Oil prices & the economy

Courtesy of Sandra Boyd, Posted 03 Dec 2014

After OPEC’s decision to maintain production and allow market forces to set the price of oil, WTI slid to the lowest level since July of 2009 before steadying.  Overall, oil has dropped 38% this year and some, such as Canadian Natural Resources Ltd. Chairman Murray Edwards, believe that crude could sink as low as US$30 a barrel before rebounding to stabilize at US$70-75.  While the overall effect for the global economy may be good, this price decline carries with it specific risks for those economies that rely heavily on oil.

Many oil producers are able to weather the storm but many will be hard-pressed to do so. 

In October the IMF assessed the oil price that different governments need to be able to balanced their books

  • Kuwait, Qatar and the UAE have a breakeven point at about US$70 a barrel while Venezuela and Nigeria need US$120 and Iran needs US$136
  • Few expected the US oil resurgence to have moved with such speed and now many of the governments that squandered their oil windfalls on subsidies will be hard-pressed to continue with these handouts
  • “If the governments aren’t able to spend to keep the kids off the streets they will go back to the streets, and we could start to see political disruption and upheaval,” says Paul Stevens, distinguished fellow for energy, environment and resources at Chatham House, in London. “The majority of members of OPEC need well over US$100 a barrel to balance their budgets. If they start cutting expenditure, this is likely to cause problems.”
Russia is among the most vulnerable.

Russia has already spent US$90 billion of its currency reserves shoring up the ruble as oil and gas represent 68% of its exports and 50% of its federal budget

VTB Group, Russia’s second-largest bank, OAO Gazprombank, its third-largest lender, and Russian Agricultural Bank are already seeking government aid to replenish capital after sanctions cut them off from international financial markets

However, in the face of these difficulties Putin has remained calm, stating that the winter will help bring the market for energy back into balance and that the recent price moves will not force him to meet Western demands to  curb his interference in Ukraine.

Iran, Nigeria and Venezuela all face acute problems if the price oil does not increase.

Oil comprises 75% of the Nigerian government’s revenue and the price drop has forced them to devalue the naira and tighten monetary policy, with a further 6% public spending cut planned for next year

Venezuela is perched even more precariously as it has been running a budget deficit of 16% of GDP and 25% of GDP is comprised of oil revenue. “The dire state of the economy is likely to trigger renewed social unrest, while it seems that the government is running out of hard currency,” Capital Economics, a London research firm, wrote in a Nov. 28 report

Iran’s oil exports were already in tatters prior to the recent price drop due to nuclear program-related sanctions.  According to the IMF, production is at a 20-year low, exports have fallen by half since early 2012, and the rial has plummeted 80% on the black market.  “The Iranians were already losing so many billions of dollars because of the sanctions that the oil price decline is just icing on the cake” says Suzanne Maloney, senior fellow at the Brookings Institution.

On the whole, the drop in oil prices is a benefit to the world economy, when looked at purely from an economic viewpoint.  However, this glosses over the possible political ramifications that such a price drop could entail and that has the potential to inject much more instability into global markets.  

SOURCE: http://business.financialpost.com/2014/12/01/oil-at-40-possible-as-market-meltdown-rivals-worst-seen-during-the-financial-crisis/?__lsa=710c-8514