Editor's Note: This is the second installment of a three-part series examining the effects of the recent drop in global oil prices. Part One focuses on the structural changes in the oil market that led to, and could prolong, the price drop. Part Two looks at the countries that stand to lose the most from the decrease in global oil prices — oil-producing countries that have benefited from years of more expensive oil. Part Three will dissect the countries likely to benefit the most.
The Gulf States, Libya and Iran
The Middle East and North Africa contain the greatest concentration of oil-dependent economies in the world. The region accounts for nearly a third of seaborne crude oil and liquefied natural gas exports. The Middle East — specifically the Persian Gulf — also accounts for the majority of OPEC production and exports. Therefore, the Middle East is the region that is most exposed to volatility in global energy markets — and the region that can cause the most variation, as seen by Libya's production fluctuations. A sustained drop in the price of oil below $90 per barrel could jeopardize the economic stability that many of the region's energy exporters have enjoyed following the tumult of the Arab Spring.
Years of large budget surpluses fed by high oil prices have insulated these economies from short-term fluctuations in prices. Many of the region's key producers — Saudi Arabia, Kuwait, the United Arab Emirates, Libya and Algeria — have hundreds of billions of dollars in currency reserves. Saudi Arabia, the United Arab Emirates and Kuwait combined have more than $2 trillion in their primary sovereign wealth funds alone. Others in the region are not as lucky: High domestic spending and domestic economic problems have left Baghdad, ravaged by war, and Tehran, hampered by sanctions, needing higher oil prices — more than $100 per barrel — to balance their budgets. Lacking the same budget surpluses and healthy balance sheets as their Gulf counterparts, these governments, already feeling pressure from the Islamic State, will suffer if oil prices remain low in the long term.
Although the downward pressure on global oil prices does not come solely from the supply side, recent regional developments are part of the current restructuring of oil prices. The resumption of production in Libya, increased output in southern Iraq and stable production out of the Gulf countries have added to an OPEC oversupply of nearly one million barrels relative to demand.
Despite this, OPEC's Persian Gulf members are unlikely to reduce production in November. The chief producer, Saudi Arabia, still hopes to maintain its production levels and global market share, and Kuwait and the United Arab Emirates show signs of following Riyadh's example for the next few months. These governments have sufficient cash reserves to help buoy them for a few years and are hoping that a potential uptick in Chinese corporate oil reserve purchases, an end to refinery maintenance in Asia and higher global demand for refined fuel in winter will help stabilize market prices in the short term. For the Middle East's relatively resource-poor countries, oil exports generally represent more than 85 percent of government income, making a voluntary reduction in exports unlikely. Therefore, despite complaining that excess supplies are driving prices down, other producers in the region — including Algeria, Iraq and Libya — are also expected to avoid significant reductions in overall production in the short term.
There could be involuntary reductions in output, however, especially in the cases of Iran and Libya. International sanctions are expected to limit Iranian exports to a total volume of about 1.5 million barrels per day for the foreseeable future, and even if Iran and the United States reach a nuclear deal by Nov. 24, Tehran will still find it difficult to liberalize its economy enough to attract the necessary investment to reach pre-sanctions export levels. In Libya, oil production has boomed even as violence and competition over resources has distracted the government and the country's myriad armed groups. Fighting in the western and eastern halves of Libya is currently locked in a stalemate, but once more decisive outcomes emerge, we can expect the losers to once again target oil infrastructure to undermine their opponents' recent victories.
Any fluctuation in oil prices has strong effects on Russia. Revenues from energy exports make up half of the government's budget and a quarter of Russia's gross domestic product. Of energy revenues, 80 percent comes from oil, making its price the most important factor in the Russian government's financial stability. Currently, the government's 2015 budget counts on oil prices remaining above $100 per barrel, but the Russian Cabinet is holding discussions on revising this forecast to $80 to $90 per barrel. Additionally, budget scenarios based on $60 per barrel are being drawn up. All of these revisions would require the government to either make deep budget cuts or to run a budget deficit — something the Kremlin rarely does.
Russia could use its vast cash reserves to plug the holes in the budget. The government has approximately $582 billion in reserves ($409 billion in currency reserves, $83 billion in the National Wealth Fund and $90 billion in the National Reserve Fund). The Kremlin has already used close to $70 billion from its reserves to aid Russian markets and the currency, both of which are under heavy stress. However, these reserves can quickly decline, as seen during the 2008-2009 financial crisis when the Kremlin spent $220 billion to prop up the economy. Currently, any additional revenue above $90 a barrel goes directly into the National Reserve Fund, so declining oil prices will mean less cash goes into the federal reserves.
The decline in oil prices comes amid a period of economic weakness for Russia, during which slow growth and tension with the West has caused foreign investment to fall by half and capital flight from Russia to reach $76 billion. In addition, the Russian regional governments' debts are skyrocketing. Demands for financial assistance from the Russian government are growing: Russian banks are set to begin receiving dollar injections in November, a reorganization of the regions' debts is being debated, and a massive aid program for Russian firms hit by sanctions, such as Rosneft, is under negotiation in the Kremlin. Moreover, in 2015 the Kremlin is set to launch an ambitious 10-year defense-spending program, allocating some $77 billion for the program's first year. It is unclear how the Kremlin will finance this defense program, considering the state budget currently includes a defense spending increase of only $20 billion.
With oil prices in decline, Moscow will have to cut spending or risk diminishing a significant part of its reserves. However, the Kremlin is at an impasse. With a crisis in Ukraine and tension with the West at a post-Cold War high, Moscow feels it must shore up its defenses, which requires a boost in spending. Russia cannot let its state firms nor the Russian regions falter financially without risking further economic weakness and a possible social backlash. The Russian government and its leaders' popularity is already wavering under all this strain. Should oil prices remain at the current level or decline further, the strain will grow and the Kremlin's future stability will be undermined.
Like Russia, Kazakhstan depends heavily on oil revenues, which make up 60 percent of the state's budget and 33 percent of GDP. The Kazakh government is already under enormous pressure as its economy slows, and many of its banks face the threat of bankruptcy. Moreover, Kazakhstan's currency, the tenge, has already been devalued once this year, there are mass gasoline shortages across the country, and inflation is on the rise. These problems are rooted in the Kazakh economy's close connection to the Russian economy and lower than expected oil production. The Kazakh state's budget is set on the price of oil being $103 per barrel, and the budget for 2015 is pinned on oil being $90 a barrel, though this forecast is being revised down to a possible $80 a barrel.
Also like Russia, the Kazakh state has large reserve funds — $21 billion in currency reserves and $76 billion in the state's National Fund. As oil prices slump and the expansion of oil production faces delays, the Kazakh government will have to either start spending its reserves or cut state spending across the board. Economic issues in Kazakhstan can quickly spiral into protests and violence among the population. In addition, any economic or social instability in either Russia or Kazakhstan could spill over into other Central Asian states, such as Kyrgyzstan, Tajikistan and Uzbekistan. These three states' economies are deeply linked to those of Russia and Kazakhstan. Moreover, large parts of the Kyrgyz, Tajik and Uzbek workforces are employed in the other two countries; with oil prices hampering the Russian and Kazakh economies, there will be less work, lower remittances and fewer opportunities for workers in Kyrgyzstan, Tajikistan and Uzbekistan — a situation that could lead to region-wide instability.
The oil and natural gas industry accounted for about 1 percent of the United Kingdom's tax revenues in 2013 (6.1 billion pounds, or $9.8 billion), when it produced 900,000 barrels of oil per day. The United Kingdom has long battled a giant current account deficit. This deficit has partly been offset in the past by energy revenues that, though not as significant as for oil giants such as Russia or Norway, have provided a welcome boost.
The United Kingdom has, to a degree, experienced an economic recovery of late, with unemployment falling but wages remaining stubbornly low. This means that the average person is looking for ways to make money stretch further. Low oil prices will harm the United Kingdom's status as an economic success story in Europe, where its recovery had more or less mirrored the United States'. In the short term, though, British citizens will have all eyes on May's elections. While oil will be an important part of the election, it will not be the most important issue. To the average British resident, lower oil prices are generally seen as good because they see the effects first-hand in their wallets, whereas the effects of other issues — such as the government's budget deficit — are more vague.
Energy is an important part of Norway's economy. In 2012, crude oil, natural gas and pipeline transport services accounted for 52 percent of the country's export revenues, 23 percent of GDP and 30 percent of government revenues. Norway's key oilfield, the Johan Sverdrup, has an estimated peak production of more than 500,000 barrels per day (the country produced 1.8 million bpd 2013).
The biggest impact of lower oil prices in Norway will be delays for certain projects in the North Sea. The oil price drop will probably not significantly affect Norway's longer-term goals in the Barents' Sea or in the Arctic, where most of its projects are focused on natural gas, and any focused on oil are longer-term in nature. However, oil projects that are in the appraisal phase, where exploration has been completed and the fields are ready to be brought online, will be affected the most. Rather than emphasizing the development of any major new fields, Norway will focus on making incremental improvements to existing wells.
This is an important issue for Norway because projects in the development phase tend to be the most employment-intensive. Statoil and several domestic oilfield service companies have already conducted layoffs, and this trend is likely to continue. Oslo has already said it is willing to dip into its sovereign wealth fund — the world's largest, at approximately $827 billion — if need be, so domestic unrest and social spending cuts are not expected.
Of all the countries affected by a drop in global oil prices, Venezuela will be the most critical to watch for major political repercussions. Venezuela's public finances are already dangerously low, and lower oil prices will reduce Caracas' ability to fund the country's high public spending, which is crucial to maintaining support for the government. In the next several months, Venezuela will continue dealing with ongoing economic problems, such as high levels of inflation and increasingly dire food and goods shortages, albeit with a reduced financial cushion. A decrease in revenue flowing into government accounts is likely to hamper the government's ability to fund imports, thereby exacerbating the current shortages of food and consumer goods. The distribution of these heavily subsidized items has been crucial to securing the public's support for the government.
The government's options to mitigate the effects of reduced oil revenue are limited. Caracas probably will continue printing more bolivars to finance its deficit spending, exacerbating the country's inflation problem. As of June, the official figure for year-on-year inflation stood at more than 60 percent. Falling oil revenue could also threaten Caracas' ability to pay the $18.5 billion in foreign debt the country owes between 2015 and 2017 — debt the state-owned energy firm Petroleos de Venezuela (PDVSA) is attempting to restructure.
PDVSA likely will continue trying to sell its U.S.-based subsidiary Citgo to gain hard currency and to divest itself of assets that could be seized because of non-payment of loans. Also, if the company's money flow problems worsen, PDVSA could begin selling the $15.1 billion of gold it has in Central Bank reserves.
China's increasing reluctance to finance Venezuela is exacerbating the effects of lower oil prices on the country. Caracas has leveraged its oil exports for loans from China for several years, but Venezuela has not been able to meet quotas for oil shipments under these deals. If crude prices remain low, the Chinese may be unwilling to offer loans as often or for as much money as before.
Venezuelan President Nicolas Maduro will use the limited tools available to him to minimize the effects of the ongoing economic deterioration on his base of support. He will likely continue anti-corruption measures to stem the use of dollars for financing imports but will back off from targeting politically important individuals involved in such schemes. Maduro will also continue targeting the black market for food and goods to reduce shortages and lower prices for consumers. Neither of these measures will have the desired effect. Consequently, Maduro's political approval rating, which is estimated at 30 percent, will decline in coming months if the price of oil does not rebound. The effects of low oil prices on the Venezuelan economy will increase the risk to Maduro at a delicate time. Failure to satisfy domestic constituents could lead to further unrest and to an erosion of the party's political base. Moreover, recent events in Venezuela suggest that the government may not have the full support from its security forces needed to address such unrest. Consequently, this period of depressed oil prices will be a crucial one for Venezuela.
For the next few months, Nigeria will be too tied up with presidential, state and local elections scheduled for February 2015 to focus on state finances or on the oil sector. Campaigning ahead of the elections will not address broad issues such as the state of the economy but will instead focus on ethnicity, regions, personalities, and control of the country's political economy.
That said, low oil prices will affect Nigerian President Goodluck Jonathan's ability to finance his political patronage. Oil and natural gas account for 35 percent of Nigeria's GDP, or 80 percent of total government revenue. There are ample reserves in Abuja's coffers for Jonathan to use, but the budget will be strained nonetheless. The real concern, however, is the outcome of the national election.
A Jonathan victory would bring continuity, and low oil prices would not affect the political system significantly; his administration would make sure money is available for the Niger Delta amnesty program, which keeps militants in the oil-producing region content. However, a victory for the opposition All Progressives Congress would bring uncertainty. Nigeria has never undergone a democratic exchange of power between parties. The People's Democratic Party has ruled since 1999, and the 2015 election is the first in which the opposition has a legitimate chance of winning the presidency. The All Progressives Congress would need to use patronage in Nigeria's south to secure that region's alignment with the new government. At the same time, unlike the Jonathan administration, the party would have significant obligations to the north because the north is key to an election victory for the opposition. Low oil prices will limit the amount of cash available for such patronage. Despite threats from Niger Delta militants that militancy will resume if Jonathan does not win, integrating the political elite from this region into the new government could mitigate the threats of violence. However, it would give the All Progressives Congress less room to maneuver in other areas.
One of those areas is the Petroleum Industry Bill, which will be among the first items on the administration's agenda after elections. The bill is meant to define legislative reforms of Nigeria's petroleum industry, from fiscal matters to an overhaul of the state-owned petroleum corporation. Investment in deepwater exploration has stagnated — and lower oil prices are not likely to change that unless prices remain low for the long term — but of greater interest is the issue of fuel subsidies. These subsidies are important to Nigeria's political structure because of the corruption and smuggling associated with them. After the election, the government will be able to address those concerns, particularly if Jonathan is re-elected. Low oil prices lead to low refined fuel prices, making the difference between the subsidized rate and the market rate smaller. This will allow the government to either keep subsidies at the same percentage and reduce the cost for the population or to keep fuel prices the same and spend less money on subsidies.
Declining oil prices put Canada in a unique position. Canada is one of the few developed countries where commodities — and oil in particular — form a significant portion of the overall economy. Crude oil and oil products alone accounted for about 20 percent of Canada's overall exports in 2013. However, Canada's resource market is embedded in the greater North American market, where more than 90 percent of its energy exports go.
Canadian Prime Minister Stephen Harper envisions that Canada will become a global energy "superpower" and produce more than 6 million barrels per day by 2030, but the downturn in oil prices and Canada's limited export infrastructure will remain a constraint. Canada has very few options for exporting oil and natural gas to countries other than the United States. There is just one oil pipeline connecting Alberta, Canada's dominant oil-producing province, to the nearest coastal province, British Columbia, and that pipeline primarily feeds U.S. and Canadian refineries. The only other option for exporting oil to non-North American markets is shipping it by rail or pipeline to distant ports — an expensive and inefficient proposition.
Canada's pipeline options even within the North American market are being constrained as Canada increases production, given that U.S. President Barack Obama's administration has been hesitant to approve the Keystone XL pipeline, which would carry Canadian oil to U.S. Gulf Coast refineries. The lack of infrastructure development that has isolated Canadian oil from international markets has made it more important for Ottawa to pressure the United States to approve more pipelines and to persuade Canadian provinces, such as British Columbia, to support Canadian pipelines.
Because of its isolation, Canada's crude oil has traded at a significant discount to international prices for several years. West Canada Select, the Canadian benchmark, has traded as low as $50 a barrel during the last three years. Its current price is $65 per barrel, mainly because it is "stranded" and has not seen as drastic a price drop as international markets recently. The long-term low price of Canadian oil has led several companies — Statoil, Total and Exxon, among others — to delay oil sands projects. Developing oil sands is a very capital-intensive endeavor, often involving upgraders to convert the oil into synthetic crude before export. Break-even costs can range from $60 to $100 per barrel. As long as oil prices stay low, investors will find such projects less enticing.
These issues will be significant in Canada's 2015 national elections. The Liberal Party has been leading the polls since Justin Trudeau began leading the party in April 2013. Whereas Harper supports all pipeline options, Trudeau is much more hesitant to back Canadian-based export pipelines, although he is a staunch supporter of Keystone XL.