Saudi Aramco's giant IPO signals a surprising development: declining demand for oil

The drilling of the first modern well in Pennsylvania in 1859 set oil on a path that led to the heart of economics and geopolitics. Oil fueled the rise of the West's consumer culture; it helped determine who won World War II and prompted a global economic crisis in the 1970s. Over the past 20 years China has become the second-biggest consumer of crude, while the U.S. fracking revolution has meant it is close to being a net energy exporter for the first time since the 1950s.

Now a new chapter in oil's story is unfolding: the prospect of stagnating or falling demand as the world shifts to cleaner energy. As in the past, this era promises economic and geopolitical change.

Consider the stock offering announced Sunday of Saudi Aramco, which produces 10 million barrels of oil a day, 11% of the global total. As well as Arabian super-light, Aramco pumps out superlatives and controversy. Worth more than $1 trillion, it could, once listed, be the world's most valuable public firm, squeezing past Apple.

The initial public offering has been delayed several times; a big Aramco processing plant was hit by a missile strike in September and the firm is ultimately controlled by Muhammad bin Salman, an autocratic royal with blood on his hands.

But take a moment to look beyond this. Aramco's underlying strategy is to be the last oilman standing if the industry shrinks, pointing to the upheavals to come.

The term "peak oil" was coined in 1956 by M. King Hubbert, a geologist worried about the stuff running out. Today the phrase is back but for the opposite reason: the prospect of dwindling demand.

That may seem odd given that this has grown by 1.4% a year since 2008. But the people running energy companies have long horizons, and on that time scale the picture for oil is darkened by urban pollution and climate change. Oil is responsible for a third of global energy use and a similar share of carbon emissions.

It would help, too, if there was a shift to cleaner oil fields, whose crude emits a fifth less than the dirtiest ones. Though oil bosses insist, in public at least, that oil remains the planet's indispensable fuel, they can feel the growing stigma.

Public opinion is shifting in the West, heralding tighter rules on emissions. And some Western firms have favored short-term projects rather than sink their capital in decadeslong bets on oil's future.

If demand does fall, some products and producers are more vulnerable than others. More than a third of all oil is used in cars and trucks that could eventually be fitted with electric engines. It is harder to find a substitute for the oil in petrochemicals and plastics. Common sense suggests that the highest-cost and dirtiest oil firms will tend to go out of business first. If so, an industry that has become gargantuan over 160 years will shrink to a core of producers that fulfill the demand at the lowest financial and environmental cost.

Many environmental activists fear this energy transition will never happen. But, in fact, it fits with Aramco's strategy and pitch to investors. The firm spends just $3 to lift a barrel from beneath the desert, less than almost anyone else.

The emissions from extracting Saudi oil are rock-bottom, too. Aramco is expanding in petrochemicals and locking in customers in Asia — in August it bought a $15 billion stake in the chemicals arm of Reliance, an Indian giant. Saudi Arabia has promised investors they will get steady dividends whatever the weather. Implicit in the approach is that, if and when oil demand falters, Aramco will be the producer of last resort.

Take energy markets first. The optimistic case is that supply and demand will taper in tandem, and that the price of oil will fall along with the cost of producing the last barrel needed to satisfy ebbing demand. But downsizing an industry with $16 trillion of capital and at least 10 million employees is never going to be smooth.

Because oil fields naturally deplete, a drought in capital spending could cause a price spike. Each firm and country, including Saudi Arabia, will face a choice between holding back supply so as to bolster profits and tax revenue and opening the taps to grab market share and use up reserves, whatever the price, before it is too late. The OPEC cartel, which combines high- and low-cost producers, could implode. And as production focuses on fewer fields, the risk of disruption from terrorism or accidents will rise.

The political implications are just as big. Twenty-six countries rely on oil income for 5% or more of their GDP, said the World Bank (the average for them is 18%).

If economic logic prevails, producers with the dearest and dirtiest oil — including Algeria, Brazil, Canada, Nigeria and Venezuela — should wind down output, but that would be painful and, for some, devastating. The United States, meanwhile, remains wedded to oil, which meets 40% of its energy needs. Its thirst has been satisfied by the fracking boom, especially in the Permian Basin in Texas.

Yet fracking is dirty and new projects need an oil price of $40 to $50 a barrel to break-even, at least twice the level Aramco requires. For the sake of the climate and efficiency, the fracking industry should eventually shrink. That, though, would make the U.S. more reliant on foreigners, just as its politics have turned inward.

Investors betting on Aramco as the last oil major standing in 30 years' time will have to consider the risk of revolution or invasion. Aramco's offering is a sign that the end of oil could be in sight. But it is also a reminder that oil's capacity to cause economic and political havoc will be undiminished for decades to come.