Written by: Ryan McGuine & Sam Alhadeff

In 1956, Shell geologist M. King Hubbert predicted that American oil production would peak in 1970 and decline from then on, and that worldwide production would do the same sometime around 2000. This narrative, known as “peak oil supply,” predicted that as humans use increasing amounts of oil, existing wells will dry up, there will not be sufficient new wells discovered to replace them, and rising oil prices will bring the global economy to its knees. However, Hubbert’s prediction never came to pass as technology and shifting cost factors stepped in to change the outlook. More recently, concerns about declining oil supply have been supplanted by those about declining oil demand. Although the exact date that oil demand will reach its peak is inherently unknowable due to the incredible scale and complexity of the oil market, countries that are heavily dependent on oil revenues would do well to begin planning for peak oil demand today. Oil-reliant countries don’t need to look far to see the potential problems with their dependency. Venezuela’s recent economic collapse, made more severe by poor governance, illustrates what these countries might face when peak oil demand does arrive. Saudi Arabia’s commitment to economic diversification with Vision 2030, on the other hand, serves as a powerful example for how to prepare for the inevitable.

Petroleum reserves are broadly categorized as economic or subeconomic based on estimated extraction costs. Over time, the development of new technology has meant that reserves previously deemed subeconomic often become economic. For example, horizontal drilling can now access tight oil reserves found in low-permeability geological formations, extra-heavy oil reserves contained in bitumen can be mined conventionally and processed to get liquid fuels, and naturally-occurring coal and natural gas can be converted into liquid fuels. While these unconventional resources are typically more expensive and require more energy input to recover than conventional crude oil, so long as there is a demand for petroleum products it will make economic sense to invest in new extraction methods. Additionally, as a given reserve is depleted over time, well pressure declines, reducing production rates. It is possible to maintain similar rates of production in the face of well depletion by capital investments into enhanced oil recovery techniques. On the scale of individual wells, this phenomena makes that particular oil more expensive and can price the well out of commission temporarily. However, because of record low prices recently, there have been multiple years of industry-wide low investment in technology, leading some to speculate about a coming supply shortfall. Whereas better technology shifts subeconomic wells towards becoming economic again by decreasing the production costs, a supply shortfall would do so by driving up the price of oil. 

Since subeconomic reserves often become economic, peak oil supply has proven to be a non-issue. However, recent structural changes at the country level and global changes within particular economic sectors have sparked concern over peak oil demand. Traditionally, the countries driving oil demand have been developed countries, but as countries reach higher levels of development, the structure of their economies shifts from the production of industrial goods toward services. The energy intensity of the economy therefore declines, leading to a decline in oil demand. At the same time, though, oil demand in developing countries is projected to increase multiple times over in coming years. A recent report by Wood Mackenzie predicts that demand in the countries that make up the Organization for Economic Co-operation and Development (OECD) will fall from today’s 50 million barrels per day to 40 million barrels per day by 2035. During the same time frame, demand in non-OECD countries is forecasted to grow from 30 million barrels per day to over 60 million barrels per day as these countries reach higher levels of income and consume more energy-intensive goods. 

In addition to structural shifts within economies, it is important to explore the dynamics of oil demand by different industries across economies. The majority of oil consumption can be divided into three boxes: passenger cars, other modes of transportation, and industrial applications that use oil and natural gas as feedstocks like fertilizer and plastics. Those uses account for approximately 25%, 30%, and 20% of global oil demand respectively. Passenger vehicles get most of the attention, and growth in transportation-related demand is predicted to peak by 2030, mainly as a result of cars — driven by increasing efficiency over the next decade and by the projected increase in penetration of electric vehicle (EV) prevalence after 2025. Even if the cities and countries that have declared an intention to ban internal combustion engines actually do so, many other modes of transportation will face a less stringent regulatory atmosphere and will, from a technical standpoint, have a more difficult time replacing petroleum fuels. While over 45 countries have fuel efficiency standards for passenger vehicles, only four have any for semi trucks. The International Maritime Organization (IMO) adopted the first ever emissions targets for the shipping industry, but much of them will be achieved via fuel switching, since the industry currently uses one of the cheapest, dirtiest crude oil derivatives. Thus, increasing demand for ground and ship freight, and air travel, threatening to slow the overall transportation sector demand decline. On the technical side, petrochemicals have few realistic alternatives and demand is expected to rise from 12 million barrels per day to 18 million barrels per day by 2035. 

Predictions for exactly when peak oil demand might occur vary somewhat. The Organization of the Petroleum Exporting Countries (OPEC) forecasts that demand will continue to increase through 2040 but offers no prediction for peak demand. British Petroleum (BP) offers multiple potential scenarios, based on different combinations of government policies, technological developments, and societal preferences to highlight the difficulty in predicting peak demand, but generally suggests some time in the 2030s. The International Energy Agency (IEA) predicts demand to begin declining by 2023, but says there is no peak demand in sight. It is not surprising that there is such variance in predictions — the sheer number of factors affecting oil supply and demand make them both notoriously volatile — but it is difficult to imagine a future where demand never decreases. For countries that depend significantly on revenues generated from oil, this situation poses a threat to their long-term political and economic stability. While the future need not be bleak for them, maintaining growth and stability will require strategic planning beginning today. 

The growth of non-OPEC oil producers has provided oil-reliant countries in OPEC a taste of what is yet to come when oil demand truly begins to decline. Although the growth of other producers and declining oil demand are separate phenomena, the result — a decline in oil revenue — is still the same. Over the past decade, the shale revolution in the United States alone has doubled crude oil production from a low of five million barrels per day a decade ago. The growth of the United States and other producers in the market has reduced OPEC’s capacity to influence oil prices like it has in the past. As a result, oil prices dropped from $110 per barrel to $48 over the course of a six-month span in 2014. 

In Venezuela, the halving of oil prices over such a short period has set off a four year long economic crisis affecting the entire country. The story of economic mismanagement and over-reliance on oil is not unique to Venezuela nor is it new. Leading up to the economic crisis, 95 percent of Venezuela’s exports and nearly half of government revenue came from oil production. When prices fell in 2014, Venezuela’s economy immediately lost 10 percent of its GDP. Since then, the International Monetary Fund reports Venezuela’s real GDP has fallen 16.5 percent in 2016, dropped another 14 percent in 2017, and is projected to decline an additional 15 percent this year. In total, Venezuela’s economy has shrunk in half since 2013.

Like many of its peer OPEC nations, Venezuela has a history of grossly mismanaging its oil industry. After coming to power in 1999, President Hugo Chavez treated the already nationalized oil company, PDVSA, as the government’s “piggybank.” Instead of investing in efficient management of the country’s greatest asset, Chavez replaced 18,000 striking workers, experts in their field, with loyalists. Instead of investing in new technology or increased efficiency, Chavez mandated 10 percent of PDVSA’s budget be invested in social programs. Since then, production remained stagnant and has fallen precipitously since 2014, despite Venezuela possessing the largest known crude oil reserves in the world.

Nevertheless, Venezuela’s situation is somewhat unique. Venezuela’s poorly functioning economy was only surpassed by its equally poor governance. With a mismanaged government almost entirely reliant on oil revenue, the drop in oil prices snowballed Venezuela into its current economic situation that other oil-dependent economies avoided. Whereas Venezuela’s economic collapse can be attributed to generally poor governance, discerning leaders who recognize the inevitably of peak oil demand can avoid a similar fate.

Other oil producing countries can rest assured their market position will remain secure until the world reaches peak oil demand in a few decades. A recent International Energy Agency (IEA) report found the impact of newcomers to oil — U.S., Canada, Brazil, Norway — will not be able to meet rising oil demand after 2020. Thus, established producers will need to invest in supply to meet demand, giving them ample time and money to prepare for a future less reliant on oil.

Saudi Arabia’s new Crown Prince, Mohammed bin Salman, seems to already be heeding this warning. In 2016, he introduced his Saudi Vision 2030, a comprehensive economic development plan intending to reduce Saudi Arabia’s  dependence on oil. Like Venezuela, Saudi Arabia’s economy took a hit when oil prices fell; 90 percent of exports, 87% of government revenue, and 42 percent of GDP came from oil in 2017. Similar to Venezuela, the Saudi government nationalized its oil company, Saudi ARAMCO. Employment problems have been particularly acute in Saudi Arabia, the public sector is riddled with inefficient patronage jobs, and the private sector is mostly filled by foreign workers. Approximately 70 percent of the workforce is employed in the public sector — including Saudi ARAMCO — a number bin Salman hopes to reduce by 20 percent by 2020. Where Saudi Arabia differs from Venezuela, though, is the size of its foreign reserves that help it weather collapsing oil prices.

Diversifying their economy has been a long mission for Saudi kings. Nine different five-year plans have been pursued since 1970 with limited success. The Vision 2030 plan, along with its accompanying documents, represents the longest time-horizon of any development strategy and the most ambitious. Among its goals are balancing the budget by 2019, running a surplus by 2020, creating a $2 trillion sovereign wealth fund, raising female labor force participation to 30 percent, and building a $500 billion futuristic city called Neom. To achieve these goals, the plan has promoted several reforms. The current Public Investment Fund has partnered with the likes of SoftBank and Blackstone, . Plus, bin Salman aims to partner with Alphabet and Amazon to create a tech hub in Saudi Arabia. Saudi ARAMCO has floated an international public offering (although it has opted for a domestic listing for the time being). The nation’s first movie theater is set to open in April and Six Flags will open the first theme park by 2022, alongside investing nearly $3 billion total in the entertainment industry. Crown Prince bin Salman introduced a 5 percent Value Added Tax, levied a new tax on foreign workers, and increased fuel prices, netting a 30 percent increase in non-oil revenue. Religious police who have traditionally harassed women lost most of their power and women will be allowed to drive starting in June, both of which dramatically improve female economic mobility. Perhaps most important for employment diversification, the government introduced the “Removing Obstacles to the Private Sector” Program to remove bureaucratic barriers for setting up new businesses, including rewriting laws to adapt to a changing economy.

These reforms aim to be disruptive and rapid, and Crown Prince bin Salman will likely face some serious domestic pushback, especially if state-sponsored energy subsidies are decreased or eliminated. Nevertheless, he has been positioning himself as a populist leader, arresting hundreds of elites ostensibly charged with corruption in 2017. Additionally, the regional chaos after the Arab Spring in 2011 provides the Crown Prince credibility solely for the stability he provides. It is not hard to find reasons for skepticism of Vision 2030’s potential success. Saudi Arabia still has several restrictive laws on women’s rights and religious freedom, Neom is incredibly ambitious with development plans outpacing available — and affordable — technology,  and the economy has been perennially resistant to major overhauls. The ambition of the plan alone has been criticized for being too disruptive, too fast. Nevertheless, these reforms are still in their nascent stages, and the time for economic disruption is now. Peak oil demand is still decades away, and by 2030, half of Saudi Arabia’s population is expected to be under 25 years old.

Venezuela and Saudi Arabia are not alone in their reliance on oil, either. 65 percent of Libya’s GDP and 95 percent of its government revenue comes from oil. Additionally, oil accounts for at least 90 percent of exports in eight different countries. Kuwait, Iraq, and Angola join Libya and Saudi Arabia with oil composing at least 40 percent of GDP. The United Arab Emirates drafted their own economic development plan, Vision 2021. Other countries like Russia and Nigeria will also need to follow in Saudi Arabia’s footsteps are prepare for the future, lest they end up where Venezuela is today. As IMF Director of Middle East and North Africa Masood Ahmed said, “the transformation of oil-exporting economies is no easy task and will be a long-term project. It will require a sustained push for reforms and well-thought-out communication.” Headwinds like Dutch Disease — where oil reserves appreciate the currency too fast compared to other goods — and economic complacency challenge the ability of regimes to make needed changes. That does not mean reform is not worthwhile or not urgent. As we stated at the outset of the article, fears of peak oil demand are overblown but not nonexistent. Countries that take difficult but necessary steps now will be the ones enjoying national prosperity when we finally reach peak demand.