Falling oil price: Political dynamite that shakes governments?

By Carl Johannes Muth

The oil price has fallen by more than 70% since June 2014, back when the price had been stable for four years at around $110 USD per barrel (Bloomberg: 01/29/2016). Although the oil industry is used to its booms and busts in prices, the current downtown has been the largest since 1990, if not earlier. What seems to be a favorable trend for car drivers and logistic companies due to decreased fuel prices means a significant loss in revenues for energy exporting states, which could in turn lead to growing political tension, turmoil and even governmental overthrows. To answer why oil is boon and bane for the producing countries, it is important to understand what the reasons are for the current low oil price and why the situation is not expected to change in the near future.

Like other raw goods, the price of oil is partly determined by supply and demand, and partly by future market projections. On the supply side, thanks to exploitation of unconventional oil (shale oil) by hydraulic fracturing (fracking), the US American production has been doubled over the past seven years. Saudi, Nigerian and Algerian oil that was meant to be shipped to the USA is now competing in Asian markets which, in turn, suffer from China´s slowed economic growth.  A cut in production that would stop the current excess surplus is refused by almost all countries due to concerns of losing market share to competitors, as Russian Energy minister Alexander Novak said in 2014: “If we cut, the importer countries will increase their production and this will mean a loss of our niche market.” (Reuters: 12/16/2014). Since Canada, Iraq and Saudi Arabia have raised their oil production to balance the expected deficit, this has sped up the decline of oil prices. Additionally, following the end of sanctions, Iran is eager to sell its own oil on the international market, which, according to Morgan Stanley, could lead to a further drop in prices to less than $20 per barrel (The Guardian: 01/11/2016).

Conversely the global demand for oil has not increased significantly and is not expected to increase relative to the global oil supply. China’s economy grew at its slowest rate in a quarter of a century in 2015 (Reuters: 01/19/2016), the European markets have also become more energy efficient and focused on green energy projects. Although India’s oil demand has been rising significantly, the current growth cannot replace China´s reduced demand volumes (Sen, Sen: 2015). In other words it is suggested that low oil prices are not a temporary phenomenon but are likely to persist, and that the energy exporting states will have to adapt new strategies to react to the changed situation after years of large profits. However, only a few oil producing countries, mainly minor suppliers, have been able to diversify their economies. For other states such as Russia, Venezuela and Saudi Arabia oil exports revenue covers the state budget to a large extent and the current price drop results in a high annual deficit. The level of this deficit surely depends on the required oil price to balance the budget. While Qatar needs an oil price of around $55 per barrel, the Russian state, after cutting spending, desires a price of at least $82 (Reuters: 01/13/2016), Algeria $96, Saudi Arabia $104, Nigeria $120, Venezuela $125 and Libya even $269 (Bloomberg: 11/30/2015). In short, all big oil players will face large budget deficits that can only be balanced by dipping into their state´s reserves. Due to price fluctuations in the past, the causal relationship between the increase in the economic development of the commodity sector and a decline in other sectors, mainly within the manufacturing sector (the so called “Dutch Disease”), the energy exporting countries raised sovereign wealth funds to save some of the revenues abroad. At the moment the Saudi national foreign exchange reserves is worth more than $660 billion (The World Factbook: 2015) that provides the country certain level of stability. Nevertheless it is expected that Saudi Arabia and other Gulf states will invest less money around the world, and may cut aid to the Maghreb states, especially countries which are already unstable. Due to international political struggles with Islamists and other military groups as well as the low price of oil, the loss of financial support could be the deathblow for the already weakened governments in this region.

The Russian sovereign wealth funds still includes around $377 billion (The World Factbook: 2015), but loses about $2 billion in revenues for every dollar fall lower than the needed oil price of $82 per barrel (BBC: 01/19/2016).  Putin is currently facing his biggest challenge during his 15 year rule due to the combination of the ruble’s collapse and the struggles in the Russian economy as a result of the western sanctions regarding Ukraine. Although the ongoing crisis has not yet had a negative impact on his popularity among the Russian population, Putin will soon have to let the cat out of the bag; a more cooperative foreign policy is likely to end the EU sanctions over Ukraine, however Putin’s foreign policy over the past year has been anything but predictable.

Unlike in the aforementioned states, in developing countries it can be politically difficult to raise funds. Due to public pressure to alleviate poverty, the revenues from oil exports are spent immediately despite the mentioned macroeconomic effects. In combination with a poorly diversified economy and mismanagement, oil price shocks then hit the oil producing states and their economies unrelentingly. This can be easily observed in Venezuela where oil accounts for 95% of its exports and half of public revenues. The country, still one of the world’s largest oil exporters, is now experiencing urban unrest and shortages of basic goods due to limited access to foreign currency, and an inflation rate near 100% in 2015 (Reuters: 12/09/2015). Nevertheless, President Maduro still refuses to cut subsidies on several goods such as fuel, bearing in mind that a petrol price rise in 1989 led to riots with hundreds dead. However the first sign of political change in Venezuela already came in December 2015; for the first time since former President Hugo Chávez came to power in 1999, the opposition Democratic Unity (MUD) won two thirds of the seats in a parliamentary election (Monaldi 2015: 2).

Africa´s largest economy and top oil producer Nigeria is facing a situation similar to Venezuela’s.  Crude sales fund about 75% of the country’s budget which is expected to run a deficit of around $11 billion for 2016 (The Economist: 01/30/2016). However, unlike other major oil producing economies, the Nigerian government was able to prop up the value of the naira by spending the state´s reserves. Due to minor reserves this is only a short-term solution and also leaves even fewer fiscal buffers at their disposal. As a result, it seems to be highly improbable that the government of Muhammadu Buhari can keep its campaign promises, upon which he won the presidential election against former President Goodluck Jonathan last year. The plan to transfer around $1.5 billion to poor Nigerians, to fight the country’s rampant corruption and to diversify the economy was already ambitious but is no longer an attainable goal considering the country’s current situation. The denouement remains incalculable though worrying. Nigeria is well accustomed to being rocked by turmoil and riots, yet now has Boko Haram – an Islamist group that has terrorized the country for over six years, causing 1.5 million people to flee the country- to contend with (The New York Times 03/31/2015). Despite the official announcement of President Buhari that the terrorist organization is technically defeated, Boko Haram has reverted to improvised explosive devices to spread fear and create further instability.

Of all countries shaken by the oil price slump, Libya´s situation can only be described as disastrous. The northern African state possesses Africa´s largest oil reserves, which were used to provide 95% of the country’s export revenues, fill up the foreign wealth fund up to $65 billion and in so doing kept the economy afloat (The Guardian: 12/30/2015). However an IS incursion in Sirte and a civil war between rival governments at both ends of the country have triggered a three-way battle for control of the country’s oil wealth, which has subsequently caused oil production to plummet, shattering the economy. Leaving the population almost wholly dependent on oil revenues, the current crash in oil prices has halved revenues and led to shortages of essential goods. Currently both governments are trying to become internationally recognized to control Libya’s sovereign wealth fund. Whichever government comes out on top in the end will be tasked with governing a country which lies in ruins and a population suffering from hunger and shortages of essential goods.

This article has shown that the exports of oil generates large revenues but also implies huge risks. It has also examined how the price of oil alone did not cause the concerning economic situations of many countries, showing that poorly diversified economies and economic mismanagement are the more likely culprits. The states under the most pressure from slumps in oil price, the so-called “fragile five” – Venezuela, Nigeria, Libya, Iraq and Algeria (Oilprice: 08/19/2015), were already facing domestic political turmoil and have had negligible fiscal buffers at their disposal. Hence the price of oil sinking was merely the straw which broke the camel’s back.  Countries which have created funds to save some of revenue abroad such as Russia and Saudi Arabia are given limited time to cover the losses and/or develop new tactics to lower their dependency on export revenues.  It is inevitable that prices will rise someday, due to the deferred effect of halted investments in oil exploration. However, the leading economies and major energy consumers are heading towards green energy solutions, which make it difficult to predict whether the price of oil will ever reach or exceed the $100/barrel levels again. Accordingly, all oil exporting countries need to adapt their energy and economic policies in general to these new situational changes.

This article was first published in January 2016 on Academia.


References:

Bloomberg Business: Energy & Oil:
http://www.bloomberg.com/energy  (seen 01/29/2016)

Bloomberg Business: “Oil States Need Price Jump to Balance Budget: OPEC Reality Check”, by Angelina Rascouet (11/30/2015):
http://www.bloomberg.com/news/articles/2015-11-30/oil-states-need-price-jump-to-balance-budget-opec-reality-check

Monaldi, Francisco: “The Impact of the Decline in Oil Prices on the Economics, Politics and Oil Industry of Venezuela”, Columbia l SIPA Center on Global Energy Policy, September 2015:
http://energypolicy.columbia.edu/sites/default/files/energy/Impact%20of%20the%20Decline%20in%20Oil%20Prices%20on%20Venezuela_September%202015.pdf

Oilprice: “Low Oil Prices Could Break The “Fragile Five” Producing Nations”, by Nick Cunningham (08/19/2015):
http://oilprice.com/Energy/Energy-General/Low-Oil-Prices-Could-Break-The-Fragile-Five-Producing-Nations.html

Reuters: “IMF cuts global growth forecast as China slows”, by David Lawder (01/19/2016):
http://www.reuters.com/article/us-imf-growth-idUSKCN0UX11Y

Reuters: “Russia says it can balance budget at oil price of $82 per barrel”, by Katya Golubkova (01/13/2016):
http://www.reuters.com/article/russia-budget-idUSR4N14H01020160113

Reuters: “UPDATE 3-Russia, Arab oil producers in no-cut chorus as price dive deepens”, by unknown (12/16/2015):
http://www.reuters.com/article/russia-oil-minister-idUSL6N0U026B20141216

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