Like James Dean and Sal Mineo in "Rebel Without a Cause," Russian President Vladimir Putin and Saudi Crown Prince Mohammed bin Salman played a game of chicken with the world economy. They ended up blowing up their OPEC+ partnership and driving oil prices down 30%, to below $40 a barrel.
Faced with a coronavirus-driven global slump in demand for oil, Mohammed tried to double-down on the OPEC+ strategy of restraining pumping. Moscow fired back that U.S. shale producers were simply taking advantage of the production cuts to steal market share. In the words of Russia's biggest producer, Rosneft, "The total volume of oil that was reduced as a result of the repeated extension of the OPEC+ agreement was completely and quickly replaced in the world market with American shale oil." Rebuffed, the Saudis returned to their 2014 strategy of thing to punish the Russians and strangle the growth of U.S. shale by flooding the market. They succeeded.
That a squabble between two economies — one of them smaller than Canada's, the other just a bit bigger than Turkey's — both of whom seek higher oil prices in the long run, can utterly upend the oil market shows how dangerous continued reliance on oil is for the rest of the world, including the U.S.
Fortunately, however, the price war has once again illustrated how absurdly easy it would be for the rest of the world — Europe, Japan, China, India and, yes, even the United States — to dispense once and for all with OPEC's ability to control oil prices, and within a decade or so to completely shatter oil's transportation monopoly and geopolitical clout.
We just need to learn five lessons from this moment:
- Tiny cuts in demand for crude drive prices down dramatically. Saudi Arabia drove the price down 30% with a production increase of less than 0.5% of current global production, or about 100 million barrels a day. But these price cuts are temporary. With oil cheap, investors won't provide the capital needed for expensive new oil fields to replace those being depleted at a rate of about 4% a year. Today's price slump actually guarantees that tomorrow there will be a corresponding spike. This drives the increasing instability of oil markets, an instability that has one obvious solution: getting off oil.
- Even a temporary price war weakens oil's economic and political clout. Independent U.S. shale producers immediately began cutting their drilling activities, and with good reason: North American energy exploration and production companies have approximately $86 billion in debt maturing over the coming four years — and 62% of those maturities are in junk bonds. Major oil companies have begun to scale back the dividends and share buybacks that make them investor favorites. There's even talk that the Trump administration may seek to bail out the industry. Investors who had been moving away from oil and gas stocks, moved even faster. A shrinking industry asking Washington for help has vastly less political clout than a booming one that's feeding money into the U.S. Treasury.
- Neither Russia nor Saudi Arabia has a winning strategy to create the world economy they seek, meaning one that will consume ever more oil and can afford to pay $70 to $80 a barrel. At those prices, demand will fall as the world economy stalls and Europe, China, Japan and India race to replace imported oil with domestic electricity to power their cars and trucks. The world does seem willing to keep consuming 100 million barrels a day of oil at $30 to $50, a price that discourages investment in efficiency and electric transportation. U.S. shale producers lose money at that level, the Russians break even and the Saudis, while still turning a profit, don't make nearly enough to cover their national budget deficit.
- Oil markets are thus not only brittle — with small changes in demand driving large changes in price — but are also intrinsically unstable. If prices rise, demand will fall. If resulting lower prices generate higher demand, supply shortfalls will promptly follow. This volatility, in turn, is a major barrier to the investments needed to convert the world's cars and trucks away from gasoline and diesel to electrons. The more rapidly electric cars steal market share from petroleum, the cheaper their internal combustion competitors appear. EVs that sell easily with oil at $80 face a much tougher marketing environment when crude falls to $35.
- There is thus no market solution to the dilemma of unstable, volatile transportation costs, and no purely market-based pathway to a clean transportation future that curbs the biggest threat to our climate, which is the world's reliance on oil. Even carbon taxes won't do the job. As long as there aren't enough EV models and charging networks, higher taxes on oil just raise consumer costs and lead to political backlash without reducing consumer dependence on oil.
But policy support for electric cars and trucks can take non-market forms. Public investments in EV charging networks, conversion of government vehicle fleets to zero-emission alternatives, stringent clean-air standards that finally end the menace of nitrogen oxide emissions from combustion vehicles, and requirements that a steadily increasing share of any vehicle manufacturer's fleet consist of zero-emission vehicles are all demonstrated and effective ways to make investors confident that if they produce consumer-appealing electric vehicles, their markets will grow steadily. And that will still be true even when, as a direct result of their success, the price of oil drops down into the $30-50 range. So it's vital that policy players invest in the long game — which, as we know, is precisely what they're bad at.
If governments can be encouraged to stay the course, the payoffs are huge. France, for example, has been an EV under-performer: Even with the cheapest off-peak electric power of any major nation and high-priced gasoline, EV sales lagged. Until January of this year, when suddenly French consumers scooped up two and a half times as many EVs as ever before, 11% of total sales. The explanation was not some new subsidy, but rather a policy allowing auto companies to take credit for the sale of electric sedans against future, more stringent emission standards. Given an incentive, suddenly car manufacturers knew how to get their dealers to move battery-powered sedans off the lot. So the French EV revolution is taking off.
Globally, EV sales of only 8 million cars would cut demand by the same volume of oil that the Saudis just used to disrupt the entire market.
The bottom line is this: If oil importing nations, including the United States in the post-Trump era, simply want to make transportation as cheap as possible, and would also like to escape their servitude to the vagaries of Putin and Crown Prince Mohammed, they have a simple and elegant solution. Just make sure that the electrification revolution gets ever greater traction on their highways. In doing so, they will also end the single biggest threat to our climate — oil's monopoly power over the global economy.