Navigating the Long Goodbye: What Decreasing Global Oil Demand Means for the Gulf

Even as global oil demand continues to grow, albeit gradually, it is broadly understood that technological developments could eventually drive that demand to zero by the end of the 21st century. However, the latest economic research shows that such a fall in oil demand won't necessarily mean a fall in oil production – in fact, in the short run, we may paradoxically see higher levels of oil consumption. This has important implications for Gulf countries.

For the time being, setting aside the disruptions associated with the near closure of the Strait of Hormuz, oil demand is buoyant and growing at a steady pace. But there are strong forces in the background that are making analysts predict a terminal decline in the demand for oil starting in the middle of this century. These include sustainability commitments, the emergence of alternative technologies such as electric cars and solar power, and the desire by oil-consuming countries to achieve higher levels of energy security.

If these forecasts are borne out, it is natural to imagine that falling demand for oil will lead to falling production. Yet this reasonable assumption may turn out to be misleading, as evidenced from recent research by University of Chicago professor Ryan Kellogg. Using simulations to predict what will happen to oil, Prof Kellogg identifies two forces that are pulling in opposite directions, making it unclear whether failing oil demand will indeed bring about a contraction in oil supply, or if it will motivate oil-rich countries to increase their production.

Starting with the more intuitive scenario, Prof Kellogg notes that the production cycle for oil is both long and requires a lot of up-front capital expenditure. For example, when a new well is discovered, the process of mobilising the extraction equipment and initiating operations typically takes about five years with a large proportion of the spending occurring during that initial phase. In light of this, if producers forecast an impending significant contraction in oil demand, it makes sense for them to hold off on investing in new wells.

Accordingly, under these conditions, oil production will simply follow its natural lifecycle of gently tapering off as existing operational fields dry up, resulting in global oil supply mirroring the decline in oil demand. Under such a scenario – which Prof Kellogg terms the “disinvestment” case – we would expect oil prices to be relatively stable.

The more unusual scenario is what Prof Kellogg labels the “green paradox”, whereby policies that are ostensibly friendly to the environment cause a decrease in oil demand, but cause a sharp increase in oil supply that results in more oil being consumed during a transition period. This happens if oil-rich countries decide they want to avoid having their reserves turn into “stranded assets”, meaning that they try to get as much oil out into the market as possible today before the currently valuable resource becomes commercially non-viable in the future.

In practice, the world will not neatly fit into either the disinvestment or the green paradox scenario. The forces associated with each will materialise to some degree, meaning that either they cancel each other out, or whichever is stronger prevails. Given the strategic significance of oil, predicting what actually happens has important implications for carbon emissions, supply chain logistics, resource-related conflicts, and even economic planning, as in the case of the Gulf states’ visions.

A key reason for the model’s prediction is that – historically speaking – oil producers have demonstrated a significant preference for the present over the future, and with it an aversion to the large up-front investments needed for the green paradox effect to dominate. Economic diversification – and, more specifically, diversification of government revenue and exports – therefore remains indispensable to ensure that the region’s prosperity no longer depends on getting the demand prediction right.