June 20, 2016    3 minute read

US ‘Fracklog’ and the Renewed Attempt of Diversification in the GCC

   June 20, 2016    3 minute read

US ‘Fracklog’ and the Renewed Attempt of Diversification in the GCC

After dropping below $30 per barrel in January, the price of Brent crude has risen to current levels of around $48 per barrel.

Militant attacks in the key oil-producing region of Nigeria has reduced the country’s output to its lowest level in more than two decades. Wildfires in Canada have affected oil sands production, while power cuts have put constraints on production in Venezuela. Altogether, the disruptions averaged around 3.7 million barrels a day in May. These unexpected supply outages combined with a robust growth in oil demand and a weaker US dollar has helped to support the price of oil and offset the acceleration in output from Iran following the lifting of sanctions back in January.

The sustained recovery of oil prices since January has brought a new word into our language – ‘fracklog’. This is used to describe the backlog of US shale wells that have been drilled but have not yet been brought into production. A revolution in US oil production started in 2010 as companies worked out how to use horizontal drilling and hydraulic fracturing to extract crude. The combination of this technological development and oil priced at more than double today’s levels had triggered an investment binge which unlocked the US shale boom.

It is now argued that as soon as the price of crude recovers enough, companies will start producing from the uncompleted wells, bringing an influx of supply onto the market, and choking off any recovery in prices. This, therefore, brings us to the reality that at least until the end of this year, there will be a ceiling to the price of oil. In a recent talk at the Oxford-GCC Business Conference, Professor Paul Stevens, a distinguished fellow at Chatham House, predicts that this ceiling will be somewhere between $60 to $70 per barrel.

At the beginning of the century, former Saudi Arabian Minister of Oil, Zaki Yamani, famously said that:

“The Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil”

The oil-dependent economies of the Gulf Cooperation Council (GCC) have long been under the realisation that they need to diversify their economies and grow their non-oil revenue streams. So far these efforts have failed, however, following the drop in oil prices, there have been more recent plans to reorient these economies towards the private sector, most important being Saudi Arabia’s National Transformation Plan under the ‘Vision 2030’ agenda.

The plan aims to undertake fiscal reforms to reduce Saudi Arabia’s widening budget deficit which is expected to reach 19 percent of GDP by the end of the year; and also aims to develop programs and incentives to provide greater private sector participation for an increasingly young population.

However, it goes without saying that there are plenty of structural obstacles within the GCC nations that prevent the private sector from becoming the engine of growth. Major issues include considerably large state spending in non-oil GDP; the lack of political liberalisation such as property rights; and the lack of investment in human capital and technology that would help increase productivity and the move towards a ‘knowledge economy.’

It still looks to be a long time until the end of the Oil age. All eyes are currently on the US shale industry and its response to higher oil prices; in the meantime, it is of utmost importance that the GCC nations stick to their reform plans, overcome the barriers they are facing, and successfully diversify their economies for the longer term.

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