Saudis are right to warn of a collapse in oil supply

This won't win me any friends among the green lobby, but Saudi Arabia's Oil Minister Abdulaziz bin Salman is right to warn of a potential energy crisis resulting from falling investment in fossil fuels. Here's why.

The prince warned that worldwide oil production could fall by 30 million barrels a day by the end of the decade because there is not enough being spent on the exploration for and development of new resources. That implies production of less than 70 million barrels a day.

Of course, he is talking his own book. The kingdom holds vast reserves of oil beneath its sands and under the shallow waters of the Persian Gulf — and it wants to see a healthy market for that oil for years to come.

But his warning isn't entirely self-serving. Saudi Arabia's oil riches aren't open to foreign investors, so his call for more spending is actually aimed at encouraging competition with the kingdom.

This serves as a recognition of two things: First, the world's need for affordable oil isn't going to disappear anytime soon; and second, despite its oil reserves, Saudi Arabia can't supply it all by itself.

Even the International Energy Agency, which has been incorrectly cited as calling for an end to new oil developments, sees oil demand remaining near pre-pandemic levels by 2030.

Even with the environmental policies that had been announced prior to the United Nations COP26 Climate Change Conference in November, the agency saw 2030 oil demand at 500,000 barrels a day — just 0.5% below its pre-pandemic level. In its "Sustainable Development" scenario — which sees advanced economies reach net zero emissions by 2050, China around 2060, and all other countries by 2070 at the latest — the drop by the end of the current decade is estimated to be just 9 million barrels a day, or 9%. That would still leave the world needing about 90 million barrels a day of oil by 2030, a supply shortfall of 21 million barrels a day — more oil than was consumed by the US in 2019 — according to the Saudi minister.

So if he's right, we're in for a tough time. But is he right? Have potential investors been so bullied, or so scared, by environmental campaigners that they are unwilling to sink capital in new oil production? 

The kingdom — holder of the world's largest oil reserves — is investing to boost its own output, but only planning to add another 1 million barrels a day in the next few years. Other countries in the Middle East, such as the United Arab Emirates, Kuwait and Iraq, are investing to boost their capacity, too. Russia has big plans for its Arctic wilderness, but that's a remote, hostile place, one of the worst imaginable from an environmental perspective to invest in oil extraction.

There are big projects in the works in other areas like Kazakhstan, Azerbaijan and Brazil, which will also add to supply before the end of the decade. But with output from all the fields currently in production declining, at an average rate of anywhere from 4% to 8% a year depending whose estimates you take, you need a lot of investment just to stand still.

Meanwhile, production in the US, once seen as the spoiler of OPEC's future output growth, is rising slowly. By the end of next year, it is still expected to be some 760,000 barrels a day below its pre-pandemic peak. The heady days of the first and second shale booms have passed.

Global expenditure on oil and gas projects slumped 30% to $309 billion in 2020 and has only recovered slightly this year. It needs to get back to near pre-pandemic levels of $525 billion a year for the rest of the decade to meet demand growth, according to Riyadh-based think tank the International Energy Forum and consultants IHS Markit.

The Western oil majors — companies like Royal Dutch Shell Plc, BP Plc, TotalEnergies SE — are increasingly focusing their investment on natural gas and renewables at the expense of oil. BP, for example, is expected to pump more oil in 2022 than it will this year, but production is still expected to be 6.5% below its 2017 peak.

These are the companies that can most effectively be held to environmental obligations. If they are not going to step into the gap between rising demand and falling production, then other firms, whose environmental performance is harder to police, will likely do so. I'd rather see Shell invest in the Cambo oil field in the North Sea, for instance, than Rosneft PJSC despoil the tundra of Russia's Taymyr Peninsula. The former is easier to hold accountable.

Prince Abdulaziz is not alone in his warning. The International Energy Agency said something very similar, though without numbers, in its World Energy Outlook published in October:

"The fact that no new oil and natural gas fields are required in the NZE (Net Zero Emissions by 2050 scenario) does not mean that limiting investment in new fields will lead to the energy transition outcomes in this scenario. If demand remains at higher levels, this would result in tight supply in the years ahead, raising the risks of higher and more volatile prices."

We ignore those warnings at our peril. A 30-million barrel a day drop in oil supply might seem like a victory to the most short-sighted of environmental campaigners, but without an accompanying fall in oil demand, it will come with a price tag none of us can afford — oil prices at levels never before imagined.

Julian Lee is an oil strategist for Bloomberg First Word. Previously he worked as a senior analyst at the Centre for Global Energy Studies.

Disclaimer: This article first appeared on Bloomberg.com, and is published by special syndication arrangement.