Impact of Lower Oil Prices Depends on a Country’s Relative Strengths and Weaknesses
The recent global oil price slump saw prices fall dangerously close to the low levels accompanying the 2007-2008 global financial crisis. Benchmark Brent crude spot prices declined to a low of USD 45.13/barrel on 13 January 2015 from a peak of USD 115.19/barrel on 19 June 2014, before rebounding to USD 65.15/barrel on 18 May 2015. Declining oil prices typically bode well for net oil consumers and importers due to the reduced outlay on their energy bills, while net oil producers and exporters lose out from the lower income receipts. However, depending on a country’s circumstances, the impact may be muted or, indeed reversed for the different actors within the economy.
COMPETITVE ADVANTAGE IN COST OF PRODUCTION
Although large oil producing countries would no doubt lose out from the oil price slump, the impact of cheaper oil still varies greatly, with some large oil producing nations faring better than others. The dissimilar impact is largely due to the inherent competitive advantage some oil producing nations have over crude oil exploration and production. Middle Eastern producers enjoy lower oil extraction costs, thus dampening the impact on operating margins. This has allowed them to remain profitable and thus operational when producers in other regions have retreated from the sector. Rig counts in the Middle East are still on an upward trend despite cheaper oil, in contrast to rig counts in all the other regions.
This is a stark difference from oil producers in the United States. Despite being a major oil consumer and importer, it is also a major oil producer due to the shale oil fracking boom. However, shale oil production tends to be relatively more expensive, thus placing pressures on margins. This has caused the sector to scale down on its exploration and production operations. The US rig count fell steeply to 976 units in April 2015 from a peak of 1,930 units during September 2014. Although domestic crude oil production has continued growing (despite reduced rigs) growth in oil production has since slowed to 14.17% year-on-year (YoY) in March 2015 after decelerating for four consecutive months from 18.34% YoY.
Similarly, Canada also faces cost disadvantages as its major source of crude oil for Canada is in the form of oil sands, which can also be very expensive to extract from. Riding on the high oil prices previously allowed oil sands producers to maintain profitability. The rising domestic production from oil sands enabled Canada to cut down expenditures on its crude oil imports, which fell to 2.51 million cubic metres in February 2015 from 3.40 million cubic metres two years ago. However, the cheaper oil price has since hampered domestic oil production, as Canada’s rig count for the first four months of 2015 demonstrates. Rig count in Canada during February 2015 (the busiest time of the year for Canadian oil producers) was only 363 units, almost half of the 626 units employed during the same month a year ago; rig counts have since declined to 90 units in April 2015.
ACCUMULATION OF OIL WINDFALLS
The relative impact of lower oil prices on the economy of large oil producers was more muted as some countries are in a more solid financial position to handle the price shocks. Saudi Arabia, for one, has been able to withstand the prolonged period of low oil prices, as it accumulated a vast amount of reserves during the oil price boom between mid-2011 and mid-2014. Saudi Arabia’s official reserve assets rose to USD 742.36 billion in June 2014 from USD 502.85 billion three years ago, with a foreign exchange reserve capacity to cover 50.02 months of import as of 2014. This is largely attributable to the government’s prudent spending of its oil revenue, which accounts for over 85% of total government revenue since 2005. The Saudi Arabian government has maintained a fiscal surplus-to-GDP ratio of more than 4% between 2003 and 2013, with the exception of a fiscal deficit in 2009 due to a sharp reduction in revenue during the global financial crisis. Due to the falling oil price, the lower revenue generated in 2014 saw Saudi Arabia record a fiscal deficit of SAR 54 billion, with the government expecting revenue to further decrease in 2015 with a projected budget deficit of SAR 145 billion. Saudi Arabia’s official reserve assets have since fallen by 4.86% YoY to USD 697.99 billion in March 2015, but there is a large asset base in hand to fund the deficit, with official reserve assets still approximately 18 times that of the fiscal deficit budgeted for 2015, thus allowing the government to finance its deficit for a long period of time without resorting to borrowing.
On the other hand, in Venezuela, another large oil producing nation that is heavily reliant on its oil sector, the impact has been comparatively larger. Oil revenue accounted for more than 40% of its total government revenue between 2000 and 2012 (except for only 35.13% of total revenue in 2009) and funds the Venezuelan government’s spending programmes and day-to-day operations. However, unlike Saudi Arabia, which was able to save its windfall gained during the period of high oil prices, Venezuela was already in trouble prior to the oil price slump as it struggled to raise funds to pay for its imports despite the oil revenue received, leading to a shortage of basic necessities and goods in the country. Venezuela’s international reserves fell to USD 21.60 billion in June 2014 from its recent peak of USD 29.89 billion in December 2012, most likely to support the economy. Nonetheless, the sharp decline in prices of one of its major sources of revenue exacerbated the economic decline. This caused international reserves to fall below the USD 20 billion mark during April 2015, its first time since September 2003.
RISK OF DEFLATION REDUCES BENEFITS GAINED BY NET OIL-CONSUMING COUNTRIES
For net oil-consuming and importing nations, the cheaper crude oil price should lead to lower prices of goods and services, thus making them better off than during the previous period of high oil prices. While one would generally benefit from buying merchandise (goods) and services at reduced prices, countries in the European Union (EU) are not suitably positioned to reap the full benefits from it. The EU has long battled against the risk of deflation, and the fear that it would provide an incentive for consumers to hold back on their demand, lowering supplier’s profit and resulting in a vicious downward spiral in aggregate demand and the economy. Collectively, the Euro Area (EA) member states’ average inflation rate fell to 0.5% YoY in June 2014 from 2.7% YoY in January 2012. Largely attributable to the fall in oil prices, the EA saw a mild deflation between December 2014 and March 2015. While domestic consumers in the EA would no doubt benefit from the cheaper prices, given that the European Central Bank’s policy rate has already been lowered to 0.05% in tandem with the launching of a quantitative easing (bond-purchase) programme to boost inflation and economic growth, lower oil prices offset the efforts made, making combating potentially harmful deflation even more difficult in the EA.
The importance of oil towards the economy has made it a vital element in policy making. Given the need to meet energy requirements to keep the economy running, the magnitude of impact in a change in oil prices should be carefully deliberated and strategized to extract the most value out of each price cycle for the fossil fuel. Recognising the positive element of this low price period, for countries that have long been providing fuel subsidies, like Indonesia and Malaysia, cheaper oil has provided the government an opportunity to remove the subsidy burden from its book without significantly affecting domestic consumers. Hence, appropriate policies and strategies, if taken, would be an important factor in allowing the country to weather any downside risk from an oil price slump, regardless of it being a net oil importer like Indonesia, or net oil exporter such as Malaysia and Saudi Arabia.
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