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Everything Has Changed: Oil, Saudi Arabia, and the End of OPEC

Elias Hinckley's picture

Elias Hinckley is a strategic advisor on energy finance and energy policy to investors, energy companies and governments. He is an energy and tax partner with the law firm Sullivan and Worcester...

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  • Jan 10, 2015

Editor’s note: Join Energy Collective contributors and energy experts Elias Hinckley, Jesse Jenkins, Jim Pierobon, Jared Anderson, Robert Rapier, and Geoffrey Styles on Monday 1/12/15 at 12pm Eastern for a live Twitter #EnergyChat on tumbling oil prices and the implications for global markets and geopolitics. Register here.

saudi arabian oil fields

Saudi Arabia’s decision not to cut oil production, despite crashing prices, marks the beginning of an incredibly important change. There are near-term and obvious implications for oil markets and global economies. More important is the acknowledgement, demonstrated by the action of world’s most important oil producer, of the beginning of the end of the most prosperous period in human history – the age of oil.

In 2000, Sheikh Yamani, former oil minister of Saudi Arabia, gave an interview in which he said:

“Thirty years from now there will be a huge amount of oil – and no buyers. Oil will be left in the ground. The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.”

Fourteen years later, while Americans were eating or sleeping off their Thanksgiving meals, the twelve members of the Organization of the Petroleum Exporting Countries (OPEC) failed to reach an agreement to cut production below the 30 million barrel per day target that was set in 2011.  This followed strenuous lobbying efforts by some of largest oil producing non-OPEC nations in the weeks leading up to the meeting.  This group even went so far as to make the highly unusual offer of agreeing to their own production cuts. 

The ramifications of this decision across the globe, not just in energy markets, but politically, are already having consequences for the global landscape.  Lost in the effort to understand the vast implications is an even more important signal sent by Saudi Arabia, the owner of more than 16% of the world’s proved oil reserves, about its view of the future of fossil fuels.   

Since its formal creation in 1960 the members of OPEC, and specifically Saudi Arabia (and in reality the Kingdom’s control over global oil markets is much larger than that 16% of reserves implies as its more than 260 billion barrels are among the easiest and cheapest to extract and before enhanced recovery techniques accounted for a much larger share of global reserves) have used excess oil production capacity to influence crude prices.  The primary role of OPEC has been to support price stability.  There are notable exceptions – like the 1973-1974 oil embargo and a period of excess supply that undermined prices and crippled the Soviet Union in the 1980s (though whether this was a defined strategy or serendipity remains in some question), but at its core the role of OPEC has been to control oil prices. As recent events show, OPEC’s role as the controller of crude oil pricing is coming to an abrupt end.  

In acting as global swing producer, OPEC relied has heavily on Saudi Arabia, which can influence global prices by increasing or decreasing production to expand or reduce available global supply.  Saudi Arabia can do this not only because it controls an enormous portion of global reserves and production capacity, but does so with crude oil that is stunningly inexpensive to produce compared to the current global market.  A change, however, has occurred in Saudi Arabia’s fundamental strategic approach to the global oil market. And this new approach – to refuse to curtail production to support global prices – not only undermines OPECs pricing power, but also removes a vital subsidy for global oil producers provided by the Saudi’s longtime commitment to price support.

Understanding Why

The widely held conventional theory is that the Saudis want to shake the weak production out of the market.  This strategy would undermine the economic viability of a meaningful amount of global production.  The theory assumes that this can be done in some kind of orderly bring-down of prices where the Saudis can find an ideal price below the production cost of this marginal oil production but still high enough to maintain significant profits for the Kingdom while this market correction plays out. The assumption is that following the correction there will be a return to business as usual along with higher prices, but with Saudi Arabia commanding a relatively larger share of that market.   An alternative rationale is that Saudi Arabia is fighting an economic war with oil; a strategy designed to economically and in turn politically cripple rival producers Iran and Russia because the governments of these countries that depend on oil exports cannot withstand sustained low prices and will be significantly weakened. 

While there may be some truth to both of these theories, the real motivation lies somewhere closer to Sheikh Yamani’s 2000 prediction.  Saudi Arabia has embarked on an absolute quest for dominant market share in the global oil market.  The near-term cost of grabbing that market share is immense, with the Saudis sacrificing potentially hundreds of billions of dollars if low prices persist.  In a world of endless consumption, this risk would be hard to justify merely in exchange for a temporary expansion of global market share – the current lost revenue would take years to recover with a marginally higher share of global supply. 

But in a world where a producer sees the end of its market on the horizon, then every barrel sold at a profit is more valuable than a barrel that will never be sold.  Current Saudi oil minister Ali al-Naimi had this to say about production cuts in late December: “it is not in the interest of OPEC to cut their production whatever the price is,” adding that even if prices fell to $20 “it is irrelevant.”  Implied, if not explicitly stated, is that Saudi Arabia wants its oil out of the ground, regardless of how thin its profit margin per barrel becomes.

Saudi Arabia is seeing a new and massively changing energy landscape. The U.S. and China have agreed to bilateral carbon reduction targets.  2014 is now officially the hottest year recorded in human history, a record set almost impossibly without the presence of El Nino.  And on January 7 a report released in Nature lays bare the fossil fuel climate change equation by concluding that to achieve anything better than a 50/50 shot at keeping global warming under 2 degrees centigrade (the most widely accepted threshold for avoiding catastrophic climate change) 82% of fossil reserves must remain in the ground.  That report puts hard numbers on the percentages of fossil fuels that must “stay in the ground” and calls for 38% of proven Mideast oil reserves to never to be pumped from the ground.  That 38% represents some 260 billion barrels of oil – worth tens of trillions of dollars – much of that not held in Saudi reserves. 

All of these threats to oil use are occurring against a backdrop where the acceleration of costs-effective alternative technologies expands the potential of viable alternatives to our current fossil fuel-based energy economy.  Yamani’s prediction no longer seems a fantasy where no one outside of science fiction writers could envision an alternative to the age of oil, but rather a stunningly prescient analysis of the future risk to the value the largest oil reserve on the planet by a man who once managed that reserve.

Saudi Arabia no longer needs OPEC.  Global action on carbon dioxide emissions is gaining global acceptance and technological advances are creating foreseeable and viable alternatives to the world’s oil dependence. Saudi Arabia has come to the stark realization, as Yamani foretold, that it is a race to produce, regardless of price, so that it will not be leaving its oil in the ground.  The Kingdom has effectively open the valve on the carbon asset bubble and jumped to be the first to start the race to the end of the age of hydrocarbons by playing its one great advantage – a cost of production so low that it can sell its crude faster and hoping not to find itself at the end of the age of oil holding vast worthless unburnable reserves. 

The end of the age of oil, of course, remains many years off (and almost certainly well beyond Yamani’s timeline of 2030), but to Saudi Arabia, that end is clearly not so far away that the owner of the largest, most accessible crude resource is willing to continue to subsidize higher prices for other producers at the risk of leaving its own oil untapped one day in the future.

Collateral Fallout 

Much has been made of the catastrophic economic consequences to Russia, Iran, Venezuela and other oil exporting nations caused by these low oil prices, as well as, the profound damage to their economies and impending political turmoil.  Meanwhile in the U.S., there has been endless analysis of the impact (or lack of impact) on the nation’s resurgent oil production and speculation about the price at which U.S.  production will begin to decline.  

Less well documented is the impact on access to capital for drilling operations (and given the disastrous economics of North American coal, perhaps fossil fuel extraction broadly).  Drilling for oil requires huge amounts of capital with a significant appetite for risk, as both production uncertainty and market volatility can undermine the value of investments.  In the current production boom, market volatility was wildly underpriced.  When combined with pent up appetite for yield due to persistently low interest rates, capital, including tremendous amounts of high-yield debt, has flooded into oil companies.  As low crude prices persist there will be substantial losses by investors.  This will cause volatility in crude oil markets to be re-priced, and access to low cost capital will disappear for all but a select group of oil production investments. 

OPEC will continue to meet and hold itself out as a cartel that can control the oil markets, but that time has passed.  The cartel was dependent upon Saudi Arabia to use its outsized swing position to control spare capacity in the market.  With the Saudis no longer interested in that role, the influence of the cartel is gone.  It would be no surprise at all to see Saudi Arabia actually increase production (though how much additional output is readily available is unclear) as prices stabilize and begin to climb later this year because excess capacity will be shed from the market and global economic growth will accelerate.

The direct oil markets impact and the geopolitical fallout will likely be the defining headlines of 2015, but there is a much much bigger story unfolding: the carbon asset bubble is deflating.  The value of effectively every asset class on Earth is influenced by the assumption that a fossil fuel-based economy will persist for so long that any potential for future change to asset values can be ignored.  That assumption is wrong.  The global industrial economy operates on an assumption of available and relatively inexpensive energy, either in the form of electricity or liquid fuels.  If the form, availability of, or cost of, those energy sources changes it will fundamentally change the cost to use and produce virtually every other asset on Earth. And that will necessarily change the value of every one of those assets. There will be both positive and negative impacts, and understanding this change, in both scope and speed, will provide insight on one of the largest wealth shifts ever experienced. 

The owner of the most valuable fossil fuel reserve on Earth just started discounting for a future without fossil fuels.  While they would never state this reasoning publicly, their actions speak on their behalf.  And that changes everything. 

Photo Credit: Saudi Arabian oil fields/shutterstock

Josh Nilsen's picture
Josh Nilsen on Jan 9, 2015

Well said.

The global industrial economy operates on an assumption of available and relatively inexpensive energy, either in the form of electricity or liquid fuels.”

The overall theme going forward will be that the inexpensive energy will be from the electrical grid.  Whether that helps your business model I don’t know, but the economy is definately going to re-adjust.

Many volatile things are going to happen if the electric grid becomes largely dominant over fossil fuels / pipelines.  The shift from natural gas heating to electric heating and the shift from oil based transport to electric based transport.  It could happen fast…unthinkably fast.

Ed Dodge's picture
Ed Dodge on Jan 9, 2015

Interesting analysis. Sell it while you can.

Schalk Cloete's picture
Schalk Cloete on Jan 10, 2015

Thanks for an interesting analysis. However, I would stop short of pegging this drop in the oil price to the carbon asset bubble deflating. My view is that this is simply a return to the expected fossil fuel price trend after the meteoric rise of China caught global energy production off gaurd in the last decade. The result was a quadrupling in the oil price (and a tripling in coal and natural gas prices) which obviously could not last forever.

These massive price increases naturally led to more expensive supply being brought online, but this could not be done fast enough. Now, US shale drillers and other unconventional oil producers have finally managed to get the expectation of future supply to the level of muted demand expectations and the result is a normalization of the price towards historically dominant levels (about $35/barrel in today’s prices). The long term price trend from this point onwards will be upwards as more unconventional sources become necessary to meet global demand, but $110/barrel oil was obviously unsustainable.

This prolonged period of exceptionally high oil prices has also stimulated research into increased efficiency and alternatives to oil-derived transportation which is certainly a very good thing. These technologies will moderate future global demand increases driven by the 6 billion (and counting) people who still have one order of magnitude less material affluence than us developed world bloggers. Hopefully this will help prevent another great global price shock like the one we just went through. Consistently cheap oil is certainly a very good thing for global development which, in turn, is essential for overcoming the sustainability crisis of the 21st century. 

Robert Bernal's picture
Robert Bernal on Jan 10, 2015


At first, I thought it was like peak oil and that it was a race to the bottom.

Now that oil extraction is ever increasing, and that there is so much more of it still in the ground, we can afford a carbon tax capable of actually meeting – the keeping of temps below 2 degrees C. Surprisingly, there is a solution, that with a rather small carbon tax, will create an exponentially expanding new industry: the extraction, pulverizing and distribution of olivine for mineral sequestration of excess CO2.

The following is an exerpt from the Shuiling report.

   “The total CO2 expenditure of the whole olivine operation (mining, milling and transport) has been calculated to be 4% of the amount of CO2 that is captured by that olivine (Koornneef & Nieuwlaar, in prep.). The cost of mining, milling and grinding of 1 ton of rock in large scale mining is estimated by Steen and Borg (2002) to be about 6 Euro/ton. If average transport costs can be limited to a similar amount, the price per ton of CO2 will drop to 10 Euro or slightly less.”

Time for a small carbon tax – and a good use for oil in its “end days”.

Hops Gegangen's picture
Hops Gegangen on Jan 10, 2015


I wonder what gets said behinds closed doors in the upper levels of Saudi government. In addition to noting calls to eliminate fossil fuels, which some of them may scoff at, they surely also take not of projected increases in global temperature. Imagine tacking another 5 degrees onto this and having it happen more frequently: 

Saudi Arabia had its hottest temperature ever on June 22, 2010, with a reading of 52.0°C (125.6°F) in Jeddah, the second largest city in Saudi Arabia …The record heat was accompanied by a sandstorm, which caused eight power plants to go offline, resulting in blackouts to several Saudi cities.” —

Tim Havel's picture
Tim Havel on Jan 10, 2015

Saudi Arabia’s oil may (or at least should) be unburnable, but oil remains a cheap and essential feedstock for all manner of industrial products, including many renewable energy technologies. So if this analysis of the Saudi’s motivation is correct, they’re being very short-sighted. The day will come when people gasp with disbelief at the way our contemporaries just burned all those billions of tons of such a valuable commodity. Perhaps even more than some of us gasp with disbelief at what our ancestors did to the whales …

Geoffrey Styles's picture
Geoffrey Styles on Jan 12, 2015


Your view seems closer to reality at this point than Eli’s analysis. We could see another price cycle before the “end of the age of oil” materializes. It’s worth recalling that as recently as early 2004 $50 oil seemed unimaginably high to industry experts.

Elias Hinckley's picture
Elias Hinckley on Jan 12, 2015

Oh I don’t disagree we could see another cycle for both prices and E&P investment globally, my point was that this is the start of a fundamental (and permanent) change in the approach by the most important player in the market. 

Geoffrey Styles's picture
Geoffrey Styles on Jan 12, 2015

Thanks, Eli. As you noted in our #energychat today, time will tell. The Saudis effectively tanked the market in 1985 by adopting “netback pricing.” That was also a switch to defending market share after years of ineffective cuts to defend an absolute price level (in the mid-$30s back then.) However, once the market tightened again they returned to cutting output in order to shore up prices, pretty effectively in both 1998 and 2009.

Where I think we agree is that the situation now has new elements, including competition from new sources–at least in some market segments–and the “carbon budget/bubble” meme. This is why I prefer scenario planning to price forecasting!  

Schalk Cloete's picture
Schalk Cloete on Jan 13, 2015

I agree that it is important to acknowledge the new elements which differentiate the current situation from previous episodes of OPEC intervention. As I see it at present, these elements are (in order of priority): 1) unconventional oil (primarily shale), 2) great advances in efficiency (4-cylinder engines, small clean diesels and hybrids), 3) alternate fuels (biofuels and battery electrics) and 4) political pressure on CO2 emissions. 

These elements will combine to both limit future global demand growth for OPEC’s oil and to cap the price that the market is willing to pay for this oil. For this reason, the total purchasing power that OPEC nations gain from selling their easy conventional oil has probably peaked and this indeed represents an important fundamental shift in how decision-makers in these nations see the future of their economies. 

I’m not convinced that CO2 considerations will have large impacts on OPEC in the medium-term future though. Limiting CO2 via various policy measures to strongly limit oil consumption will probably do more harm than good by impeding the economy to effectively go after other lower hanging decarbonization fruits. There are many other more important reasons for controlling oil consumption and imports including energy security, congestion & traffic accidents and even local air pollution. 

Robert Bernal's picture
Robert Bernal on Jan 13, 2015

You have me convinced that they see it as the priorities you listed, however, I see the excess CO2 problem as becoming the most serious – and that possibly, oil itself in the form of diesel will partially remedy that problem by enhanced weathering mineral sequestration via heavy industrial means. This might create an additional demand.

Robert Bernal's picture
Robert Bernal on Jan 13, 2015

Perhaps, they’ll bankrupt quite a few competitors (including U.S. shale oil) that had to pay a higher price for startup equipment, and then, the price goes sky high. This low is just a blip on their overall plan. Besides, they can readily aford it – look at their cities!

They must assume we won’t use these low prices to build oil’s replacement.

Pieter Siegers's picture
Pieter Siegers on Jan 16, 2015

I hope the current price fall is a simple indication demand is lowering. If so, there’s hope human kind will be smart enough to leave those filthy fossil fuels in the ground.

Even Saudi Arabia must be very aware today of being on the wrong road. They must have changed plans because of that. I hope they finally recognized that our sun created the oil, and will change from dirty oil production to clean solar production.

Anything of fossil fuels that are to be used for expanding clean energy sources should have a carbon tax to justify its use. All other use is just bad news and should be banned.

A good example is transport where clean energy sources are needed to charge our coming EVs on a massive scale. Fossil fuels can help create the change but they should be priced accordingly because of the pollution they represent.

Subsidies should be reviewed and readjusted. Our economies should change their dependancy on oil and other fossil fuels. The time has arrived to do it. Economies that resist and profile themselves as climate change deniers will find themselves further and further left behind.

I repeat, for human kind to be able to really thrive in the future, fossil fuels must stay in the ground. I have been saying this for more than two years now, and I will repeat this as long as it is necessary.

I wish human kind had listened more closely to Nikola Tesla, and had accepted his generous offer to provide abundant clean energy for everyone on this planet. But economic interests killed that splendid offer and used ordinary fossil fuels to create an energy dependant economy and made it prosper in each and every corner on this planet.


Robert Bernal's picture
Robert Bernal on Jan 16, 2015

It’s probably just a ploy to bankrupt new oil industries – they can afford to. We have to try harder at the solution to excess CO2 – see other posts, I mean comments.

Matthew Mellen's picture
Matthew Mellen on Jan 19, 2015
Why 2015 is the year renewables will win

An update on the top-line drama from the man who knows. A Big Oil bust is on the way!

Robert Bernal's picture
Robert Bernal on Jan 20, 2015

It takes low priced oil to make really cheap renewable energy parts. We’ll need to green a desert for that kind of biofuels – add nuclear made hydrogen and it’ll go further. Cellulosic means possible raping of the forest’s biomass – needs to be regulated to the same exrent as nuclear, as should coal’s heavy metals and NG’s leakage. The industrialism required should be given the subsidy to initiate getting the job (of building clean energy infrastructure and CO2 removal) done!

Elias Hinckley's picture
Thank Elias for the Post!
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