© 2018 by Daniel Anthes

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Falling oil prices - implications of current volatility on commodity markets for exporters

For a few months now oil prices are on a steady downward trajectory. Some people even speak about the possible beginning of the end of a super commodity cycle, with the result now of a long-term price slump lying ahead of us. This would have severe economic implications for countries heavily depending on oil exports - and with that particularly countries in the south.



Not so long ago a barrel of oil was listed with nearly 150 US-Dollar and both politicians and scientists feared for the world economy could be choked off by steadily rising oil and energy prices. Though curbed drastically by the crisis in 2008, crude oil has been traded continually between 110 and 120 US-Dollar since 2011. However, in the last six months the oil price has fallen by more or less 50 percent, now standing at less than 58 US-Dollar a barrel after its 2014 annual high of 116 US-Dollar in June (see Fig. 1). 


Fig. 1: Spot price for Brent crude oil, 2004-2014 (EIA 2014 adapted by author)


In general, the oil price is determined by actual supply and demand, which directly links it to economic activity. But market expectations and speculation respectively are also a pivotal component of the price setting, both on the producer and consumer side. Assuming the price stays high, producers invest and thereby boost supply. Low prices on the other hand normally lead to disinvestment.


So what exactly has caused this sudden crash on crude markets? Within the media landscape certain developments are said to be mainly responsible for the recent slump in oil prices* - and following the above mentioned we first and foremost speak about aspects that have been leading to changes in world supply and world demand: 

  • Lower economic activity worldwide (austerity measures and decreased consumption in e.g. Europe and China) leading to lower demand, combined with increased efficiency and a gradual shift away from fossil fuels;

  • United States have become world’s largest oil producer (thanks to deposits trapped in shale rock), hereby importing a lot less crude, which leads to spare supply - e.g. North Dakota alone produces a million barrels of oil per day;

  • Turmoil in Iraq and Libya that - although yet with no influence on their output - stresses the global market due to the concomitant geopolitical risk 

  • Saudi Arabia and its Gulf allies are not willing to curb production, since they can tolerate lower oil prices quite easily because of comparably lower extraction costs


But what does this actually mean for countries relying on oil for their exports and thus their economic well-being?


“If prices remain weak – and many forecasters suggest they will – then from Moscow to Caracas and from Lagos to Tehran governments will start to feel the impact on macroeconomic policy.” (Elliot 2014: 3) 


In fact, it is already obvious how currently low oil prices depreciate a dozen of currencies against the Euro and US-Dollar: The Russian rouble rose from 40 against 1 Euro in 2013 to over 80 in mid-December. You would also have to pay more for the Norwegian crone, which increased from 7,3 at the beginning of 2013 to 9 for 1 Euro by now. Same picture in oil-rich Africa - the Nigerian naira climbed from 160 for 1 US-Dollar this summer to 182 shortly before Christmas. Also the Angolan kwanza shows a stedy upward movement, now being listed with 102 against the US-Dollar, from 96 at the beginning of July this year (XE 2014).


The Organization of the Petroleum Exporting Countries (OPEC) back in November in Vienna failed to reach an understanding with regards to curbing production rates, sending the oil price on a downward trajectory ever since and hereby continuing to rattle markets. But not only OPEC member states, also other oil-exporting countries such as Russia or Venezuela are hard hit. The problem now is that particularly these countries need to sell oil at a certain price to balance their budgets by breaking-even. Fig. 2 provides an overview about selected oil producers and their respective break-even prices per barrel. 


Fig. 2: Fiscal break-even oil price for selected countries (EIA 2014, Deutsche Bank 2014, Wall Street Journal 2014, Guardian 2014 adapted by author)


Overall latest estimates suggest that the oil price (Brent) is now below the level needed to balance the budget in the majority of oil-exporting countries. However, it is safe to assume that substantial cushions of oil savings (often in form of so-called natural resource funds or sovereign wealth funds) most certainly would enable some of the exporters to adjust to a sustained period of lower oil prices. In particular high per capita producers such as Norway or countries from the Arab World (e.g. Kuwait or Saudi Arabia) command large buffers that definitely help them to soften pressures on their budgets and external balances.


For other countries this situation proves far more difficult. In fact, the greatest risk is with oil producers that have high fiscal break-even prices and are already running fiscal deficits - here budgetary and exchange rate pressures will be felt dramatically. And with that we are easpecially speaking about resource-rich as well as resource-dependent developing countries from the global south.**


For instance, in the case of Nigeria a price fluctuation of 50 US-Dollar per barrel would be equivalent to a difference of 50 percent in its GDP (Gelb & Grasmann 2010: 4). But certainly Nigeria is just one of many examples in this context. According to IMF estimates, in Africa, oil exports account for 40-50 percent of GDP for Gabon, Angola and the Republic of Congo, and even up to 80 percent of GDP for Equatorial Guinea. Likewise oil also accounts for 75 percent of government revenues in Angola, Republic of Congo and Equatorial Guinea. In Latin America, oil contributes about 30 percent and 46.6 percent to public sector revenues in Ecuardor and Venezuela, and about 55 percent and 94 percent of exports respectively.


"This shows the dimension of the challenge facing these countries." (Arezki & Blanchard 2014: 34). It is therefore hardly surprising that several countries in Sub-Saharan Africa have revised down their budgetary oil prices in 2015 against the backdrop of falling prices on crude markets (see Fig. 3) (Brookings discusses further consequences for Sub-Saharan Africa).


Fig. 3: Fiscal budgetary oil price for selected countries in Sub-Saharan Africa (Arezki & Blanchard 2014 adapted by author)


Now if prices remain weak - and there seems to be a consensus among forecasters*** - then oil-rich and equally oil-dependent developing countries will be facing severe economic obstacles - from growth fall to lost revenues and budget deficits. In the medium-term it will be of crucial importance for these countries to foster economic diversification and structural transformation in order to guarantee broad-based and sustained growth in non-resource tradable sectors after oil has been depleted. But as of now in the short-term a stabilization of oil prices seems to be of highest priority in order to not let these countries slip into severe economic recessions. According to the IMF "tough adjusments" (Arezki & Blanchard 2014: 57) are required to cope with the challenges ahead - policy recommendations in this context are a larger real depreciation with a strong monetary framework to avoid that this depreciation leads to persistently higher inflation and further depreciation. 


"The many bullish oil investors who still expect prices to rebound quickly to their pre-slump trading range are likely to be disappointed. The best that oil bulls can hope for is that a new, and substantially lower, trading range may be established as the multi-year battles over Middle East dominance and oil-market share play out." (Kaletsky 2014: 3).


Whatever development of the oil price we will be seeing this year, oil exporters that are heavily dependent on revenues from exports are confronted with severe challenges due to high commodity volatility and thus the unpredictability of correspondent revenues. The government’s management of such oil revenues and appropriate macroeconomic and fiscal policy frameworks are noticeably affected by changes in the market, and this situation - as I said - will be particularly challenging for countries in the global south. 





Foto: Oil Barrel - Khosrow Eznir (taken from flickr)


*For a more detailed media review about the reasons for falling oil prices please refer to e.g. Reuters, The Economist, Bloomberg, or Guardian.


**At this point it is of fundamental importance to differ between resource abundance and resource dependence:  Resource abundance refers to the actual subsoil wealth of a given country that is defined by the sum of its available and thus exhaustible deposits of oil, gas, and minerals below the ground. Resource dependence on the other hand refers to the fact that current consumption levels mainly rely on natural resource production and export. It hereby reveals the extent to which a country’s economy depends on rents derived from natural resources. Common measures are the share of resource exports of overall merchandise exports, the proportion of natural resource rents to GDP or the fraction of total government revenues. 


*** E.g. the EIA in its Short-Term Energy Outlook (STEO) predicts that global crude oil prices level off at between 58-68 US-Dollar in the first half of 2015.

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