The price of oil has been declining steadily for a little more than a year. The price of Brent crude is now below $60 a barrel. What’s behind this 50% slide since last June?
We can identify several factors:
All things considered, Saudi Arabia is showing that it is capable of controlling the price of oil, a vital commodity for many countries, as well as the profitability of extraction activities and the attainment of fiscal balance.
It's obvious that some of the factors mentioned above are demand-side shocks while others are supply-side shocks. Identifying these shocks is one thing but quantifying them is quite another. Without ignoring the obvious significance of the economic downturn, the geopolitical and supply shocks influence on current oil price trends is obvious.
What is the impact likely to be?
We list some of the many consequences below:
1. To see the price of oil rise again, growth must recover momentum and/or supply side factors must fade away. It is not unreasonable to believe that the price of crude will be $80 in 6-12 months. In periods of low prices, investment in exploration, development and production taper off, which in turn drives prices higher, all other things being equal. On top of this, the slowdown in emerging countries like China, Brazil and Russia is dragging down demand, while shale oil will probably keep the market off balance.
2. Don't confuse cause and effect. With specific regard to economic growth, it should be kept in mind that if the economic slowdown is –at least in part– responsible for the fall in oil prices, then we can’t be too excited by the idea that this same drop will boost the economies of countries already experiencing a downturn.
3. The current situation suggests that a downward revision of inflation expectations is in order, including in the eurozone. This adds to current deflation pressures and reinforces the idea that the ECB should continue its quantitative easing programmes.
4. In terms of profits, the energy sector has a weight that varies from one country to another. The graph below shows the importance of this sector in countries like Norway, but also Italy. It is certain that falling oil prices will have a marked impact in these countries. Also note Germany's absence from this graph. Germany exports heavily, but does not depend on the energy sector - in other words, two positive impacts in the current economy.
5. Countries should be divided into two groups:
6. For some countries, lower oil prices can be a big advantage. According to the IMF's estimates (World Economic Outlook), a $20 drop in the price of oil would, all else being equal, result in a 0.5% uptick in global GDP in 2015, followed by another jump of 0.7% if this ends up boosting confidence. Bear in mind that since mid-2013, we've seen a $40 slide. In the eurozone, the drop in the dollar price of crude can be partially offset by a drop in the euro's value against the dollar (though we should not forget the fact that some of our oil imports are invoiced in euro). In China's case, the numbers speak for themselves. China imports six million barrels per day, which means a simple $1 decline amounts to $2 billion. What is more, oil and petroleum products make up 13% of China's imports. Falling oil prices have an immediate impact on the improvement of China's current accounts.
7. For other countries, lower oil prices can spell disaster. In the case of Russia, a $20 decline could result in a 2% drop in GDP three years from now. Russia was already in an economic downturn and the fall in oil prices only exacerbated existing problems. Russia is now entering a severe recession and we predict negative GDP growth of -4.5% for 2015. However, Russia is still able to honour its commitments on its debt for 2015. Venezuela is an even more serious case, as it is on the brink of default and economic chaos: oil represents almost 40% of government revenue and 95% of exports. Bahrain, Angola and Ecuador are the other countries most vulnerable to falling oil prices.
Lower oil prices will result in lower exports and thus a deterioration in current accounts. It will also lead to a drop in the exporting governments' revenues, and make it harder to balance budgets. Let us just mention that Latin American companies that export oil generate one-third of their revenues from their oil-related activities. This figure is almost 80% of revenues for Gulf countries (57% for Qatar, and a little less than 95% for Kuwait).
Overall, oil-producing countries can be split into three groups:
• One group of "safe" countries that will be in surplus even if the price of oil stays where it is. These include Kuwait, the United Arab Emirates, Qatar and Norway, countries that have current account and budget surpluses large enough to cushion the fall of oil prices. In Norway's case, we can even count on stability of government surpluses.
• A group of "fragile" countries made extremely vulnerable by their dependence on oil and petroleum products, given their current situation. The decline in oil prices will considerably reduce their surplus, or even lead to current account and/or budget deficits. Saudi Arabia, Oman, Azerbaijan and Venezuela will face government deficits.
• A group of countries "of concern", whose financial position and oil dependency suggest that the only outcomes can be recession and/or default. These countries' financial vulnerability is taking a serious hit from the drop in oil prices.
As far as investors are concerned, the current environment is an argument for preferring resource-consuming countries to resource-producing countries. For the latter, this assumption also takes into account the usual solvency and economic vulnerability criteria. Canada, Norway and Kazakhstan are already looking much less risky than Russia, Bahrain,Nigeria or, even worse, than Venezuela. Watch the countries' ratings: Russia is now just one notch away from high-yield...
China, Brazil and Russia... a confirmed economic downturn
Saudi Arabia is having a negative impact on prices
Lower crude oil prices: a supply-side shock and a demand-side shock
Don't confuse cause and effect
Russia and Venezuela both have a lot to lose
Safe countries, fragile countries and countries of concern... a typology based on financial vulnerability