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Analysis

Winners and losers from low oil prices

by William Baunton

Winners and losers from low oil prices

Since the fall in oil prices in June 2014 from around $115 to the current price of around $55, the effects on national economies have been immensely disparate.

Many oil producers, particularly in developing markets, rely heavily on oil exports to balance the budget. In an extreme case, Nigeria funds almost 90% of its budget from oil receipts. The winners from low oil prices are, more generally, the importers and, on balance, the world economy.

Shifting capital

The IMF estimates that a $10 fall in oil prices increases world growth by 0.2% annually, with capital shifting from producers to consumers. This could mean low oil prices have added nearly 1% to world growth over the last 12 months. The fall in oil prices, as shown in Chart 1, in the midst of conflicts in oil producing nations Iraq, Syria, Nigeria, Libya and the third largest producer Russia intervening in Ukraine, caught many off guard.

The world’s largest producers, detailed in Chart 2 (for importers see Chart 3), will be the most under pressure from low oil prices. Every month the oil price remains stubbornly low, the pressure mounts on oil exporters. For example, Russia loses $20bn for every $10 drop in the oil price, according to the World Bank and Citi analysts believe a $10 drop in oil prices lowers Venezuela’s revenue by $7.5bn.

In Venezuela’s case, the low oil prices could not have come at a worse time, already struggling with a budget deficit measuring over 15% of GDP in 2014. Most recent estimates put the oil price needed to balance Libya’s budget in 2015 at $215 a barrel.

Next in line is Algeria, which needs $111 to balance its books, followed by Saudi Arabia ($103), Iran ($93), Venezuela ($89), Nigeria ($88), Russia ($78), UAE ($73) and Iraq ($71).

Qatar and Kuwait are among the few oilproducing nations which are on track to balance their 2015 budget with current oil prices. They need oil to be selling at $59 and $47 respectively. Most of these countries can sustain a short period of low oil prices, however sub-$100 a barrel prices look to be staying.

Both the World Bank and IMF project that oil prices will only return to around $70 in 2019, with the Economist Intelligence Unit projecting $90 in 2019 (see Chart 4). Among these nations it will be survival of the fittest, exposing those who have not diversified their economies and built up reserves during periods of high oil revenue.

Opec heavyweights Saudi Arabia, UAE, Qatar and Kuwait, although losing revenue, could win long term with a period of sustained low prices. By continuing their policy of stubbornly maintaining production levels, these nations will maintain their market share and outlast the weaker, high-cost operators. Even though government budgets will certainly be in deficit for the foreseeable future, these countries have amassed vast reserves and have set up sovereign wealth funds during periods of high oil prices.

The central bank in Saudi Arabia for example, the Saudi Arabian Monetary Agency, held $737.4bn in total reserves at end-2014. This makes it comfortably the fifth largest global public investor in the world, as highlighted in the latest edition of OMFIF’s Global Public Investor Top 500 Ranking.

These reserves alone could finance the entire government budget, which is projected to be $229bn in 2015, on its own for three years. The budget deficit is projected to be $39bn in 2015, or 5% of GDP. By borrowing from itself, the government can sustain two decades of deficits of this level.

Market share

It’s a similar story for its neighbours which have amassed huge wealth in forms of the Abu Dhabi Investment Authority ($679bn), Kuwait Investment Authority ($600.1bn) and Qatar Investment Authority ($175bn). These vast war chests will aid them to outlast anyone in the battle for market share. It is no wonder the most powerful members of Opec are staunchly against reducing oil production.

At the top of the list of winners is, almost certainly, China. In 2013 the largest net importer would have saved $2.1bn for every $1 drop in the oil price sustained over the year. A $50 drop, as experienced over the last 12 months, could lower the world’s second largest economy’s import bill by over $100bn annually.

India is also benefiting, with low oil prices helping inflation come back under control and strengthening its exports. An added bonus is the government’s ability to reduce fuel subsidies, helping the government balance the budget.

Perversely, for many importers, cheap oil could not have come at a worse time. Japan’s Prime Minister Shinzo Abe was finally making ground on the two decade-long battle with deflation in Japan. As the third-largest importer of oil in the world, the oil price shock has brought back the downward pressure on prices.

 The same is true in Europe. European Central Bank President Mario Draghi believes 80% of the decline in inflation since 2011 was due to low oil prices, as well as low food prices.

Though not straightforward, the overall effects of low oil prices on the US economy is marginally positive. When oil prices plummeted in 2008, it was a clear cut boost to the economy suffering from the worst financial crisis since 1929. Thanks to shale oil, the US is now the largest producer of oil in the world, a position it did not hold in 2008.

The more powerful and immediate effect is that it stimulates consumption, comparable to a cut in taxes, leading to spending on something else. However, there are longer term structural effects to US oil producers and the states in which they operate. A lower oil price filters through to lower tax revenue and consumer income for those states.

Long-term effects

Shareholders of the oil companies will also be hit with reduced dividends further down the line. Many of these may reside abroad. These effects are long-term and affect only some states and industries, the stimulus from lower prices to the consumer are far larger and immediate.

Other major losers, on the surface at least, appear to be the oil and gas producing and refining corporations. Tens of billions of dollars of planned investment have been canceled and cuts are being implemented across the board.

Renewable energy developers and companies producing ‘green technology’ such as solar panels are finding investment and demand are slowing from investors and consumers alike. Showing some parallels with Middle East oil producers, the only winners in the energy industry are perhaps the giants. They, like Saudi Arabia, have amassed vast amounts of capital and market share, leaving the smaller firms weak, undervalued and exposed to takeovers allowing the large firms to consolidate their market position.

For importers, although unwelcome in some cases where this complicates inflation targeting, low oil prices are providing a welcome boost to consumers. In the oil producing countries, with prices expected to remain low until at least 2016, pressure is mounting in the other direction.

In the same way as wealth is moving internationally from producers to consumers, among the oil producers, capital is flowing from sovereign funds back to governments as the latter seek funding to compensate for lost revenues.

Most countries are winners or losers, with some falling somewhere in between. But most importantly, the world economy will benefit. ■

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