US, WASHINGTON (ORDO NEWS) — The idea of a negative price for any commodity is ridiculous, it suggests that the seller himself is ready to pay money to the buyer. However, for oil, which is the largest commodity market in the world and the main fuel in the modern world, selling at negative prices is, in fact, a striking phenomenon.
On April 20, at the beginning of the evening (according to the time of the US East Coast), the price of May contracts for WTI crude oil reached minus $ 40.32. This was a concentrated demonstration of how serious the Covid-19 crisis is.
The reason for the sharp drop in oil prices on April 20 was the excess of unused oil in the storage facilities of Cushing, Oklahoma, where quotes for US oil futures are set. However, the collapse in oil prices caused shock waves that spread around the world.
People in the West tend to perceive any oil shock from the point of view of consumers. They notice when prices go up. The sharp jumps in prices in 1973 and 1979, caused by a boycott of oil producers, were imprinted in their collective consciousness, as price controls forced Americans to queue at gas stations, and European governments banned car trips on weekends. It was more than just an economic shock. It seemed that the balance of power in the global economy is shifting from the developed world to the developing world.
The same thing, but gradually, happened in the early 2000s, when oil prices rose sharply and remained at a high level until 2014. Once again, consumers suffered – and not only in the West. Most of all, this situation affected the poorest of the developing countries. The flip side of this process was the huge accumulation of wealth by oil producers. Energy companies representing developing countries such as Brazilian Petrobras and Malaysian Petronas have attracted global attention in global financial markets. Backed by the influence of companies such as Gazprom, LUKOIL and Rosneft, Russian President Vladimir Putin reappeared on the world stage as a geopolitical force.
A sharp jump in fuel prices is rebuilding the global economy, but this effect is happening in the opposite direction. For the vast majority of countries in the world, lower oil prices are a great boon. Emerging markets such as Indonesia, the Philippines, India, Argentina, Turkey, and South Africa benefit from this because the cost of imported fuel accounts for most of their costs. Cheaper energy will alleviate the pain of the recession caused by Covid-19. But at the same time and for the same reason, low oil prices are causing a concentrated and devastating blow to oil producers. Compared to the dispersed benefits of consumers, producers face instant impoverishment.
Shocks of this kind have occurred in the past, although they are not well remembered in the West. The first of these occurred in 1985, when Saudi Arabia launched a price war to restore its market share, which it had previously ceded to other OPEC members. Another shock occurred in 1997, when the Asian financial crisis led to a collapse in demand. The third shock began in June 2014, when an increase in production at US shale deposits fundamentally changed the balance between supply and demand. This process of sliding downhill was temporarily suspended in September 2016 as a result of an agreement between OPEC countries and Russia to reduce production.
Today we are faced with the fourth counter-shock. As a result of the unprecedented collapse in prices caused by Covid-19, negotiations in early March between Russia and Saudi Arabia were interrupted as Russia refused to cut production, and Saudi Arabia decided to make the main bet on lowering the price of the global market and selling oil at a very large discount . Despite the joint efforts made in recent weeks to correct an agreement to reduce production, the oversupply in the market is quite significant. A fleet of nearly 20 supertankers filled with Saudi oil is heading to US oil ports. Even if negative oil prices in May are the result of technical factors in the futures market, prices for June are also at the lowest level.
Current oil prices – adjusted for inflation – are comparable to the prices of the 1950s, when the Gulf states were, in fact, customers of the largest oil companies in the United States and the British Empire. As a result, the question arises as to what impact the current situation will have on modern global manufacturers.
We are inclined to imagine oil-producing states as rich oligarchies served by the armies of foreign workers, and a similar image applies to the Gulf states. Lower oil prices will undoubtedly force these countries to tighten their belts. In February this year, even before the coronavirus attack, the International Monetary Fund (IMF) warned Saudi Arabia and the United Arab Emirates that by 2034 they could become net debtors to the rest of the world.
A similar forecast was based on an oil price of $ 55 per barrel. At a price of $ 30 per barrel, this schedule will be shorter. But even among the Gulf states there are weak links. Bahrain avoids the financial crisis only through financial patronage by Saudi Arabia. As for Oman, then he is in an even more difficult position. His public debt is so devalued that the country may soon become bankrupt. After this, Bahrain will most likely be forced to seek help from either Riyadh or the IMF.
This unexpected shift in the terms of trade leads to a reduction in export earnings, violates fiscal stability and questions the prospects for economic growth.
However, the economic profile of the Gulf states is not typical of most oil-producing states. Most of them have a significantly lower coefficient that determines the ratio of oil reserves to population. Many large oil exporters have a large and ever-growing population that is hungry about consumption, social spending, subsidies, and investment. At the same time, countries such as Saudi Arabia and Kuwait, as a rule, receive more money than they can reasonably invest within their own country, and this was even at the peak of OPEC’s influence in the 1970s, when the shah regime in Iran not only he himself consumed all oil revenues, but still used his oil assets as collateral for borrowing funds.
Therefore, it is not surprising that counter-shocks due to changes in oil prices often cause political upheavals. An unexpected shift in terms of trade undermines export revenues, fiscal stability and economic growth prospects. Fiscal crises caused by falling prices limit the space for governments to maneuver and force them to make painful political choices. The dilemma associated with defaulting on debt held by foreign creditors, as well as the introduction of an austerity regime for the local population, caused deep political crises, some of which had serious geopolitical consequences.
In the late 1980s, the decline in oil revenues brought to nothing Mikhail Gorbachev’s efforts to reform Soviet communism and also accelerated the collapse of the Soviet Union. Both Hugo Chavez in Venezuela and Vladimir Putin in Russia were able to come to power, as their predecessors failed to stabilize the internal situation that arose as a result of the collapse in prices in the late 1990s. After 2014, the fall in oil prices once again began to exert enormous pressure on the regime of Chavez’s successor, Nicolas Maduro, in Caracas. Although United States economic sanctions against Russia and Venezuela have occupied and continue to occupy a significant place in the news, aggressive competition from American shale producers has played an important role in determining their economic fate.
But who is vulnerable today?
Under Putin, after the collapse of prices in 2014, Russia restructured its economic policy. Her budget was reduced under the influence of a constant regime of austerity. When Moscow launched the current oil price war in March and refused to cooperate with OPEC in reducing production, it probably did not expect to see the collapse that occurred as a result of its refusal. However, Russia began this period with gold and foreign exchange reserves of just under $ 570 billion, and as a result of fiscal consolidation, it began to experience a deficit only when oil prices fell below $ 42.
Other emerging oil economies have been faced with significant debt burdens. Petrobras in Brazil had net debt at the end of 2019 of $ 78.9 billion, and this is the largest debt burden among all oil companies. Her bonds are traded at the trash level. However, so far there are not so many signs of panic. In Malaysia, Petronas revenue over the past five years has accounted for more than 15% of total government revenue. Today, Fitch rating company negatively assesses its prospects. But, like the government, Petronas firmly holds its bonds at level A. These are sustainable businesses with deep pockets in diversified economies.
Not only Venezuela, but Ecuador, the oil producer in Latin America, is facing very serious problems. In February 2019, this country received a $ 10.2 billion loan package from a group of multilateral lenders led by the IMF. But to take advantage of this package, Ecuador must implement painful reforms. By October last year, the government was forced to suspend plans to abolish fuel subsidies due to massive protests from the population. Ecuador was already in this precarious position when the oil price shock occurred. At the end of last week, the government announced an agreement with investors to defer payment of $ 800 million in interest on the country’s external debt, which is $ 65 billion. It means,
Highly populated, middle-income countries that are critically dependent on oil are vulnerable and their vulnerability is unique. Iran is a special case due to the punitive sanctions regime imposed on the country by the United States. However, Iraq, neighboring with a population of 38 million and a government budget 90% dependent on oil, will face serious problems related to the remuneration of civil servants. Not paying government executives is a recipe for instability at a time when the country is a theater of shadow war between Washington and Tehran.
Algeria, located in North Africa, with a population of 44 million and an official unemployment rate of 15%, is 85% dependent on oil and gas exports in the formation of its foreign exchange reserves. In the late 1980s, the oil shock provoked by Saudi Arabia caused serious damage to Algeria and destabilized its economy, in which the public sector dominated. When austerity measures were introduced, the Islamic Salvation Front became the main opposition force and rival for the National Liberation Front regime. After the Algerian military did not recognize the Islamist victory in the 1991 elections, a civil war broke out in the country, which lasted until 2002 and cost the country an estimated 150,000 lives.
The oil and gas boom in the early 2000s made it possible to create a financial basis for the subsequent pacification of Algerian society under the leadership of the President of the National Liberation Front Abdelaziz Bouteflika. Numerous Algerian military, the main pillar of this regime, became the main beneficiaries of the wealth created, as well as Russian arms suppliers. In 2012, the country’s foreign exchange reserves reached a peak and amounted to $ 200 billion. Sending these unexpected funds to aid programs and subsidies allowed the Bouteflika government to survive the initial wave of protests during the Arab Spring. But when oil prices went down, it turned out that the government’s actions could not be called a long-term and stable course. In 2018, the stabilization fund, which at one time accounted for more than a third of GDP, completely dried up. Given the huge trade deficit, the volume of gold reserves of Algeria by 2021 will be reduced to 13 billion dollars. Tight self-isolation rules introduced because of the coronavirus pandemic are holding back popular protests, but the fragile Algerian government is preparing to cut its budget by 30% today, so it seems that peace in this country will not last long.
A positive point is that Algeria has almost no external debt. Even if obtaining loans at present is not an attractive option, the difficult decisions to be made in domestic politics will not be complicated by external pressure. The same cannot be said for Angola and Nigeria, the two main oil producers on the African continent located south of the Sahara.
Angolan President João Lawrence came to power in 2017, replacing the long-standing ruler of the country, Jose dos Santos, who ruled the country for 38 years. Lawrence was trying to ease Angola’s debt burden as its debt grew from 30% of GDP in 2012 to 111% of GDP in 2019. Before the collapse in oil prices last month, Angola was already spending from one fifth to one third of its export earnings to service external debt. Now this tax burden will increase significantly. Ten-year Angolan bonds this week traded at 44 cents per dollar. As the country’s rating has dropped to CCC +, many believe that Angola is facing default. Although it is necessary to spend six times more on servicing existing debt than the amount that Angola spends on healthcare,
Nigeria overtake South Africa last week and became Africa’s largest economy. This country has a significant and diversified economy; therefore, it cannot be considered an oil state, comparable in this respect with Iraq or Algeria. However, most of the economic activity in Nigeria is informal, it is not taxed and is not related to the global economy. As a result, revenues from the sale of oil account for the lion’s share of the state budget and provide 90% of the foreign exchange earnings in the country. The decline in oil prices in 2014 was already very painful for this country. And after the collapse of oil prices in 2020, Finance Minister Zainab Ahmed (Zainab Ahmed) said that Nigeria is in a “crisis”. In March, Standard & Poor ‘rating agency s downgraded Nigeria’s sovereign debt rating to B-. This will increase the price of borrowing, as well as slow down the economy in a country in which 86 million people or 47% of its population live in extreme poverty, and this is the largest indicator in the world. In addition, 65% of government revenues go to servicing existing debt, so the country’s leadership can resort to a printing press to pay for civil servants, and this will spur inflation, which is already at a high level due to a shortage of food products.
Fluctuations in oil prices are becoming milestones in the development of the global economy. The sharp rise in prices in the 1970s and the nationalization of the oil industry in the Middle East marked the end of the imperial era. In the 1980s, a global economy based on market principles took shape. It seemed that the 2000s opened the door to a new era for state capitalism, and during this period, China would be the main driver of demand, while titans such as Saudi Aramco and Rosneft would provide supply.
However, the collapse in prices in 2014 created problems for this model of capitalism based on petroleum states (petrostate capitalism). The growth in demand in China is no longer as significant as before. US producers of shale oil have nullified efforts by OPEC and Russia to control the oil market. As the failure to stabilize oil prices in the face of the crisis caused by the coronavirus pandemic has shown, there is currently no order at all in the oil market. The diplomacy of supply agreements is very fragile. In matters of geopolitics, there are many random elements. It is not clear whether the United States Administration prefers low or high oil prices. The financial backbone of the shale oil boom is shaky. The physical structure of oil storage does not meet real needs.
The lack of order in itself creates an important historical pause, but the question also arises of what will happen next. Giants such as Saudi Arabia and Russia will use their forces to survive the crisis. However, the same cannot be said of weaker manufacturers. For states such as Iraq, Algeria and Angola, current threats are, in fact, a threat to their very existence. What are the long-term prospects for these states?
Many of the commodity producers most affected by the price shock line up for financial assistance from the IMF and the World Bank. Priority at the moment is the provision of emergency assistance. However, a certain background during the meetings held in the spring was the question of whether China would cooperate with other international lenders. Since 2004, Beijing has provided $ 152 billion in secured resource loans to countries in Africa, Asia, and Latin America. China today owns a large part of the external debt of Venezuela and Angola. Is it possible to say that China is systematically restructuring the supply chains in the world, using for this its financial and political influence? If so, is it possible to expect that the crisis caused by Covid-19 will be the moment when will china say its weighty word? So far, Beijing has shown little interest in using the current crisis for debt-based diplomacy. He signaled his desire to collaborate with other members of the G-20 group on the issue of supporting a debt moratorium. This may be useful, since such a position facilitates negotiation of debt review. In this case, Western lenders will be less worried that any concessions to them will help pay off the debts that China owns. since such a position facilitates negotiations on debt review. In this case, Western lenders will be less worried that any concessions to them will help pay off the debts that China owns. since such a position facilitates negotiations on debt review. In this case, Western lenders will be less worried that any concessions to them will help pay off the debts that China owns.
While debt relief may provide a respite, this option does not provide answers to other fundamental questions. This century is characterized by climate change, so the question arises: how useful will be the restoration of income and prosperity based on the extraction of fossil fuels? This year, due to coronavirus, global carbon emissions could fall by 5%. Perhaps the moment has come to direct the world economy towards changing energy installations and decarbonization?
Even before the current crisis, many politicians and economic analysts have expressed concern about the vulnerability of fossil fuel producers. The question is not how they will respond to negative oil prices, but how they will be affected by the transition to renewable energy and carbon taxes. And what will the most vulnerable producers in the world do after hydrocarbons, in a world in which energy prices are low and oil consumption drops sharply?
Such a combination is unlikely under normal conditions, since low prices tend to stimulate increased demand. However, joint efforts in the field of decarbonization can lead to a suppression of demand. That is what we are seeing at the moment. The shock caused by the coronavirus provides us with an opportunity to look into the future, and this is a harsh future.
The crisis caused by Covid-19 convinces us that producers with high production costs are on a dangerous and unsustainable path, and that existing problems cannot be resolved by state support for their uncompetitive oil sectors. Even more important is the need to diversify the economies of highly vulnerable countries in the Middle East, North Africa, sub-Saharan Africa and Latin America. If such an approach does not become a priority for both national governments and international agencies, then deep decarbonization will turn into a formula leading to a social crisis and affecting hundreds of millions of people. If these states have not yet become fragile, they will be doomed to become so.
It would be a conceptual mistake to separate the current crisis from the crisis that is still looming on the horizon. A certain set of improvised measures can help vulnerable oil-producing countries to quickly recover, but they need a coordinated strategy whose goal is to get rid of dependence on fossil energy exports. Otherwise, the oil countershock of 2020 will be nothing more than the first step towards a final and final crisis.
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