Robin Mills: Region quenches oil demand with end to subsidies

Lavish consumption was encouraged by subsidies, which kept Middle Eastern fuel prices the lowest in the world.

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Which region has contributed the most to growth in oil demand so far this century? China, of course, which gained 7.3 million barrels per day of consumption between 2000 and last year. Which is second? Maybe India, or Latin America? No, it was the heart of global oil exports, the Middle East, whose demand for its own crude swelled by 4.4 million barrels per day.

Swelling economies under the stimulus of high prices drove the Middle East’s oil thirst, as new gas guzzlers cruised freshly built highways. Lavish consumption was encouraged by subsidies, which kept Middle Eastern fuel prices the lowest in the world. Those same subsidies discouraged gas development, so some countries turned to burning oil for electricity. So 240 million people in the Middle East managed to increase their demand by more than did 3 billion Asians outside China.

Now all those factors have gone into reverse. The slowing of the region's oil demand is a further factor prolonging the current oil price slump.

While prices stay low, regional growth will be moderate at best. This year, it is forecast at 2.3 per cent, respectable by global standards but the lowest since the 2009 financial crisis. Next year may be a little stronger, with 3 per cent expansion.

With an end to the boom, attempts to cut oil, gas and electricity subsidies have accelerated. Iran moved first in December 2010, with a wide-ranging reform of all energy prices coupled with cash compensation to families. Initially successful, high inflation, currency depreciation and deep recession undermined its effects and have led to further rounds of price adjustment.

Oil-importing nations in the Middle East and North Africa were badly hit by soaring prices and in response Morocco, Jordan and Tunisia have essentially reached market-based energy prices.

Arab oil exporters were the last to move, but the UAE decided to set its fuel prices at international levels from August last year, Saudi Arabia raised prices in December although they remain heavily subsidised, and Bahrain, Oman and Qatar largely eliminated petrol and diesel subsidies in January. Algeria too has raised prices in this year’s budget.

Amongst the hold-outs, Kuwait tried to cut subsidies last year but reversed the decision in the face of parliamentary opposition. The country raised diesel prices in January and will try again with petrol from next month. Fiscal pressures and IMF loan conditions for Iraq are likely to encourage subsidy reform here too.

What effect has this all had? Analysts trying to understand the twin impacts of slowing economies and subsidy reform have to read the tea-leaves – firm data is patchy and late. What the available numbers do show is that, in the months following their reforms, petrol consumption in Bahrain and Qatar fell slightly; in Oman, sharply. Saudi overall oil demand is down by 2 per cent this year, partly replaced by new gas supplies to power plants.

Diesel use in Egypt fell by 23 per cent in the month after its July 2014 reform, such a steep drop that it suggests fuel was probably being smuggled out of the country before. Only this summer did demand again reach June 2014 levels.

If Middle Eastern economic growth rebounds, does this mean that oil demand will soar again? Probably not. Subsidy reform has become entrenched policy in most of the major consuming countries, which have budgets to defend and repair. New gas supplies and alternative energy should slow the use of oil for electricity in Saudi Arabia and Iraq, and largely eliminate it elsewhere.

Reducing the region’s unsustainable surge in oil demand has been financially and environmentally essential for years. The full impact of an end to subsidies will ripple through the economy in the years to come. But as oil not used at home goes for export, the Middle East is doing its part in prolonging the global glut.

Robin Mills is the chief executive of Qamar Energy and author of The Myth of the Oil Crisis.

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