Oil tales, or how the Saudi king can end up funding the green economy

Oil tales, or how the Saudi king can end up funding the green economy

Prices of crude oil have experienced a massive fall in the past two years. In June 2014 you would have to spend over 110 US dollars to buy a barrel of oil – now you can get the same amount of oil for 46 (less than half).

You might have read around that one of the key factors is that developing economies are slowing down and Europe is not recovering, and that is reducing significantly the demand for oil. You might also think that vehicles are becoming more efficient (hello Volkswagen!) and that that is implying that people don’t need that much oil anymore.

Don’t believe them. All of that is true, and it might be playing a role, but I think we need to look for the explanation somewhere else. For instance, even though there are some concerns (as I analysed in my previous article about China), I don’t think we are more concerned about the world economy now than we were in 2008-2009, and still in those years we didn’t see such a low oil price for such a long time.

No: the answer to the low prices of oil needs to be found somewhere else, and I can pinpoint you the coordinates of the answer: Riyadh and Washington, D.C.

For a long time, Saudi Arabia has been the policeman of oil prices. As the largest producer in the world and the leader of the organization of producers of oil (OPEC), they basically had the key to the oil tap. They were so important that as soon as they decided to reduce their production, prices would go up; as soon as they signaled that they were willing to pump more oil, oil would become cheaper. That role was costly for them, but thanks to that and OPEC they managed to keep oil prices significantly high for a reasonable amount of time.

What has happened now to change this situation? The answer lies in Washington, D.C. In the past few years, the US has increased a lot their production of oil via the quite environmentally questionable method of hydraulic fracking, which basically consists on pumping water and chemicals into the ground to break rocks and release the oil beneath them. This, apart from (arguably – I don’t want the lawyers of the big companies knocking on my door) polluting a significant part of the US groundwater, increased significantly the ability of the US to produce their own oil.

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An area of heavy hydraulic fracturing seen from the sky.

With fracking, supporters of the technique were claiming, the US would become energetically independent and would no longer depend on the mood of the Saudi royal family for their oil. And, for some time, it looked like they were right. However, fracking had an economically weak point: it is far more expensive to extract oil via fracking than it is via direct drilling as Saudi Arabia does. Therefore, if oil prices went sufficiently down, the whole industry would be suffering.

Be it because of the good perspectives on production, or the doubts about the global economy, or geopolitical considerations, oil prices started to drop around mid-2014. But now, suddenly, we found out that Saudi Arabia was not interested in reducing production to keep prices high anymore. I can only speculate on this, but it seems clear that the existence of the fracking industry made that they were not interested in playing the game anymore. If they had decided to keep oil prices up, that would have supported the growth of an industry that would eventually reduce their future benefits (and geopolitical influence) by a great deal.

And we’re not only referring to the fracking industry – by keeping oil prices up they would be helping some other people who are not of their utmost sympathy (the Iranian regime or Vladimir Putin come to mind). Why would they care anymore? Why not let prices go down, produce happily, wait to see how many regimes suffer (Russia is a clear example, Venezuela would classify as collateral damage, but even ISIS has been affected) and to see how fracking and energy companies in the West collapse (they didn’t so far, but they are under great constraints at the moment)? Furthermore, cheap oil benefits one new friend of the Saudis – the Chinese.

Given all of this, would you expect oil prices to raise in the near future? I definitely wouldn’t, and future markets of oil don’t either (which are no guarantee of what will happen, but they are the best we have). Even if the European economy starts to recover and the troubles of emergent economies get solved (which would be quite a good scenario), I don’t think anybody would have a strong incentive to let oil prices get even close to where they were before 2014.

But is this good or bad from an environmental perspective? Apparently it looks that it is negative: we have always been told that the search for alternatives to oil would become stronger and stronger when prices were high because that’s when the potential benefit of finding something else is higher. In such a context, low oil prices are terrible – if we have this cheap energy available why should we change?

But I’m starting to think that incentives for the green economy work the other way around. When oil prices are high, energy companies tend to make large profits, and so they are interested in keeping the status quo. I think low oil prices, and therefore low profits of their oil investments, will be the key reason forcing them to invest in new, efficient, green ways of producing energy. They will be interested in being the first to provide a new type of energy where they can get a margin of benefit that they can’t get with oil anymore.

Or maybe I am just too much of an optimist.