January 8, 2016 | 23:09 GMT
Oil prices hit their lowest level since summer 2004 this week, continuing the
rapid tumble that began in June 2014.
The global benchmark, Brent crude oil, closed trading Jan. 8 at $33.37
per barrel, closing out the lowest week of prices in more than a decade.
A number of factors contributed to the drop. The Chinese economy and
financial markets performed poorly this week,
sparking fears that a slowdown will dampen demand.
In the major markets of Europe and North America, a mild winter has
lowered seasonal consumption of natural gas and heating oil. On the
supply side,
Iranian oil will soon be back on the global market, and OPEC signaled that it would
continue to supply high volumes of oil. The United States, too, has
managed to produce a significant amount of oil,
despite increased financial pressure on many U.S. producers. All of
this may well push prices into the $20 to $30 per barrel range.
Oil is the most
geopolitically important commodity,
and the ongoing structural shift in oil markets has produced clear-cut
winners and losers. Between 2011 and 2014, major oil producers became
accustomed to prices above $100 per barrel and set their budgets
accordingly. For many of them, the past 18 months have been a period of
slow attrition. And with no end in sight for low oil prices, their
problems are going to only multiply. Each nation, though, has its own
particular level of tolerance, and the following guidance highlights the
key break points to monitor.
Former Soviet Union
Russia,
Kazakhstan and Azerbaijan stand to lose the most among the countries of
the former Soviet Union. As one of the world's largest producers,
Russia is the most important. Russia's economy relies heavily on energy,
and energy revenues constitute more than half the current budget. This
budget, however, is calibrated to oil prices of $50 per barrel. As
prices deviate further from this benchmark, Moscow has two funds
totaling $131.5 billion to make up the discrepancy. But the margins are
tight: Nearly half the amount on hand may be needed to cover 2016
budgetary shortfalls even if oil rises to $50 a barrel.
To remain afloat, the Russian government would have to drain both of these funds
unless it cuts the state budget. Cuts would come with major tradeoffs. Moscow is
embroiled in a standoff with the West, so
slashing defense or security spending would be challenging. Russia will
also hold critical parliamentary elections in September, so cutting
social programs is not a good option either. Compounding this dilemma,
Russian oil firms are in dire straits;
although the government could restructure the tax system to provide
them with relief, it would undermine government revenues. Moscow also
has the option to privatize a large part of state-owned oil giant
Rosneft this year to raise funds.
Both Kazakhstan and Azerbaijan
face dilemmas similar to that of Russia. Kazakhstan's budget is set at
$40 a barrel, although it does have $55 billion in its national oil
fund. An alternative budget is now being drawn up based on $20 a barrel,
but such a change will almost certainly mean cuts in spending. Like
Russia, Azerbaijan's government set its budget based on $50 a barrel.
Azerbaijan holds $51 billion in its state oil fund. Both countries are
concerned with rising social tension over their weakening economies,
although their governments have proved adept at cracking down on
dissent. Kazakhstan plans to privatize state-owned companies and assets
to raise money in 2016, though there has been little interest in the
program among potential buyers.
Middle East and North Africa
Regionally, Algeria, Iraq, Iran and the
oil-producing countries of the Gulf Cooperation Council,
will feel the most impact from low oil prices. For 2016 government
budgets to break even, the International Monetary Fund projects that
Saudi Arabia will need oil prices of $98.3 per barrel. Bahrain will need
prices of $89.8 per barrel and Oman of $96.8. All are significantly
higher than the break-even points of Kuwait, Qatar and the United Arab
Emirates. For the most part, however, the Gulf Cooperation Council
nations are in a position to weather low prices, since they hold low
levels of debt and high financial reserves built up from years of high
oil price revenues. Although Bahrain is an exception to this because it
is not a major producer, Riyadh would sustain the country through a
crisis to prevent spillover into Saudi Arabia's Eastern Province.
In
the short term, the Gulf Cooperation Council will not fall into
financial crisis, but its member states are still making the financial
adjustments needed to keep their reserves high and to avoid going deeper
into debt. All of the Gulf nations will cut government spending in 2016
to some degree, albeit carefully, and will accelerate legal reforms. To
ease the burden on citizens, Saudi Arabia and the United Arab Emirates
are reducing fuel subsidies but maintaining spending on education and
social services. Bahrain has reduced food subsidies but is considering
cash handouts to balance the cuts. The United Arab Emirates, Saudi
Arabia, Oman, Qatar and Kuwait are all discussing implementing taxes to
increase state revenue, a measure unprecedented in the regional bloc.
Saudi
Arabia is the most important country to watch. In addition to the
careful cuts in social spending, the government has already started to
privatize assets, starting with three major airports. Riyadh has even
discussed floating a part of state-owned Saudi Arabian Oil Co., known as
Saudi Aramco, in an initial public offering. Privatization will
diversify the funding sources of these entities but also is politically
risky. Deputy Crown Prince Mohammed bin Salman has hinted that reforms
may be rapid, even as the king emphasizes the strength of the economy,
but powerful members of the Saudi royal family will be wary of moving
too swiftly. With dozens of privatization plans on the table, discontent
within the ruling family is all but inevitable. Riyadh is also
facing major regional changes with the
return of Iran to the international economy and the enduring
conflict in Yemen, meaning that defense and foreign spending will need to remain high.
Not
all regional players have the fiscal advantage of the Gulf Cooperation
Council. Algeria's economy is highly dependent on natural gas, and its
foreign reserves dropped precipitously in 2015 because of lower oil
export revenue, leading to a $10.8 billion deficit. A mild winter in
Europe, a key market for Algerian natural gas, will not help the
situation. Algeria has sought to boost foreign investment through tax
reform and the introduction of import and export license authorizations.
But the country is heading toward a precarious political moment: the
eventual death of President Abdelaziz Bouteflika,
who has held office since 1999. The nation's elite are now jockeying
for position ahead of this transition; although continued reform
measures are necessary, many will be wary of any that may erode their
power. This will limit the country's options, compounding the current
crisis.
In Iraq, both Baghdad and the Kurdish capital of Arbil are
already in serious financial trouble. The national government and the
Kurdistan Regional Government need to maintain high levels of spending
to fund their
battle against the Islamic State.
With oil revenues dropping, this means they will need to reduce other
expenditures. The governments do have the option of renegotiating their
contracts with international oil companies. Baghdad is in the midst of
such talks to replace its current contract, which stipulates that
Baghdad pay oil companies a fixed fee. Arbil is juggling its security
situation with payments to international oil companies and the giant
Kurdish civil service sector. The Kurds have already made it clear that
they have no plans to export oil through Baghdad's state-owned marketing
company but will instead market it themselves and export through
Turkey. Ankara and the Kurdistan Regional Government in Arbil will grow
closer as both increase energy cooperation and deal with the mutual
threat of the Islamic State. Arbil's increased suffering under low oil
prices will only strengthen this relationship.
Amid low oil
prices, February elections are also approaching in Iran. Iranian
President Hassan Rouhani will be banking that his talks with the West
and success in negotiating the end of sanctions will help moderates and
his traditional conservative allies defeat hard-line conservatives. The
opposition has asserted that Rouhani's economic policies are not
working. Low oil prices will make these arguments only more credible.
The end of sanctions will enable Iran to increase the volume of its
exports, but with prices down nearly 70 percent since 2014 the revenue
generated will not reach the level it would have two years ago. This
realization may not become clear to voters until after February
elections, meaning Rouhani could perform well. But by 2017, the
discrepancy will likely be obvious, jeopardizing his chances for
re-election in 2017.
Latin America
Oil-dependent and ailing Venezuela
will suffer a great deal because of sustained low oil prices. Annual
inflation is already at nearly 300 percent according to leaked central
bank estimates. Inflation will mount and shortages will become even more
extreme. Lower oil export revenues will reduce the country's
expenditures not accounted for in the budget, which in 2015 supplied
much of the additional foreign currency needed to finance imports and
foreign debt payments. Venezuela will likely need to decrease imports,
and the country could even default on its foreign debt later in 2016. In
the near term, the government, now with an opposition supermajority,
will take what steps it can to address the economic situation. Currency
devaluation and consumer price hikes would be the most effective remedy,
but these would come with unacceptable political costs. Further unrest
is inevitable, and the government will need to work to contain this from
spreading too widely.
Brazil's economy has already sustained a great deal of damage from the
corruption scandal in state-owned energy firm Petrobras.
Unless the government decides to curb the major criminal investigation
into the company and associated officials, the scandal will continue to
disrupt supply chains and contractor financing, further delaying
existing projects. In response to the disruptions, Petrobras will need
to further cut its investment plans, which will slow future foreign
investment and energy production.
Ecuador's oil exports plummeted
by 30 percent in 2015 and will continue to be low through the next year.
Quito has the option of imposing trade barriers to reduce imports and
to compensate for lower export revenue, but this would compound the
economic slowdown. The nation will hold a presidential election in
February 2017, which could highlight eroding public approval for the
ruling Alianza Pais coalition because of the declining economy.
North America
North
America has, of course, been under the same low oil price pressure as
the rest of the world. Nevertheless, production has been resilient in
recent months, staying at around 9.2 million barrels per day since
October. Production has the potential to fall again, however, as the oil
hedges taken out against low oil prices in 2015 expire. The remaining
2016 hedges are mostly at a lower volume or price, a fact that will
increase the burden on oil-producing companies. Across the continent,
companies have drilled numerous new wells, but companies are holding off
for higher prices before they complete the projects. This means that
there is spare capacity that can react if prices make a sudden leap. As
Iranian oil comes back on the market, if North American production
remains high, it could exert more downward pressure on prices. Producers
of heavy oil in Canada in particular are going to remain under more
pressure as Western Canadian Select, the Canadian heavy oil benchmark,
is already well below $20 per barrel.
Sub-Saharan Africa
The
portion of Africa below the Sahara Desert is home to numerous small
oil-producing countries that will feel the pinch of low oil prices to
different degrees. The continent's largest economy and oil producer,
Nigeria, will be affected the most. Unlike producers in the former
Soviet Union and in the Middle East, Nigeria has calibrated its budget
using the rather realistic price of $38 per barrel. The problem is that
even at this price point, the budget will run a deficit of $11 billion,
2.2 percent of GDP. Abuja will find it difficult to maintain its fuel
subsidy programs and its currency peg to the U.S. dollar, put in place
in June 2014 when the naira fell 25 percent. Since that time, the gap
between the official and unofficial currency exchange rates has widened.
Low oil prices will only make it wider. The new president, Muhammadu
Buhari, has been clear that he does not support devaluation but will
face pressure from various political interests and will likely need to
cut spending.
Angola, Africa's second-largest producer of crude
oil, is under the same financial pressure as other world oil producers.
The government, however, is quite stable. The ruling Popular Movement
for the Liberation of Angola (MPLA) has tight control of the state
security apparatus. Any threat would have to come from within the party
itself. The government has based its 2016 budget on $48 per barrel oil
prices and is continuing the large-scale austerity programs it began in
2015 in response to the initial drop at the end of the previous year.
Angolan President Jose Eduardo dos Santos is now contemplating whether
to step down in 2017. Power brokers within the ruling party are
competing to become his successor, and low oil prices will make this
competition more heated simply because there will be less money to pour
into patronage networks.
Asia-Pacific
Most Asia-Pacific
countries are net consumers of oil rather than net producers. This means
that much of the region stands to benefit from low oil prices. However,
there are two exceptions:
Malaysia and Indonesia.
As
one of the few net producers in the Asia-Pacific, Malaysia will feel
the greatest pressure from cheap oil. Last year, roughly 20 percent of
the Malaysian government budget came from the earnings of state-owned
oil company Petronas. As the firm's earnings declined, Kuala Lumpur was
forced to impose an unpopular goods and services tax to make up for the
shortfall. The government's 2016 budget has Petronas contributing less
than 12 percent of federal income. If oil prices continue to plunge,
however, Malaysia will have to find new ways to raise money, either new
taxes or pared-down services and subsidies. This will make the
government unpopular at a time when Malaysian Prime Minister Najib Razak
is mired in a
corruption scandal
involving the country's sovereign wealth fund, 1Malaysia Development
Berhad (1MDB). Since the political opposition in Malaysia is still
incoherent, those who stand to gain from Razak's declining public
support are probably his rivals in the ruling United Malays National
Organization.
To the south, Indonesia will find low oil prices to be a
mixed blessing
because the country is a net consumer of oil but a net producer of
natural gas. Natural gas revenue will certainly drop, which will
hit state and export revenue. But low oil prices will give current President Jokowi Widodo a chance to continue delaying unpopular gasoline and
diesel subsidy cuts.
When Jokowi came to office in 2014 he cut fuel subsidies, bringing
domestic prices to international levels. But as prices rose during the
course of the middle of 2015, he declined to raise consumer prices and
instead had state-owned Pertamina sell imported products at a loss. Now,
with prices still dropping, Jokowi may be able to avoid the issue of
raising prices and instead may cut them.
Europe
Much
like the Asia-Pacific region, low oil prices will be largely a boon for
Europe because most countries are net oil consumers. Norway, the
Continent's main oil and natural gas producer,
will not be so lucky. The country is in the middle of an economic slump
due in no small part to a drop in oil-related investment and activities
in Norway. According to the International Monetary Fund, Norway's GDP
growth fell to 0.8 percent in 2015, down from 2.2 percent the year
prior. Over the same period, unemployment grew from 3.5 percent in 2014
to 4.2 percent in 2015; this figure is expected to rise even further in
2016. Though the Organization for Economic Co-operation and Development
projects a gradual economic recovery for Norway in the next two years,
the trajectory of oil prices could impede this.
In the long run,
low oil prices could also cause problems across the Continent as a
whole. Presently, they are improving Europe's economic climate; this
could lead Europeans to believe that they are witnessing a "real"
recovery when in fact a sizable share of the
progress is caused by external factors.
This misperception could play a particularly significant role in
Southern Europe, where governments are beginning to slow reform efforts.
Additionally, reduced oil prices could work against the European
Central Bank's attempts to create inflation in the eurozone in the hope
of boosting economic growth in the bloc.
