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Economic Insight There's another problem lurking for the global oil industry

A car is filled with gas at a Petrobras BR station in Rio de Janeiro, Brazil, on Wednesday, April 6, 2016.

Dado Galdieri/Bloomberg

If you are wondering what gasoline will cost when you load the kids and the dog into the car this summer for the long holiday haul, don't look at the price at your local gas station. Don't even look for clues in the New York crude oil futures market. The interesting gas price is to be found in Riyadh.

Today, in Saudi Arabia, a litre of gas costs about 32 cents. If that sounds very nice, you are missing the point. Even if Saudis are paying a fraction of what it costs for a Canadian to fill up, they are not very happy. They are paying 50 per cent more since the beginning of January when the Kingdom hiked the fuel price in a bonfire of public subsidies that also raised the cost of electricity and water.

Austerity is a new idea for Saudis who have been paying 20 cents for a litre of gasoline as long as anybody can remember. But energy subsidies cost the Kingdom more than $100-billion (U.S.) in 2014, some 13 per cent of GDP, and the oil price collapse has forced the government to finally begin to wean the country off its addiction to cheap fuel. Other Gulf countries have followed suit: Bahrain raised its gas price by 50 per cent in January and Qatar increased the pump price by 30 per cent. In February, Venezuela acknowledged that even Bolivarian socialism couldn't provide free fuel forever and the gas price rose by 6,000 per cent.

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The OPEC states are only copying wiser oil-consuming economies such as India, where the government saved $2-billion last year by cutting fuel subsidies. More interesting than these efforts by wobbly OPEC states to balance their budgets is the likely impact of a consumer price surge on demand for crude. In a market forecast this week, OPEC predicted that the surplus of oil supply over demand this year would average 790,000 barrels per day (b/d), some 30,000 higher than last month's estimate. The difference, highlighted by the cartel, was weaker global demand, in part due to the removal of fuel subsidies.

This may just be the beginning of a problem for the global crude oil industry: demand from the producers themselves. Since its foundation, the cartel's members have refused to acknowledge within their domestic economies that oil has an economic cost. The Middle East is consuming about a third of the oil that it produces and the trend is rising in intensity with more barrels needed to produce an economic buck.

Heavily-subsidized energy is the price the region's elites have been forced to pay to hold on to power. However, the price war unleashed by Saudi Arabia in 2014 has forced oil-producing states to recognize the loss they sustain by giving away energy that could be sold at a profit. There will be probably more cuts in oil welfare in the Gulf, and even without public unrest the shift in behaviour by Middle Eastern consumers has probably only just begun. The oil price shocks of the 1970s had a dramatic impact on fuel efficiency and conservation efforts in North America – there is little understanding of what the removal of subsidies might do to demand in the Middle East.

Meanwhile, the oil market prefers to speculate about the prospect of a "production freeze," an old-fashioned OPEC effort to manipulate markets by rumour and innuendo. Curiously, Russia, which is not an OPEC member, has most enthusiastically promoted the notion of a production freeze, probably in the knowledge that Russian oil output is widely expected to decline slightly in the coming months anyway. The Russian oil industry is feeling the effect of economic sanctions but other states still plan to increase output, including Iraq and, notably, Iran, which insists that it will export a further 500,000 b/d.

U.S. crude stocks continue to hit new record highs but oil bulls draw comfort from the continuing fall in U.S. shale oil output which the U.S. Department of Energy now reckons will decline by 900,000 b/d this year. Even if you think the oil market could be in balance by the end of the year, it's a dead certainty that the Bakken shale producers will be back in the saddle as soon as the price hits $60 a barrel.

Your holiday drive is probably safe for now; the same may not be true for a lot of people in the Arabian Gulf.

Carl Mortished is a Canadian financial journalist based in London.

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