The sharp drop in oil prices hasn’t been kind to the world’s petro-states, but it has provided an opening to address one of their most pressing economic problems: runaway domestic energy demand.
In the Middle East, the growth in demand is driven in part by expanding populations, as well as a deliberate move into energy-intensive industries such as aluminum and petrochemical production. But a big part stems from the region’s ubiquitous energy subsidies.
Voracious energy use in countries such as Saudi Arabia and Iran is threatening exports from the most oil-rich region in the world. Failing to restrain this galloping demand could leave global markets more volatile, pressure domestic budgets and eventually nudge prices back up.
The 12 members of the Organization of the Petroleum Exporting Countries have increased domestic energy consumption tenfold in the past four decades, a period in which energy use in the rest of the world has a little more than doubled. Saudi Arabia has seen an eye-popping, more than 60-fold increase in consumption over that period.
As a group, OPEC members—mostly countries in the Middle East and Africa, plus Venezuela and Ecuador—now consume almost as much energy as China, with less than half its population. The Middle East, especially, is expected to account for a major chunk of future global demand growth. Saudi energy use is expected to grow at a 3.8% rate through 2020, according to the International Energy Agency. That’s slower than the country’s 5.7% annual average over the past six years, but well above the expected global average of 1.2%.
Consumption is “out of control,” said Steve Griffiths, an executive director at the Masdar Institute, an energy think tank in Abu Dhabi.
Nearly every country in the Middle East long ago embraced the notion that cheap fuel was essentially a birthright. As a result, energy is all but free in some places, such as Saudi Arabia, where a gallon of gasoline costs 45 cents. Governments pick up the rest of the tab, either paying for imports or forgoing income that could be earned by exporting domestic oil or gas rather than selling it for rock-bottom prices at home.
Most countries have realized that’s not sustainable. Some countries, such as Iran, Nigeria and Venezuela, have already hit that wall: They are unable to maintain their spending on imports to meet demand or balance their budgets without the export revenue they are forgoing to satiate consumers’ growing energy appetite. Iran has made some halting progress in raising prices closer to market levels; Nigeria and Venezuela haven’t.
Slashing subsidies is never easy, with the risk of social turbulence from an unhappy citizenry. The good news: Economists and policy makers point out that the steep drop in oil prices presents a historic opportunity to reel back price supports with minimal or even no immediate adjustment to what consumers pay.
Governments could take the time offered by the reprieve to design policies to construct a stronger social safety net, aiming support at those who need it when prices rise rather than an across-the-board subsidy.
Iran, facing runaway expenditures to import gasoline, has reduced subsidies (and thus raised prices at the pump) twice over the past five years, substituting direct cash payments to all consumers. Elsewhere, Indonesia and India have made similar moves more recently.
But there’s been little progress in other quarters of the Persian Gulf, particularly Saudi Arabia, where the problem is particularly acute. The cost of artificially low prices there has ballooned from $5 billion in 2004 to $32 billion last year. Continued growth in Saudi energy use could make the country, now among the world’s largest oil exporters, an importer by 2038, according to Chatham House, a U.K.-based think tank.
Long before that, Saudi Arabia’s ability to hold back on pumping some of its oil—known as “spare capacity”—would disappear as domestic demand grows. That capacity, which can be switched on or off at the country’s whim, is key to its role as king of the world’s oil markets, and has been critical to its ability to smooth out what would otherwise have been some huge market swings.
Ballooning Saudi demand is “going to take away their ability to be the swing producer, to go up or down in production,” according to Jim Krane, a fellow at Rice University’s Baker Institute for Public Policy.
That might seem irrelevant today, when the globe is glutted with oil. But as demand catches up to supply—in no small part due to swelling demand growth among Middle Eastern petro-states—the global oil market could become significantly more volatile, he notes.
Some big energy importers—such as Egypt, Indonesia and India—have managed to cut subsidies significantly to head off fiscal disasters. But the major petro-states, beyond Iran and Venezuela, have no budget pressures to focus officials’ minds on overhauls.
Countries like Saudi Arabia, fearful of a social blowback, can tap huge reserves to maintain their subsidies and cover the loss of export revenues. They are focusing on improving energy efficiency and expanding their domestic energy supplies through nuclear power plants.
But that only means energy use will continue to rise—and well above the rate new supply can be added. “Saudi is not a small energy consumer,” said Laura El-Katiri, a research fellow with the Oxford Institute for Energy Studies. “What happens to demand there is important to the overall demand picture globally.”
Write to Bill Spindle at bill.spindle@wsj.com