Oil producers face costly transition as world looks to net-zero future
Ali Allawi, Iraq’s finance minister, found himself in a quandary last year as the spread of coronavirus cut demand for oil and prices tumbled. Allawi’s treasury, which receives more than 90 per cent of its revenues from crude sales and spends 45 per cent of its total budget on salaries and pensions, suddenly didn’t have enough money to pay millions of public employees and retirees.
Opec’s second-largest producer borrowed billions of dollars, mostly from local banks, to bridge the shortfall. But public anger boiled over. The fallout of the virus then battered businesses as their most important customers — public employees — cut their spending.
Iraq’s economic fragility was laid bare: the hit to both public and private sectors caused the country’s gross domestic product to shrink 11 per cent in 2020 according to the IMF, and poverty rose amid worsening unemployment.
Yet this scenario — a huge fall in revenues as demand for Iraq’s oil drops — is not just a pandemic phenomenon, it is the future for oil producing countries.
Last year’s oil crash coincided with an unprecedented focus by global governments, corporations and the public on committing to net-zero emissions targets by 2050. For producers, a global shift towards cleaner fuels will amplify the challenges of the past year, prompting questions about which resource rich countries can come out of the energy transition in the best shape.
The International Energy Agency has warned of the drastic impact that pursuing a net-zero emissions target by 2050 could have. Opec’s share of world production would rise to more than half of the total, as oil and gas supplies become concentrated among a smaller number of countries, but annual per capita income from these commodities could fall by as much as 75 per cent by the 2030s.
“We’re facing a potential declining market in terms of size,” says Allawi, “a potential decline in price [and] demands by our trading partners and allies, mainly in the industrial world, that we should abide by the Paris climate agreement terms.”
If Iraq — which has 145bn barrels of proven crude reserves — stays dependent on oil, Allawi says, “it could be catastrophic”. Sweeping state and economic reforms could avert this scenario, but the minister has struggled to push through change.
For decades oil price booms and busts have provided shocks to producer states, underscoring economic frailties and the urgent need to develop new business sectors to reduce fossil fuel dependence. The worst-off countries tend to be the most exposed: states where hydrocarbon exports make up a large part of GDP. They are also the least resilient: where the revenues from the sale of oil, gas and coal have not been adequately managed. This could mean failing to use the cash to diversify and foster other industries domestically or create a sovereign wealth fund that makes investments abroad to secure long-term revenues.
How fossil fuel-dependent economies make the adjustments heralded by the energy transition will be critical. They represent almost one-third of the world’s population and a fifth of global greenhouse gas emissions. Their success or failure in a lower-carbon global economy could have widespread implications for geopolitics, global inequality, energy security and migration patterns.
Among those least prepared include Iraq, Libya, Venezuela, Equatorial Guinea, Nigeria, Iran, Guyana, Algeria, Azerbaijan and Kazakhstan, according to the World Bank. These nations have not diversified exports or shifted their economies towards non-polluting industries. Most have been mired in war, plagued by widespread poverty or unable to secure international investment to drive a shift away from fossil fuels. Many of them are also among the most vulnerable to the real-life effects of climate change.
Iraq is not only struggling to pull itself together after decades of conflict and instability, it is already on the frontline of global warming — desertification, water stress and extreme temperatures have an impact on daily life already hampered by rolling electricity blackouts.
The pandemic, the World Bank says, offers these countries “a once in a generation moment” to diversify from hydrocarbons.
Allawi, too, had hoped last year’s shock would pave the way for sweeping reforms. But the alarm did not last as prices began to rise again — from $38 a barrel in October to near $70 today. Instead of cutting government salaries and pursuing the investment and economic overhaul he says are necessary, the state dealt with unemployment by adding even more college and university graduates to the state payroll.
“It was a wake-up call last year,” says Allawi. “But as the oil price crept up [again] the demands of various constituencies forced themselves back on to the agenda and the pressure returned to use the public [spending] trough.”
A fight to be ‘last man standing’
The transition towards cleaner fuels is likely to play havoc with supply chains and businesses that serve the natural resources sectors. The disruption to revenue streams and labour markets means there is little incentive, for now, for these national producers to join global initiatives to combat climate change, say economists and energy analysts.
Ashim Paun, a climate change strategist at HSBC, says it is a tough pill to swallow: “When you have so much cheap oil and gas you stay hooked on it.”
Fossil fuels have provided unimaginable wealth, leading to economic modernisation and prosperity in some countries, including the Gulf states. But in many cases these riches have been squandered or concentrated in the hands of a few. Still, the lure of this cash windfall is so great that countries such as Guyana — which produced its first commercial-grade oil in 2019 — are, even now, trying to become petrostates.
Many oil economies have recognised the downside of being beholden to fossil fuel exports and volatile commodity prices. Corruption, mismanagement of state funds and subsidies have also led to bureaucratic, government-dependent nations rather than dynamic entrepreneurial states.
Yet it is not entirely clear which economies will lose out in the energy transition. Saudi Arabia and Russia — the second and third-largest oil producers in the world — are vulnerable but their more complex economies and bigger financial buffers have boosted their resilience despite their high exposure to hydrocarbons exports.
“This is not a homogenous group and their resilience and core sources of comparative advantage vary tremendously,” says Bassam Fattouh, director of the Oxford Institute for Energy Studies, who adds that some countries are “in a position to benefit from transformations associated with the energy transition”.
Canada, Norway, Australia and the UAE are among those reliant on fossil fuel sales that have successfully developed other areas of their economies. Some are trying to add clean energy capabilities.
Success or failure will depend on the pace of change. A slow and smooth transition towards cleaner fuels is possible, but so is a brutal upheaval.
Dictating the speed of change will be technological advances, political momentum, regulation and how big energy consumers choose to meet their needs. New supply chains linked to the energy systems of the future will also pose challenges — from the supply of metals such as lithium to the production of batteries, wind turbines and solar panels.
Most energy ministries in producer countries are banking on fossil fuels remaining a big part of the energy mix for decades to come. State-owned energy companies are set to spend $1.9tn on new oil and gas projects by 2030, according to the New York-based Natural Resource Governance Institute. Despite net zero ambitions, the reality of today’s consumption is quite different. Developing economies in the Asia-Pacific region alone are expected to account for nearly two-thirds of global energy demand growth between now and 2040.
For producers, the calculation is that even if demand for oil and gas falls, they will still be able to sell their precious commodities for years to come and be the “last man standing”.
“There is a massive need to bring energy to the billions of people that continue to go without,” says Mohammed Barkindo, Opec secretary-general. “Opec supports the need to reduce emissions and use energy more efficiently, but we do need to be cognisant of the implications of under-investment . . . It is not just crude oil, it is the plethora of products that are derived from it.
“A shortfall in investments could affect stability in markets, prices could rise, and we could see product shortages, all of which would have an impact on the global economy,” he adds.
Big fossil fuel consumers — such as Japan — are also wary of the growing momentum to shut down new investment into oil, gas and coal developments. They are fearful of their energy security should renewables fail to replace robust demand for hydrocarbons.
For investors, governments and the public, a country’s future depends on its ability to attract foreign investment, eliminate inequality, manage inflation and other factors.
But among producers even Saudi Arabia, the world’s largest oil exporter with the lowest-cost barrels, is nervous. Despite a stronger economy than other producers and grand plans to create new industries — from technology to tourism — the kingdom is concerned about a cash shortfall before it is able to sufficiently develop new revenue sources. Mohammed bin Salman, the crown prince, said in a recent interview: “We are an oil country, not a rich country.”
“We were very rich in the 1970s and 1980s when we had a smaller population and a lot of oil. But now . . . we are growing quickly,” he said. “If we do not maintain our savings and distribute our tools every day, we will be transformed into a poorer country.”
Ill prepared for change
At a petrol pump on Akin Adesola Street in Lagos, managed by the state oil company Nigerian National Petroleum Corporation, a couple of dozen cars are queueing up in a knotty, noxious snarl, waiting for the cheapest fuel available in sub-Saharan Africa.
The subsidy that discounts petrol prices for the country’s 200m people mainly benefits the wealthy and costs the government $300m a month. It is emblematic of the mismanagement at the heart of Nigeria’s energy sector — from oil and gas to electricity — undermining the entire economy.
Clarkson Pwabili, a 38-year-old driver filling up his boss’s car, says even the N162 ($0.38)-a-litre price is too high. “The economy keeps going down, so even this price is a hardship on people [because] it increases the cost of transportation,” he says. The minibuses he rides to and from work have doubled in price over the past year, to N1400 a day. “This is very high for me,” he adds.
Nigeria is Africa’s biggest oil producer, churning out about 1.7m barrels a day from pumps far offshore in the Gulf of Guinea or deep in the swamps of the Niger Delta. Yet the government-subsidised fuel is imported. Oil provides roughly half of government revenues and nearly all of its foreign exchange, but the lack of refining capacity in Nigeria and the chunky import bill for petroleum products all but nullify the benefits the state gains from higher global oil prices. Smugglers ferret an estimated 30 per cent of the country’s petrol supplies into neighbouring Benin and Cameroon, where fuel prices are higher.
When the oil price crashes, as it did last year, the consequences are horrific.
The failure to manage its resources properly means most ordinary Nigerians are yet to see any real benefits from the billions of dollars in revenue extraction. Forty per cent of Nigerians live in poverty and state funds are yet to stimulate alternative industries. Yet with the population expected to double by 2050, the need to act is urgent.
The sector’s dysfunction is typified by the bloated NNPC, notorious for mismanagement and corruption. It buys, sells and trades oil and refined products while also acting as its own regulator. “If the government had managed it well, I don’t think we’d be in this situation,” says Pwabili.
Other sectors are hamstrung by Nigeria’s inability to generate and distribute electricity across the country. Africa’s most populous country is among the least electrified in the world on a per capita basis, with many businesses largely forced to generate their own power using costly, polluting diesel generators. This is preventing a shift from a hydrocarbon-led, capital-intensive growth model to one that is labour or knowledge-driven — from technology to agriculture and industry.
President Muhammadu Buhari’s administration has made efforts to exploit Nigeria’s natural gas reserves, which at about 5.3tn cubic metres are among the biggest in the world. The hope is a resolution of the power crisis will help other sectors thrive.
When trying to understand what a successful transition looks like, energy analysts say properly managing existing fossil fuel infrastructure and investments should be the priority. Only then can a country try to navigate a move in to new industries.
Mark Finley and Paul Kolbe of Rice University’s Baker Institute in Texas say poorer economies are unlikely to join the net-zero bandwagon with fervour given their limited economic and political choices.
“The uneven pace of the energy transition could threaten to derail its success if not properly managed. Given the global nature of the challenge, winners have a stake in the overall success of the transition, not just in their part of it,” they said in a recent paper. “It is not helpful (or appropriate) for richer countries to force the cost of this transition on to poorer countries.”
For those in Nigeria, this double standard is abundantly clear. “A transition [away from] the fossil fuel economy [would] represent doom for Nigeria and her people,” says Idayat Hassan at the Abuja-based Centre for Democracy and Development. “The country will get poorer and the naira worthless . . . and lawlessness [may] reign . . .
“Neither the country,” she adds, “nor her people are really ready for it.”
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