Effect of Declining Oil Prices on Oil Exporting Countries
By Roy Mathew
Introduction
The price of oil is of
critical importance to today's world economy, given that oil is the largest
internationally traded good, both in volume and value terms, creating what some
analysts have called a hydrocarbon economy.
In addition, the prices of energy-intensive goods and services are
linked to energy prices, of which oil makes up the single most important share. Finally, the price of oil is linked to some
extent to the price of other fuels.
Therefore, abrupt changes in the pi-ice of oil have wide-ranging
ramifications for both oil-producing and oil-consuming countries. The sharp decline in world oil prices since
late 1997 certainly qualify as an abrupt and significant change.
Oil Price History and Analysis - Post World War 11
Oil prices behave much as
any other commodity with wide price swings ill times of shortage or
oversupply. The domestic industry's
price has been regulated though the production or price controls throughout the
twentieth century.
Pre Embargo Period
Crude oil prices ranged
between $2.50 and $3.00 from 1948 through the end of the 1960's. Throughout the post war period, exporting
countries found an increasing demand for their crude oil and a 40ul(, decline in the purchasing power of a barrel of crude. In March 1971, the balance of power
shifted. This happened as a result of
the Texas Railroad Commission setting a proration at 100%, for the first
time. This meant that Texas producers were no longer
limited in the amount of oil that they could produce. More importantly, it meant that the power to control crude oil
prices shifted from the US (Texas, Oklahoma, Louisiana) to OPEC.
Yom Kippur War – Arab Oil Embargo
In 1972, the price of crude
oil was about $3.00 and by the end of 1974, the price of oil had quadrupled to
$12.00. The Yom Kippur War started with an attack on Israel by Syria and Egypt
on October 5, 1973. The US and many
western countries supported Israel. As
a result of this support, Arab oil exporting nations imposed an embargo on the
nations supporting Israel. Arab nations
curtailed production by 5 million barrels per day (MBPD). About I MBPD was made up by increased
production by other countries. The net
loss of 4 MBPD extended through March 1974 and represented 7 percent of the
free world production. Prices increased
400% in six short months!
Crises in Iran and Iraq
Events in Iran and Iraq led
to another round of crude oil price increases from 1979-80. The Iranian revolution resulted in the loss
of 2.5 MBPD between 1978 and 1979. In
1980, Iraq's oil production fell 2.7 MBPD and Iran's production by 600,000
barrels per day during the Iran-Iraq War.
The combination of these two events resulted in crude prices more than
doubling from $14 in 197 8 to $35 per day in 1981.
Oil
Prices - An Economic Analysis
Low oil prices since late
1997 have been caused by several main factors, including:
1. OPEC's December 1, 1997 agreement to raise the group's
production quota by 10%
2. A warmer-than-normal winter(1997/1998)in the northern
hemisphere
3. Increasing Iraqi oil exports
4.
Reduced
oil demand due to the severe economic crisis in East Asia.
If low oil prices continue
for a prolonged period of time, this could result in long-term reductions in
OPEC oil export revenues, and would force OPEC countries to make difficult
economic, social, and political tradeoffs.
A sharp decline in oil
prices benefits oil importing nations and hurts oil exporters. For importers, lower oil prices act similarly
as a tax cut, increasing consumer disposable income. This allows for looser monetary policy, and hence lower interest
rates with lower inflation and stronger economic growth (as in the case of the
US). Sharper oil prices, on the other
hand, have been identified as a major cause in seven out of eight post WW II
recessions in the US.
Firstly, oil revenues earned
by producers are to a large extent "recycled" back to consumers in
imports of all types of goods and services.
In this way, oil-importing nations earn back much of the petrodollars
they originally spend on oil purchases.
A drop in oil revenues for oil exporters, as in the present situation,
leaves oil producers with fewer petrodollars to "recycle".
Another complicating factor
is considering the impact of oil prices fluctuations on oil importing countries
is that certain states within a country may be affected totally different than
other states, while the effect of the overall economy may be positive or
negative. In the US for instance, Texas
and Alaska are major oil exporting states and are therefore hurt on balance by
lower oil prices. Northeastern states,
on the other hand, are major net oil and gas importers, and are therefore
generally helped by the same oil price drop.
OPEC - Failure to Control
Oil Prices
OPEC (Organization of
Petroleum Exporting Countries) was founded in 1960 with five founding members: Iran, Iraq, Kuwait, Saudi Arabia,
and Venezuela. By the end of 1971 six
other nations had joined the group: Qatar, Indonesia, Libya, UAE, Algeria, and
Nigeria. These nations had experienced
a decline in the real value of their product since foundation of the OPEC.
OPEC has seldom been
effective as a cartel. The rapid price
increases caused several reactions among consumers: better insulation in new
homes, increased insulation in older homes, and automobiles with higher
mileage. These factors along with a
global recession caused a reduction on demand that led to falling crude
pi-ices. Unfortunately, for OPEC, only
the global recession was temporary.
Nobody rushed to remove the insulation from their homes or to replace
the energy efficient plants and equipment; much of the reaction to the oil
price increase by the end of the decade was permanent and would not respond to
lower prices with increased demand for oil.
From 1982 to 1985, OPEC
attempted to set production quotas low enough to stabilize prices. These attempts met with repeated failure, as
various members of OPEC would produce beyond their quotas. During most of this period, Saudi Arabia
acted as the swing producer cutting its production to stein the free falling
prices. In August of 1985, the Saudi's
linked their oil prices to the spot market for crude. Crude oil prices plummeted below $1() per barrel by mid year.
The price of crude oil
increased in 1990 with the uncertainty associated with the Iraqi invasion of
Kuwait and the ensuing Gulf War. But
following the war, pi-ices entered a steady decline until in 1994, inflation adjusted
prices attained their lowest level since 1973.
With a strong economy in the
US and a booming economy in Asia, increased demand led a steady
price recovery well into 1997. This
came to a rapid end when OPEC underestimated the impact of the financial crisis
in Asia. In December, OPEC increased
its quotas by 10% to 27.5 MBPD but the rapid growth in Asian economies had come to a halt.
Impact on Oil Producers
Algeria
Algeria is heavily reliant
on oil and natural gas export revenues.
In 1997, Algeria hydrocarbon exports revenues accounted for 97% of
Algeria's total export revenues, and 58% of total fiscal revenues. A rule of thumb for Algeria is that every $1
per barrel drop in the price of Algerian Saliaran Blend results in a $560
million annual revenue loss (around 4.3% of normal export levels, 2.6170 of the
country’s budget, and 0.8% of GDP).
Declining oil revenues are a complicating factor for a country which is
already experiencing severe economic and social tensions and has suffered an
estimated 75,000 deaths resulting from a six-year conflict with the Islamic
Salvation Front and the Armed Islamic Group.
Indonesia
Indonesia's oil revenues
were expected to fall 32clo, to $3.5
billion, in 1998, compared to $5.1 billion in 1997. This comes in addition to the already dire economic conditions
that Indonesia finds itself in as part of the Asian economic crisis. For 1998, Indonesia’s economy was expected
to fall 13.5-20% in real terms. To cope
with its economic crisis (which is being aggravated by low prices), the country
has taken a number of measures, including lowering its oil price projection for
the country's 1998/99 budget from $17 per barrel to $13 per barrel currently.
Iran
Oil exports account for
about 36% of Iran's state revenues, and 80-85% of total export earnings. In March 1998, Iran's Central Bank Governor,
Dr. Mohsen Nourbaksh, estimated that Iran had $26.4 billion in foreign debt
obligations, including $14.1 billion in confirmed debt. Repayment of this debt will be made much
more difficult due to the sharp decline in Iran's oil revenues. Iran also will most likely experience a
larger budget deficit, a depreciation of the Iranian riyal, and a shortage of
foreign currency. Other problems facing
Iran's economy include inflation and unemployment. At current oil export levels, Iran loses about $1 billion per
year in oil export revenues for every $1 drop in oil prices. A serious implication of the decline Iran’s
oil export revenues has been lack of available cash for much-needed investment
in the country's oil sector. As a result,
Iran is looking towards Western capital markets as a source of capital
investment.
Iraq
Iraqi oil exports continue
to be constrained by United Nations oil export sanctions, imposed following
Iraq's invasion of Kuwait in 1990. But
they continue to be increasing steadily, reaching an estimated 1.7 MBPD in July
1998. This increase in oil exports has
been playing a significant role in the sharp decline in world oil prices since
late 1997. For 1998, Iraq was forecast
to earn $6.1 billion in oil export revenues, up 45% from $4.2 billion in 1997.
Kuwait
Oil revenue accounts for
about 90% of Kuwait's government income, which comprises nearly half the
country's GDP. For 1998, Kuwait oil
export revenues were expected to reach $7.9 billion, down 33% from $11.8
billion in 1997. At the beginning of
March 1998, in response to plummeting oil pi-ices, Kuwait's finance minister
asked state bodies to cut spending by 25% for the remainder of the fiscal year
ending June 30, 1998.
Libya
Libya was expected to earn $5.8
billion from oil exports in 1998. This
represents a 36% decline from Libya's earnings of $9.0 billion. Oil export revenues account for about 95% of
Libya's hard currency earnings. In
addition to lower oil prices, Libyan oil export production and export
earnings have been affected by UN sanctions imposed following the 1988 bombing
of Pan Am flight I03 over Lockerble, Scotland, in which 270 people were
killed. As a result of both sanctions
and lower oil prices, Libya's economy has barely grown in several years (0.7%
growth in 1996, 0.6% in 1997, 0.5% in 1998).
The country has been forced to adopt a more conservative fiscal policy
and to limit public infrastructure spending to a few main projects.
Nigeria
Crude oil exports generate
over 90%, of Nigeria's foreign
exchange earnings. Due to lower oil
prices and production cuts, Nigeria's crude oil export revenues were expected
to fall by 36% in 1998, to $9.2 billion, compared to $14.5 billion in 1997. The sharp decline in world oil prices and
export revenues comes amidst a period of political instability and social
turmoil for Nigeria, especially following the deaths of President Sani Abacha
on June 8, 1998 and of Masliood Abiola (presumed winner of the 1993
presidential elections) on July 7. All this is having a serious effect on
Nigeria's short-term economic and fiscal growth.
Qatar
Oil accounts for about 70%
of Qatar’s government revenues, and also has an impact on production of
condensate and associated natural gas.
Qatar has tile third largest gas reserves in the world, after Russia and
Iran. Qatar's oil export
revenues for 1998 were forecast at $3.0 billion, down 26% from $4.0 billion in
1997. Despite the fall in oil prices,
Qatar is still planning to increase oil production capacity by 20%, from
714,000 billion barrels per day at present to 854,000 billion barrels, by the
end of 1999.
Saudi Arabia
Saudi Arabia is the largest
OPEC producer and is a leader in the organization's quota decisions. It is a critically important player behind
the recent oil price collapse, and also in actions taken to reverse tile Situation. Saudi Arabia's difficulties are being
compounded by the economic crisis in Asia, since Asia accounts for around 60%
of Saudi oil sales.
Saudi Arabia earned about
$45.5 billion in 1997 from crude oil exports.
In 1998, it was expected to fall by 35% to around $29.4 billion. Saudi
Arabia is being affected both positively and negatively by the decline in oil
prices as well as by its supply cutbacks of 725,000 bbl/d.
On the positive side, lower
oil prices to some point can be helpful
for several reasons. Firstly, it
has at least 250 billion barrels of oil in the ground and is among the world's
lowest-cost oil producers. Considering
the country's high reserve to production ratio of 100 years or more, low oil
pi-ices can help accomplish several economic objectives like: deterring
development of alternative energy sources, maintaining Saudi market share
against its main competitors both in and out of OPEC, and deterring marginal
non-OPEC oil production investment.
On the negative side, Saudi
Arabia remains heavily dependent on oil revenues, for 88%of total export
earnings, about 75% of state revenues, and 40% of GDP. The dramatic reduction in revenues will result in a significantly
lower GDP growth rate, as well as higher budget deficit.
UAE
UAE's economy is slowing
significantly, at least in part due
to the decline in oil prices. This
country has not been hit as hard as the other Gulf states because a significant
portion of its revenue comes from business and trade. In response to falling oil export revenues, UAE has called for
restraint in government expenditures.
Venezuela
Venezuela was expected to
earn $11.1 billion in oil export revenues for 1998, down 37% from $17.7 billion
in 1997. This is seriously hurting its
economy, which could see a contraction of –2%, in 1998, compared to 5"/,,
growth in 1997, and also has adding
political uncertainty in the wake of the December elections. In response to its economic crisis
(including a 40%, drop in the country's stock market in the first 9 months of
1998), Venezuela is attempting to Curb
expenditures by the government and by state-owned corporations, as well as to
increase revenues wherever possible.
Mexico
Mexico has been forced to cut
its budget three times during 1998 to make up for lost oil export income, which
amounted to as much as $4.0 billion.
Partly as a result of low oil prices, Mexico's stock market fell 40%
between mid-July and early September 1997, while the peso was down by 13%, during tile same period. To counter this threat, the government has
recalculated its budget based on an oil price of $11.50 per barrel, down from
$15.50 per barrel contained in the original budget.
Russia
Russian oil export revenues
fell by about 25%, despite higher export volumes, during the first half of
1998, compared to the first half of 1997.
This has contributed to a severe deterioration in Russia's trade
balance. On August 17, 1998, Russia
announced that it would allow the ruble to fall by as much as 34%, suspended
trading of Treasury bonds, and announced a 90-day moratorium on repayment of
corporate and bank debt.
Trends in US Petroleum
Consumption and Imports
The US is steadily
increasing its reliance oil imported oil. The importance of petroleum products to the
economic and energy security of the US was dramatically highlighted in 1991 by
US willingness to go to war with Iraq to ensure access to Persian Gulf oil
under favorable conditions. Paradoxically,
while the US was willing to fight to protect petroleum supplies on the other
side of the world, it has no long-term strategy to reduce national dependence
on imported oil wither by improving energy efficiency or by developing
alternative energy sources. Between
1983 and 1996, oil imports to the US increased by around 40%(, (Fig. 1). By 2015, the Dept. of Energy expects imports
to account for 61% of US oil supply.
Unless the US gets serious about reducing oil consumption, it will have to import an even larger fraction of its supply, increasingly from OPEC producers and increasingly from the Persian Gulf. As OPEC regains dominance in world oil production, the risks of supply disruptions as a result of regional conflicts is highly likely.
Future of Oil Prices
It is possible to calculate
when the world production of conventional crude oil might begin to decline,
based on the estimates of recoverable oil, and assuming moderate growth in
world oil demand (about 2% per year) (Fig. 2).
There will be an
upward pressure on world oil prices from their present low levels as global
oil production reaches it peak. The
economic impacts will depend largely on the price and availability of energy alternatives and the rate at which production declines. Transportation, which is almost totally dependent
on oil, will be hard hit unless vehicles fueled by sources other than oil are
developed and rapidly entered into the market.
We urgently need policies to encourage ignore efficient oil use and
reliance on alternative energy sources.
Unfortunately, because oil pi-ices are low, few decision-makers
appreciate how little time remains
References &Works Cited
1. Hawdon, D., 'Oil prices in the 1990s' (1989)
2. Kohl, W.L., 'After the oil price collapse: OPEC, the United
States, and the world oil market' (1991)
3. United States Congress.
Joint Economic Committee.
Subcommittee on Consumer Economics.
'The economic impact of forthcoming OPEC price rise and "old"
oil decontrol', (1975-76)
4. Mallakh, R.E., 'OPEC: Twenty years and beyond' (1982)
5. lbrahim, Y., 'Oi1 Producers Cope With Steep Drop in
Revenues," New York Times (June 23, 1998)
6. Williams, J.L., 'Oil price History and Analysis', WTRG
Economics (1998)
7. WRI, 'Oil Security' (1998)
8. USETA, 'OPEC Revenues Fact Sheet' (1998)