 75 years.⁴
• Slowing economic growth in developing countries such as China further limits the demand for oil.⁵
• It is now well accepted that the world is approaching a point of peak demand, after which demand for crude will begin to decline into the foreseeable future.⁶
• Major efforts by governments around the world to promote electric or hybrid vehicles has also limited the demand growth for oil,⁷ further flattening the demand curve. Parties to various production-curtailment agreements have both the motivation and the ability to circumvent those agreements, potentially leading to additional supply.

The crude future curve shows that oil prices are projected to gradually decrease over the next 73 months, bottoming at around $60 (see Exhibit 1).

Importance of the Oil Sector to OPEC Members

It is evident that many OPEC members are increasingly dependent on revenues from their oil industries. This is evidenced by the large percentage of gross domestic product (GDP) contributed from their oil sectors. The oil segment accounts for 43 percent of Saudi Arabia's GDP.⁸ The obvious conclusion is that these countries' economic well-being is directly tied to the price of oil (see Exhibit 2).

Budget Deficits and Surplus

Beginning in the early 2000s, OPEC enjoyed a decade of unprecedented prosperity resulting from the oil price surge from around $30 to almost $100.⁹ This increase allowed many OPEC countries to create massive social programs for its citizens. The obvious risk is the assumption that pricing will remain at a level that supports those expenditures, which is a now-clear falsity for a volatile commodity.

A few OPEC members, particularly Saudi Arabia, have belatedly realized that an investment in diversifying their economy is the only way out of this economic trap. The question is whether Saudi Arabia has the financial resources and the time to accomplish this repositioning of...