6. Conclusions to the Current Energy Transition and its Implications
The position of this paper so far is that the energy transition is likely to be deeper and to occur more rapidly that many realize. The next stage is to consider what the implications of this are likely to be. One obvious implication is that the market for hydrocarbons will begin to shrink, and with it the revenue accruing to producers. This is a very large topic, but for the purposes of this paper, the analysis focuses on the major oil-exporting countries. Figure 11 lists those countries in which fuel exports account for more than 25 per cent of total merchandise exports. There are 25 such countries in total. The ability of these countries to meet the challenge of a declining market will depend in large part upon their political stability, data for which are also included in Figure 11 (a ‘plus’ indicates political instability, a ‘minus’ indicates political stability).
An important conclusion is that eight of the countries are in the MENA region, and of those only two – Qatar and Oman51 – could be considered politically stable, according to the source data. Taken together, 15 of the 25 countries listed both depend on fuel for more than 25 per cent of their exports and are politically unstable. Together, these countries account for some 52 per cent of global proven oil reserves.
Figure 11: Fuel export vulnerability and political instability, 2017
— Sources: Fuel exports: World Bank, 2018; Political stability: adapted from GlobalEconomy.com, 2018. Note that the original political stability index numbers – e.g. 1.17 (Norway, highly stable), negative 2.28 (Iraq, very unstable) – have been multiplied by minus 100 to allow readier comparison with the fuel exports.
Figure 11: Fuel export vulnerability and political instability, 2017
Policy options for vulnerable countries to manage the transition
The next stage in the analysis is to consider the policy options available to the vulnerable countries in terms of managing the decline in their oil revenues. These options will clearly depend upon the speed of the transition, and on technical and regulatory changes in consumer markets. This raises the key question of how governments (both of oil-consumer and oil-producer countries) and companies should prepare for potential policy changes.
One option concerns the depletion policy of the country in question. If a producer country believes that the transition is imminent, it would make sense for it to maximize production from its reserves to take advantage of prices before they begin to fall. However, such a policy, if followed by a number of producers at the same time without effective coordination by OPEC and possibly ‘OPEC+’,52 would cause crude oil prices to fall. At one level, this might inhibit growth in the use of renewables. However, such a view neglects the potential impact of ‘OECD disease’ in maintaining elevated product prices to consumers, which would leave the choice of fuel for the energy-using appliances largely unaffected. While policies to reduce crude oil prices may not in themselves inhibit investment in renewables, encouraging price volatility could certainly do so.
A more realistic, and indeed desirable, policy would be for producers to pursue policies of diversification away from dependence on oil. The logic is expressed in Figure 12.
Figure 12: The trajectory of oil production in economic development
— Source: Mitchell and Stevens, 2008.
Figure 12: The trajectory of oil production in economic development
As output rises in the early stages of a country’s oil production history, the period can be characterized as one of ‘depletion-led development’. This implies that the revenues accruing to the government can be used to promote development in the country as a result of fiscal, forward and backward linkages.53 However, eventually production will reach a plateau rather than a peak in output. This is simply because the associated infrastructure is expensive and must be operated at close to capacity to minimize fixed costs on a unit cost basis. It is unrealistic that investors would provide infrastructure for any short-lived peak. They would inevitably smooth out the peak into a plateau. This period of a plateau can be characterized as the ‘transition phase’. In this period, it is essential that the government uses oil revenues to develop the non-oil economy. Oil revenue is not income. It simply reflects a reshuffling of the national portfolio of assets, in which crude oil below ground is in effect exchanged for dollars above ground. The below-ground asset is depletable, either through extraction and usage or through a deliberate transition away from oil. Thus, the new above-ground asset must be used to create an income-earning asset. The reason for this is that the final stage in a country’s oil production history is ‘decline’. If domestic oil consumption is rising while production is falling, this accelerates the decline in revenue from oil exports. As this occurs, the ability of the oil sector to fund the non-oil sector declines, which then creates serious economic and political problems for the country in question. The level of diversification of an oil-producing economy is measured by the non-oil fiscal balance and the non-oil current-account balance. The former accounts for revenue that supports the fiscal balance in the non-oil sector, the latter foreign-exchange revenue that supports the current account in the non-oil sector.
If domestic oil consumption is rising while production is falling, this accelerates the decline in revenue from oil exports. As this occurs, the ability of the oil sector to fund the non-oil sector declines, which then creates serious economic and political problems for the country in question.
The non-hydrocarbon fiscal positions, over time, of some of the oil-producing countries are shown in Figure 13.
Figure 13: Non-oil fiscal balance of selected producers, 2007 and 2012
— Source: IMF, 2007.
Figure 13: Non-oil fiscal balance of selected producers, 2007 and 2012
To diversify an oil-producing economy is not an easy task (Cherif, Hasanov and Zhu, 2016). While Norway has succeeded, its position and experience are unusual. The reasons for this are outlined in Box 2.
Box 2: Why Norway is a nuisance
There is general agreement in the literature on the role of extractives in economic development that Norway got it right. The country managed to develop its interests in North Sea oil without suffering the usual symptoms associated with the resource curse. At the same time, it managed to diversify its economy away from dependence on crude oil production (as can be seen from Figure 13), while accumulating huge financial reserves. For this reason, it is often held up as a role model of how to make the most out of resource extraction, with the Norwegian government pension fund (see footnote 48) frequently cited as a way to optimize the use of oil revenues. It has also been one of the fastest adopters of EVs and one of the fastest nations to decarbonize, although this is in large part due to the country’s hydropower resources.
However, the Norwegian example was born of very special circumstances. When the country was first developing oil, in the early 1970s, Norway was a long-established and fully functioning democracy. It had well-functioning political institutions that were wholly transparent, and a history of very low levels of corruption in the public sector. It also had a small population that was extremely well educated, only a very small percentage of whom were considered to be living in poverty. Moreover, Norway has a history of shipbuilding and significant experience of working at sea in various contexts – a great advantage considering that its oil deposits are offshore. It also had a history of managing resource wealth from fisheries. Such conditions are difficult to find elsewhere, especially among the countries that have potential extractive resources. Norway, arguably, is a special case – the only way its experience can be replicated is to start with 5 million Norwegians. Unfortunately, many policymakers fail to grasp that basic reality.
Source: Adapted with permission from Stevens, Lahn and Kooroshy, 2015.
Many barriers must be considered when planning policy for economic diversification. The first and main barrier is the nature of the ruling elite. In many oil-producing countries, the ruling elite is effectively a kleptocracy whose position has been reinforced by many years of securing oil revenues to support its own interests. By definition, this elite has no incentive to change the status quo. Indeed, its interests are to maintain the sources of its wealth and power. This goes back to the debate in the former Soviet Union at the time of Mikhail Gorbachev, who argued that economic liberalization (perestroika) was not possible without political liberalization (glasnost).
A number of issues follow on from this view of the world. First, diversification requires a dynamic and active private sector. However, to achieve this requires secure property rights and the rule of law, to protect private investors. At the risk of oversimplification, it is not unreasonable to assert that a kleptocracy comes into existence because the ruling elite is not constrained by law. A good example of this has been the recent experience in Saudi Arabia. Following the oil price collapse in the summer of 2014 and the rise of Mohammed bin Salman with the accession in January 2015 of his father, King Salman bin Abdul-Aziz Al Saud, there have been extensive plans to reform the Saudi economy and diversify away from dependence on oil. This has been embodied in the Vision 2030 process. However, in October 2017 more than 100 senior Saudi figures, including many members of the royal family, were arrested and held in detention in the Ritz Carlton Hotel in Riyadh. They were held there until they agreed to pay ‘fines’. It is far from clear what the legal basis of this action was. It simply appeared as a whim on the part of the crown prince and his supporters. One obvious consequence, not surprisingly, has been that private-sector investment in the kingdom has dried up, causing growing concern about prospects for the non-oil economy. Indeed, it has been estimated that since the detentions there has been a capital outflow from Saudi Arabia of more than $100 billion (Dudley, 2018).54
A second barrier is that many oil-producing economies suffer from high degrees of state interference in the economy, together with significant distortions associated with mechanisms such as subsidies. This in part reflects the social contract between the rulers and the ruled that has dominated in many oil-producing countries. In return for its acquiescence, the population is given access to goods and services on preferential terms. Changing this social contract is essential for economic reform. However, it is not easy, since it invariably requires the removal of subsidies, which leads to higher prices of basic goods. It also requires political reform on the grounds that there should be ‘no taxation without representation’.55 This requires the ruling elites to relinquish at least some degree of power and influence. Given that such elites gain so much materially from their exercise of power, voluntary relinquishment is not a plausible option.
A third potential barrier to developing the private sector is the availability of the entrepreneurship and skilled labour required by a modern, increasingly digital, economy. In particular, in many oil-producing countries in the Middle East, the quality of publicly provided education is abysmal. For example, one-third of the curriculum in Saudi Arabian elementary schools consists of ‘Islamic studies’, i.e. rote learning of the Qur’an; in secondary education, the share is still one-quarter. In the kingdom’s universities, some two-thirds of students earn degrees in ‘Islamic studies’ (House, 2012). This is not an adequate preparation for a workforce in a modern economy. Attempts at reform have consistently been resisted by the religious establishment, which the Al Saud family needs to keep on board in its attempts to contain pressure from Islamist militant groups such as Islamic State of Iraq and Syria (ISIS) and Al-Qaeda in the Arabian Peninsula (AQAP).
Many of the countries currently dependent upon oil are likely to face increasingly serious economic problems and, as a result, domestic political unrest.
All these barriers present a formidable problem for any Middle Eastern government that is serious about trying to diversify its economy away from oil. There have been some signs of success in a few cases: for example, in Iran and the United Arab Emirates, where oil’s contribution to GDP and government revenues has fallen. However, in most cases the prospects are not good. Thus, many of the countries listed in Figure 11 as currently dependent upon oil are likely to face increasingly serious economic problems and, as a result, domestic political unrest. This risks fuelling regional conflicts that could further destabilize the MENA region, as outlined in Section 3. This in turn increases the imperative for oil-consuming countries to reduce their exposure to oil price instability, thereby increasing the likely pace of the transition to non-hydrocarbon energy. This is a vicious circle as far as the oil-producing countries are concerned.
All of this leads to the final question of this paper: what will be the geopolitical fallout as the energy transition proceeds and speeds up?
51 This illustrates the uncertainty associated with such indices, given that Oman faces a major problem of political succession and Qatar is currently in a serious dispute with Saudi Arabia and the United Arab Emirates.
52 ‘OPEC+’ consists of the OPEC countries and a number of non-OPEC oil producers, most importantly Russia.
53 The term ‘forward linkages’ refers to the inputs from the sector to the rest of the economy. In the case of oil, this obviously refers to the supply of energy, but the term can also cover the managerial skills of the oil companies transferred to the rest of the economy. The term ‘backward linkages’ refers to the inputs to the sector from the rest of the economy, such as employment for nationals and within the local supply chain.
54 Ironically, this is the same sum that Crown Prince Mohammed bin Salman claimed would be raised by the (now postponed) privatization of 5 per cent of Saudi Aramco.
55 This is not always necessary. The classic example was Frederick the Great of Prussia, who once remarked he had a special relationship with his people – namely ‘they say what they like and I do what I like!’