Effect of Declining Oil Prices on Oil Exporting Countries
By Roy Mathew
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 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'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.
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.
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.
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 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.
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.
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 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'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 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 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.
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
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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)