Effects of the Decline in the Price of Oil

The price of crude oil has collapsed over the last several months with some analysts holding the belief that

prices will drop to USD42/bbl. Since June 2014, the price of high grade (ICE Brent) crude oil has fallen

more than 40 percent, declining from around USD$115 a barrel, in January 2014, to just USD52/bbl as of

January 2015. A variety of factors have coalesced into a perfect storm, placing sustained downward pressure

on global prices. The global oil market is unpredictable and dependent on a variety of factors ranging from

government intervention to cartel manipulation. The main factors which have predicated the recent trend of

backwardation in crude oil market include:

• Expanding US Oil Production: increased US production transformed one of the world’s leading oil

consumers into one of its leading producers. U.S. production of crude oil surpassed both Russian and Saudi

Arabian levels this year with daily output exceeding 11m bbls. The introduction of innovative processes

such as hydraulic fracturing has unlocked oil and natural gas deposits trapped in shale rock, leading to a

“Shale revolution” of sorts. As a result North Dakota alone produces 1m bpd.

• Saudi Arabia: The Arab nation proudly holds the largest proven reserves of crude oil on the global

market. Traditionally as a member of OPEC, Saudi Arabia has taken the role of a swing producer. This has

meant that their willingness to cut production in the past has limited global supply thus maintaining an

artificially high price. At OPECs latest meeting in November, the decision to maintain OPEC supply saw

prices fall further due to expectations of a continued glut in global supply.

• Dampened Asian Demand: A global recession has left Asian demand weaker than expected. High growth

economies such as China and India have seen decreased consumption that is curbing oil demand

throughout the continent.

• Appreciating US Dollar: Oil is bought and sold in US dollars across the globe. When the dollar gets

stronger (as it has over recent months), it makes oil more expensive to buy in countries outside the US.

That, in turn, weakens worldwide demand and further puts downward pressure on oil prices.

• Steady Global Production: Lastly and perhaps most importantly is the fact that traditionally risky

producers such as Libya, Iraq, South Sudan and Nigeria have all maintained production despite the threat

of instability in those regions. This steady production has caused a glut in global supply at a period when

demand is relatively weak.

The decline in the oil price will have varying effects on different nations depending on the role crude oil

plays in their economy and the infrastructure they have on ground to meet their energy needs.

Africa

The continent predominantly serves the global crude oil market as a net exporting region through producing

nations such as Nigeria, Gabon, Ghana, Angola, Libya and Mozambique. The Republic of Congo, Equatorial

Guinea, and Angola are three West African nations that rely on oil to fund a high percentage of their

economy and state revenues will be affected negatively by the decrease in oil prices. The c. USD60 a barrel

fall in crude prices represents billions of dollars in lost revenue equivalent to roughly 20% of their GDP.

Effects of the oil price fall typically tend to affect exporting nations currencies. The Ghanaian cedi has

plunged, while Nigeria has been forced to devalue the Naira.

Nigeria

Nigeria's oil resources are the mainstay of the country's economy. The International Monetary Fund (IMF)

estimates that oil and natural gas export revenue accounted for 96% of total export revenue in 2012.

Nigeria’s 2013 budget was framed on a reference oil price of USD 79/ bbl. The current oil price of

USD52/bbl (6th January 2015) indicates the nation will register a fiscal deficit. The EIA forecast a fall of

USD 28.15bn in government revenue as a result of the fall in price. Private investment, consumption and

government spending will likely decline in the coming year. This will have a dampening effect on the

country’s GDP growth.

Angola

Angola is the second-largest oil producer in Sub-Saharan Africa, behind Nigeria. The Angolan government

required USD94/ bbl to meet its government expenditure in 2013. The fall in price has resulted in a fiscal

deficit for the country. According to the EIA 2012 saw Angola export c.1.7m bpd of crude oil nearly half of

which went to China (46%). The United States (14%), the European Union (11%), and India (10%) were

also major destinations for Angolan oil. Dampened demand from all these regions has seen a c.USD 23bn

drop in government revenues. This will severely limit public spending on much needed infrastructure

investment. (See Appendix 1)

Gabon

Gabon is a mature oil producing country off the coast of West Africa that has been facing declining oil

production for over a decade. Despite recent attempts to diversify, crude oil exports underpin Gabon's

economy; c. 90% of crude output is exported, accounting for 65% of government revenue and 75% of export

revenue. The recent fall in price will see a c. USD 3bn fall in government revenues roughly 15% of GDP.

The sustained decline will limit the scope of fiscal policy and may have a damaging effect on the nation’s

debt situation as seen during the oil price deflation of the 80s. (See Appendix 1)

Ghana

Ghana's energy sector has expanded considerably after the discovery of the Jubilee oil field in 2007. The

field came online in 2010, and production in Ghana has since increased from 7k bpd in 2009 to 99k bpd in

2013. This recent discovery has seen the nation borrow heavily on the back of anticipated revenues to fund a

tripling of the civil service wage bill and generous fuel subsidies. Increasing worries over the government

budget saw the introduction of IMF restructuring policies this year. The Ghanaian government has already

estimated down its 2015 oil price to USD 93/bbl from a realized price of USD 107/bbl in 2014, the effect of

the price crash may not affect Ghana much. Unlike the countries analyzed above, Ghana does not heavily

depend on oil revenues to finance its budget.

This sample of net exporters shows a common trend of currency devaluations, decreased revenue, limitations

on public spending and negative effects on GDP levels. Individual effects on net exporters will depend on

specific government policies, their ability to manage their oil revenues, the extent of diversification of their

economy and the level of dependency on oil exports.

Middle East

This region highlights the potential of oil exporters to adequately traverse this period of lower prices having

learnt from the oil crises of 1970s. According to the FT, the Gulf economies collectively have run a current

account surplus of more than 20 per cent of GDP for six of the last ten years, and Saudi Arabia has saved

25% of oil export revenues in the past decade compared with 7% in the 1970s. The introduction of efficiently

managed Sovereign Wealth Funds has meant that states such as Saudi Arabia and the UAE will have the

ability to absorb an extended period of low prices. Fitch calculate that Saudi Arabia have net sovereign

asset holdings equal to 111% of GDP (USD 737 bn in August 2014), enabling it to maintain public spending

thus avoiding political unrest and a significant dampening of GDP growth. This is in stark contrast to nations

such as Iran, Iraq and Bahrain where civil and political unrest have translated to oil production disruptions,

inadequate management of oil revenues and will result in constrained GDP growth due to a high dependence

on crude oil revenues. The loss of the American market due to the Shale revolution will see Middle Eastern

exporters shift their focus to Asian markets, with Saudi Arabia recently (December 2014) increasing the

discount at which it sells its light crude in Asian markets. In general, as opposed to African exporters, Gulf

exporters have managed the years of high prices by investing in diversified projects such as infrastructure

(Qatar's SWF is a prime example) and rapidly adjusting to current market conditions as seen by Kuwait’s

move to base its budget on a price of USD55/bbl.

Europe

Historically, the knock-on effects of lower oil prices have generally been positive for Western economies.

Europe is an immediate potential beneficiary as on aggregate the region is a net importer of crude oil. The

lower price will result in a decreased import bill for the region in general. Energy imports into the European

Union cost $500 billion in 2013, of which 75% was oil. Assuming oil prices average at USD85/bbl, the

overall import bill could fall to under $400 billion a year. The main concern for the Eurozone is the fear of

further deflation which could serve to dampen economic growth in the region. The European Commission

President Jean-Claude Juncker presented a plan (November 2014) to leverage c. USD 375bn of primarily

private new investment in the European Union aimed at infrastructure development in a bid to promote

growth and avoid the period of deflation in major EU economies such as Germany, France and the UK.

The two major exceptions to the importing trend in the European region are Norway and Russia. Each

nation is a net exporter with different views on the reduced price. Norway has maintained its Sovereign

Wealth Fund currently at c. USD 880bn thus has the ability to weather a lengthy period of low prices.

However the case in Russia is different. Oil and gas revenues accounted for 52% of government revenues

and over 70% of total exports in 2012 and analysts predict the fall in price has seen a loss of c. USD 98bn in

government revenues. The current joint US and EU sanctions against the state do not bode well for GDP

growth rates in the near future.

Conclusion

The general trend seen is that net exporters (Africa and the Middle East) who have sufficiently diversified

their economies and managed the years of high oil prices efficiently will be affected by lower oil revenues

but not as severely as nations who have failed to implement such policies. Europe, predominantly made up of

net importers, will have different issues to contend with. The deflationary pressures that stall private

consumption and investment may dampen economic growth, but the EU and its large economies will

implement policies to avoid such a situation.

Analysts believe that a USD 10/bbl fall in the oil price would boost global demand for goods and services by

0.2% - 0.3%. The fall has already seen a price decrease of circa USD 60/bbl, indicating growth of c. 1.5% in

the global economy. This decrease in the oil price will serve to shift purchasing power from net exporters to

net importers. As the global economy acclimatizes to the new oil price, the major winner will be increased

consumption in net importing countries and the global economy.

Appendix 1

Angola

In order to balance the 2014 budget Angola would need an oil price of 90USD/bbl. The current pegged price is

98USD/bbl. The 2015 fiscal break even benchmark is 80USD/bbl which is still higher than the current Brent benchmark

price of USD52/bbl. The nation has not implemented policies to manage its previous revenues from strong oil prices

and does not have an adequately diversified economy.

Oil production in Angola is increasingly carried out in deep water, which requires high investments, with Brent oil as a

reference. As the oil price declines it will have a direct and negative impact on the commercial viability of investment in

new projects. This reduction in investments will significantly reduce the GDP of the nation.

However, the low price of oil on international markets is an opportunity for the Angolan government to diversify its

economy and reduce dependence on exports of hydrocarbons. Abraão Gourgel (Economy minister) has noted

agriculture, food, agro-industry, mining activity, as well as the oil production chain as potential sectors for economic

diversification. He also mentioned housing, water, transport and logistics, as sectors the government has already

identified in its diversification programme, which aims to reduce the impact of oil price fluctuations on the national

economy. This bodes well for infrastructure projects in said sectors, the government will aim to support promising

projects in these areas and mitigate any risks attached to such transactions in an attempt to stem the GDP decline and

foster economic growth through other sectors.

Gabon

The country is sub-Saharan Africa's fifth largest oil producer and pumps around 250,000 barrels per day, accounting for

around 80% of exports, circa 60% of fiscal revenue and c. 50% of GDP for the government of Gabon. The decline in oil

price will see a reduction in the government’s ability to maintain public expenditure and a rise in the current budget

deficit. Recent years have seen dwindling levels of oil production and, the Government is centring its new strategy on

diversifying the economy by improving the investment climate, developing skills and improving infrastructure.

Gabon wants to lure investors into its mining and manufacturing sectors as it tries to reduce its dependence on oil

exports. Manufacturing, forestry, mining and industrial projects have been targeted as areas of potential growth and

increased foreign direct investment. In particular, road infrastructure projects have been prioritised as the nation looks

to expand links to neighbouring countries and become an investment hub.

General Consequences

Countries that import a large volume of oil relative to the size of the economy stand to gain the most relief. For

example, Pakistan, Chile, Turkey, the Czech Republic and South Africa all have net hydrocarbon imports that equal

more than 4% of GDP and will record positive effects on their fiscal policy as their oil import bill falls.

Emerging Markets will also benefit from an improved environment for global growth and investment. Lower oil prices

will boost growth in a range of Developed Markets, boding well for export demand. Greater liquidity stemming from

loose monetary policy in Developed Markets (especially the EU) will support capital flows into Emerging Markets.

Graphs

Oil as a %age of Fiscal Revenue and Total Exports

Sub- Saharan Africa (SSA) - Share of Net Oil Exporters' Budgets Derived From Oil

SSA Fiscal Break-Even Prices 2015

Sources

http://www.businessmonitor.com/news-and-views/significant-drop-in-oil-prices-would-damage-sub-saharan-

africa

http://www.reuters.com/article/2014/11/27/africa-currencies-idUSL6N0TG3CX20141127

http://www.macauhub.com.mo/en/2014/10/30/angola-needs-to-diversify-the-economy-to-reduce-impact-of-

falling-oil-prices/

http://blog-imfdirect.imf.org/2014/12/22/seven-questions-about-the-recent-oil-price-slump/

http://www.emergingmarketsmonitor.com/economic-analysis-oil-price-drop-positive-ems-balance-08-dec-

2014

http://www.economist.com/blogs/economist-explains/2014/12/economist-explains-4

African Development Bank

International Monetary Fund

OPEC Website- Monthly Reports

http://theenergycollective.com/jemillerep/2146151/are-declining-oil-prices-increasing-risks-opec-us-energy-

security-or-clean-fuels-

Energy Information Administration : http://www.eia.gov/

International Energy Agency: http://www.iea.org/

World Factbook: https://www.cia.gov/library/publications/the-world-factbook/

A falling Oil Price is good for the World Economy: http://www.ft.com/cms/s/0/86916314-8776-11e4-bc7c-

00144feabdc0.html#axzz3O2y0SCEQ

Winners and Losers of Oil Price Plunge: http://www.ft.com/intl/cms/s/2/3f5e4914-8490-11e4-ba4f-

00144feabdc0.html#axzz3O2y0SCEQ

Bloomberg Energy Prices: http://www.bloomberg.com/energy/

Written January 2015