The Fuse

Oil-Producing Countries Could See Trillions in Revenue Losses From Energy Transition

by Nick Cunningham | February 11, 2021

The unfolding transition from fossil fuels to cleaner forms of energy is already wreaking havoc on the finances of the top oil companies in the world, with more than a few oil majors already charting a new course towards renewables.

But the energy transition presents a much larger disaster for oil-producing nations, many of which are not rich and remain ill-prepared for a massive gap in their budgets as the global economy moves on from oil and gas.

Shrinking revenues

The collapse of oil prices during the depths of the pandemic in 2020 offered something of a preview of a future of declining oil demand, albeit on an extremely compressed time lime. Still, the experience was constructive. Private sector companies shed jobs, shut in production and slashed spending levels. Governments had a serious hole in their budgets that required a combination of austerity, debt issuance, and foreign exchange drawdowns.

The most recent downturn may be cyclical in the sense that as the pandemic recedes, demand will come back. Oil prices have already rebounded, and drilling has begun to increase again, even as fiscal scars are set to linger for years to come.

The top 40 “petrostates” could see a budgetary gap of $9 trillion over the next two decades.

However, a much larger structural decline looms as oil begins its permanent decline amid a broad shift to renewables and electrification. According to a new study from Carbon Tracker, a survey of the top 40 “petrostates” could see a budgetary gap of $9 trillion over the next two decades compared to what they are assuming, due to the transition to clean energy.

The NGO looked at a low-carbon scenario that aims to keep global warming limited to 1.65 degrees Celsius and the scenario assumes oil prices averaging $40 per barrel oil. They compared that against the International Energy Agency’s Stated Policies Scenario for future demand combined with Rystad Energy’s $60-per-barrel base case forecast to arrive at something approximating “industry expectations.”

The gap between the two scenarios is stark. Total government revenues worldwide would be roughly $13 trillion smaller compared to expectations, while 40 petrostates alone would miss out on $9 trillion. Of course, the more dependent an individual country’s economy is on fossil fuels, the more exposed they are. But countries with low production costs fare better than those with more expensive reserves. Carbon Tracker identified seven countries it deems to be most vulnerable: Angola, Azerbaijan, Bahrain, Timor-Leste, Equatorial Guinea, Oman and South Sudan.

The next level down in terms of vulnerability includes Congo, Nigeria, Saudi Arabia, Libya, Kuwait and Iraq, among others.

To make matters worse, most of these petrostates are already dealing with high levels of indebtedness, which was only exacerbated by the pandemic and the meltdown in energy markets. The average petrostate surveyed saw government debt nearly double from 24 percent of GDP in 2010 to 46 percent in 2018.

The economic, social and political fallout is daunting. Over 400 million people live in the 19 most vulnerable countries, and a half dozen of them are characterized as having low human development, according to the United Nations.

A separate report from the Natural Resource Governance Institute estimates that National Oil Companies alone are on track to spend $414 billion on new projects that will become stranded in a carbon-constrained world. Or, put another way, they only pencil out if governments blow past climate targets.

An organized transition is necessary

Even as oil and gas production account for the bulk of government revenues in petrostates, there is a temptation to double down on extractive industries as a quick fix in the face of an immediate crisis. But gambling on an industry that is facing structural decline is a losing bet. “Propping up a failing oil and gas industry has huge opportunity cost,” Carbon Tracker noted.

Constraints in the political economy are formidable – that is, vested interests will resist change. There are no easy answers on this front, Carbon Tracker notes, other than for governments to seek broad buy-in and use investments to improve the lives of the population, especially the poor. Instead of propping up the declining fossil fuel industry, revenues should go to healthcare, infrastructure, education and income transfers. Similarly, the transition should not be done on the backs of the poor through regressive taxation.

Pivoting to a more diversified economy is extremely difficult.

Pivoting to a more diversified economy is extremely difficult, and petrostates differ in their available resources. Some have sovereign wealth funds, such as the UAE and Kuwait. Some can use low production costs and still very large revenues to diversify, such as Saudi Arabia.

Others remain poor and have few tools available to navigate the troubled waters ahead. At the same time, Carbon Tracker notes that the world simultaneously has an interest in global decarbonization and also seeing petrostates avoiding fiscal disaster. As such, more vulnerable countries will need international assistance to avoid a disorderly transition. And just as years of inaction require a faster timeline for decarbonization, the same dynamic is true for oil-dependent petrostates: the lack of diversification to date means petrostates need to act on an accelerated timeline.

While the policy prescriptions may vary from country to country, there are on-the-shelf solutions for which experts in natural resource economics have long advocated. For example, countries can hike the “fiscal take” on each barrel produced, which can be thought of as something akin to a carbon tax. Governments can use fossil fuel revenues to establish sovereign wealth funds if they don’t already have them.

Importantly, national oil companies should be “steered away” from reinvesting revenues into high-cost fossil fuel projects that will likely end up wasting money and compounding their dependence. Revenues should instead be invested in the non-oil economy, Carbon Tracker said.

Ultimately, the coming energy transition may be chaotic. But the transition will be more orderly if it “avoids oversupply,” Carbon Tracker concludes.