By Marina Tolchinsky for Global Risk Insights
With global oil prices at record lows, American consumers are rejoicing at the pumps. President Obama recently hailed low oil prices in his State of the Union address, stating the typical American family would save $750 at the pump this year.
For families in African oil-producing countries, however, the situation is starkly different. The drastic drop in oil prices has, and will continue to have, serious negative impacts for African oil exporters. Investors should be wary of fiscal, monetary, and political risks arising from the changing oil market.
A rapid drop in prices
After five years of relative stability, the global oil market has witnessed a sharp decline in the price of crude oil. Falling 50% since June and 40% since September, oil prices have dipped below $50 a barrel. This marks the lowest prices the international community has seen since 2009.
Though financial futures markets indicate that the price will rebound within the next year, there remains uncertainty over the future trajectory of the market. The one thing economists remain fairly certain about, though, is that prices will not fully recover. The years of over $100 per barrel are over, and oil-exporting countries are reeling from the shock.
Since governments use a benchmark price for oil to estimate national revenue, the sudden decline in oil prices has caused many oil-exporting countries to revise their budgets down. The below graph compiled by the IMF shows how countries have revised the benchmark oil price. Many countries anticipated a price of over $100 a barrel in 2014, and even after revising down in early 2015, the new benchmark is still higher than the world price.
It is uncertain when oil prices will rebound.
Ghana, a new oil exporter, has considered scenarios where oil falls to as low as $40 a barrel and is in the process of revising the budget. The revisions will force the government to substantially cut spending to prevent a budget deficit. Though Ghana only relies on oil for about 3% of its GDP, other oil exporters are more heavily dependent on the commodity.
The below graphic from the Wall Street Journal shows the impact of the oil price decline on national revenues. Angola will be among the hardest hit, with revenues from oil likely decreasing from 56% of GDP to below 30%. Similarly, Gabon, the Republic of the Congo, and Equatorial Guinea (all of which rely on oil exports for more than half of government revenue) will face severe budget shortfalls.
Whereas developed and Gulf oil-producing countries have large reserves to cushion the budget during times of oil price volatility, Africa’s exporters are much less prepared.
Ghana has perhaps the best petroleum revenue framework, with a portion of revenues dedicated towards a fund intended to support the economy when oil prices decline. However, as the country only began to export oil in 2011, this fund is miniscule in light of the expected shortfall for 2015.
Angola and Nigeria also recently began to save in such a fund, however both currently have less than $5 billion in the accounts. In comparison, Saudi Arabia has nearly $800 billion in cash reserves to protect the economy against declining oil prices.
In addition to budget deficits, governments will experience volatile foreign exchange rates. Declining oil prices are typically associated with currency depreciation. The Angolan kwanza has reached an all time low. Ghana’s cedi and Nigeria’s naira have also depreciated rapidly in the past few months, as the oil shock has affected their ability to generate foreign exchange. In addition to placing pressure on the countries’ central banks, this will make servicing US Dollar and Euro denominated debt payments difficult for national governments.
Nigeria faced a particularly difficult environment, as political risks from the upcoming election and recent upsurge in Boko Haram attacks have deterred investors. In an attempt to lessen capital outflows, the central bank took measures to devalue the naira nearly 10% and raise the interest rate by 1%. Investors have called the measures a form of capital controls, and many fear they will have increasing difficulty in obtaining foreign currency when exiting investments.
Exacerbating political risks
The impact of decreasing government spending and worsening economic situations for oil-producing countries may also exacerbate political risks. This is especially true in Nigeria, which is preparing for a national election in February and facing an insurgency from Boko Haram. The Ghanaian government has already witnessed protests in the past year due to the worsening economic situation and rapid depreciation of the cedi.
But the most serious implications may be in South Sudan, where 95% of government revenue comes from oil exports. Having recently emerged from civil war, the dramatic drop in revenue may cause a resurgence of tensions internally between ethnic factions in government and externally with Sudan. Currently, South Sudan is receiving the lowest oil price in the world, at $20-25 a barrel. Since Juba pays Khartoum a fixed payment of $11 a barrel for use of the oil pipeline, this leaves little revenue for the South Sudanese government.
Finally, the decline in oil prices will shift the dynamics of the upstream exploration sector and weaken the negotiating position of African governments. With less profits to be made from expensive offshore exploration, countries in West Africa like Liberia, Ghana, and Cote d’Ivoire will have less to leverage in contract negotiations. Future oil contracts will likely includes more incentives for private companies and less controversial provisions such as local content requirements.
Though the oil price is likely to increase somewhat in 2015, it will likely not fully recover in the near future. The increase of shale gas production in the U.S. has transformed supply in the sector, and it is likely oil-producing countries will need to adjust for lower oil prices in the medium to long term.
Countries that rely heavily on oil exports for national revenue will struggle the most in this adjustment period, but flexible fiscal policy and strong monetary policy should be able to prevent serious economic impacts. However, investors should remain wary as the economic situation exacerbates existing political risks.