Oil War
A symposium on the American-Israeli war on Iran
Hello, and welcome back to the BREAK–DOWN’s weekly newsletter. I’m going to keep my introductions brief this week, as we have four new essays on the website, responses to the American-Israeli war on Iran, and what this means for both the Middle East and the politics and economics of oil. You can read Kate Mackenzie’s essay below, and for the contributions of Guy Laron, Toby Craig Jones and Patrick Bigger and Kevin Cashman, visit our website.
Finally, later today, our deputy editor, John Merrick, will be speaking at Scotland’s Economic Festival in Leith. If you find yourself in the Edinburgh area, please do come along and say hello!
Demand Destruction By Kate Mackenzie
The effective closure of the Strait of Hormuz raises a prospect that has only been gamed out theoretically: of a material portion of the world’s fossil energy supply (and its fertilizers and feedstocks) being blocked, with no adequate route to market.
That high oil prices benefit anyone in the business of selling oil—assuming they can get their product to market—is a given. Oil companies stand to make an additional $63 billion this year if prices average $100/bbl for 2026, according to energy consultancy Rystad. This huge windfall obscures the fact that a “sustained” period of high prices is a nightmare for many oil producing interests. Oil prices that remain too high for too long are uncomfortable even for commercial producers, and can pose an almost existential threat to sovereign producers.
Not all countries that sell oil are equally vulnerable. The spectre looms largest for the sovereign producers that are most dependent on oil export income. Poorer petrostates are usually too constrained to plan for the future, which is why countries like Angola and Ecuador quit OPEC+ as they chafed under its requirements to cut production. Wealthier petrostates can afford to think about the long-term.
“Demand destruction”, in which prices remain so high that some users quit oil altogether, haunts Saudi Arabia in particular. Despite the country’s crude oil being the cheapest in the world to extract, it needs a “fiscal breakeven” price well above the profit levels required by oil companies or other countries. Oil rents underwrite Saudi Arabia’s social contract with its citizens, who enjoy well paid jobs and a high standard of living to compensate for a lack of say in their governance. Saudi Arabia’s bigger population and resulting lower per capita oil revenue puts it at a disadvantage compared with fellow wealthy petrostates such as the UAE and Norway. Saudi has not built sufficient alternative sources of income to significantly cut its reliance on oil exports.
The kingdom’s former oil minister, the late Ahmed Zaki Yamani, either originated or popularized the adage that “the stone age didn’t end because we ran out of stones”. Yamani held the ministerial position from 1962 to 1986, through the oil embargo of 1972-73 and the oil crisis of 1979. The first incident heralded the formation of the OPEC group of countries that built enormous wealth for its members, particularly those in the Gulf. But the combined oil price shocks of the 1970s rocked the ability of their customers in oil-consuming countries to maintain their habit.
Saudi Arabia has long maintained a volume of spare capacity, a result not just of its attempts to keep prices high, but also as a demonstrable means to reduce them if they threatened to go high enough to harm demand. This latter function became particularly important after the price run-up in 2007 leading to an all-time high for West Texas Intermediate of $147 in July 2008, which exacerbated recessions arising from the global financial crisis.
Later in 2008, prices fell well below $40 per barrel, but the experience left both importing and exporting countries anxious; a widely cited paper by James Hamilton at Brookings Institution partly attributed the US recession of the late 2000s, which actually began in 2007, to the run-up in oil prices. Even though macroeconomists have tended to argue that oil prices have played a smaller role in economic activity since the shocks of the 1970s, there is little dispute that high and volatile prices can provoke recessions, which in turn hurts oil demand.
No-one wanted a repeat of those mid-2008 highs. In the aftermath, Saudi authorities insisted that they could, relatively easily, ramp up production if prices threatened to get too high. Increasingly, they also specified a price window which included a ceiling. Oil minister Ali al-Naimi said in September 2009 that the current price was “good for everybody, consumers and producers.” Around the same time King Abdullah of Saudi Arabia gave a newspaper interview declaring $75 a price he considered to be “fair”; which he reiterated later in the year, saying $75 - 80 was “a fair price”.
While oil producers were effectively advocating for a price ceiling, leaders of the world’s biggest oil-importing countries were voicing support for a price floor. Gordon Brown and Nicholas Sarkozy in a 2009 Wall Street Journal editorial publicly called for a price range that would be high enough to support investment in oil production. “We as consumers must recognize that abnormally low oil prices, while giving short-term benefits, do long-term damage,” they wrote, adding that low prices disincentive investment in oil production (inexplicably, they asserted that it also hurt investment in “energy savings and carbon free alternatives”).
This kind of rhetoric over price ranges has evolved as the fine supply-demand balance has shifted towards oversupply. This is in part due to the US shale boom of the 2010s which, along with the actions of Russia and the more cash-strapped of the traditional OPEC members, shifted the balance of power towards producers with less interest in the long-term stability of the oil market. Throughout this, Saudi Arabia has maintained and even increased its spare capacity, which was approaching 3 million barrels per day prior to the US and Israel attacking Iran.
The aftermath of more sustained price shocks, however, remains in the psyche of the major oil producers. The 1979 shock, sparked by a collapse in Iranian and, later, Iraqi production, sent many oil-importing countries into recession. Consequently, oil consumption fell more than 10 percent in the four years to 1983. As the experience demonstrates, if prices stay too high for too long countries can and will cut their consumption in ways that can be enduring.
The self-inflicted effects are most memorable. “For the Arab OPEC states, the ‘success’ of the embargo proved somewhat pyrrhic and fleeting,”, wrote Frank Verrastro and Guy Caruso of the Center for Strategic and International Studies in 2013, in reference to the 1973 oil embargo, “as the price and disruption shock spurred new government policies and investments in energy efficiency, including the adoption of fuel efficiency standards for cars (CAFE), research into and the accelerated deployment of alternative fuels, and in the United States, the eventual removal, beginning in 1979, of oil price controls.”
The combined price shocks of the 1970s also led Japan and France, two of the most oil-dependent OECD countries, to build their nuclear fleets. Many countries introduced energy market legislation; in Japan, these powers remain and almost the entire industrial sector and almost half of the commercial sector are required to maintain energy efficiency plans.
The sellers of oil now face a new type of existential problem. Oil producing companies and countries alike have been at pains to downplay the prospect of transport electrification and other developments that render oil unnecessary. As evidence of continued increase in oil demand they have held the recent decision by the International Energy Agency to resume publication of its “Current Policies Scenario” in its annual long-term energy outlook. The IEA’s scenario modelling famously underestimates clean energy deployment and the CPS scenario also assumes that even announced energy policies won’t be implemented.
The reality looks less rosy. If non-gas liquids such as butane and ethane are excluded, crude oil production peaked in 2018, while on the consumption side, a significant but unknown amount of oil purchased in recent years has been poured into China’s strategic petroleum reserve. Bloomberg New Energy Finance estimates that electric passenger vehicles already cut oil demand by 1.5 million barrels a day in 2023 and sales of internal combustion engine cars peaked in 2018. Countries that have been subsidising diesel and gasoline consumption, such as Indonesia, will face immense fiscal strain if prices remain high. About 45 per cent of crude oil consumed worldwide is used for road transport, much of which is increasingly cheap to electrify.
Around the world—especially in Asia—emergency measures have been enacted to cut oil and gas consumption. Some, such as 4-day working weeks in the Philippines and work-from-home rules for Thai civil servants, could easily be reversed. Others will be difficult not to sustain. Declines in demand for gas-guzzlers might lead to more permanent shifts in already-fragile western car manufacturers, especially when—in countries outside the US at least—Chinese EVs are increasingly available at sub-$10,000 prices.
A subtle shift in OPEC+ countries has already begun to take place in the last few years. Saudi Arabia has moved away from its “oil for security” stance towards the US as it became a less reliable partner. The country has established regional and Asian ties, and it has rebuilt diplomatic ties with Iran, brokered by China, becoming a “dialogue member” of China’s Shanghai Cooperation Organization. The US is now too unpredictable a partner.
Meanwhile, the UAE—the second-most powerful Gulf producer in OPEC—has taken a different path. As Ziad Dauod, chief emerging markets economist at Bloomberg, said in 2024:
[The UAE] is pushing for its OPEC quota to increase and it wants to produce more today so that it doesn’t end up with stranded assets when oil prices drop in the future. Saudi Arabia is the other sort of end of the spectrum where it has large funding needs, which requires it to have a high oil price.
Since then, Saudi Arabia has largely abandoned its stance and agreed to increase production even into a market that was looking oversupplied. The closure of the Strait of Hormuz will almost certainly be another long-term blow for petrostates, even when they can get to market.
Kate Mackenzie is a researcher and writer on climate, energy and finance. She is a former Financial Times journalist, a founding contributor to Bloomberg Green, and a regular contributor to Heatmap. She co-edits The Polycrisis newsletter and is an adjunct fellow at Macquarie University and a fellow at Australia’s Centre for Policy Development.
Read the rest of the contributions to the symposium, from Guy Laron, Toby Craig Jones and Patrick Bigger and Kevin Cashman on our website.