The Washington Diplomat / March 2015
By Larry Luxner
U.S. motorists are reveling in $2-a-gallon gasoline for the first time in years, but the sudden collapse of petroleum prices has been a nightmare for some of world’s biggest oil exporters — worrying politicians and budget planners from Baku to Baghdad.
It’s also having repercussions closer to home, with some observers predicting the price crash could cost Texas — heart of America’s energy industry — 125,000 jobs this year while slashing new home construction by 20 percent.
The crash in global energy markets is indeed a hot topic. In the past month alone, half a dozen Washington think tanks including the Brookings Institution, the Council on Foreign Relations, Wilson Center, the Atlantic Council, the Hudson Institute and the Center for Strategic & International Studies all hosted discussions on this very subject.
What’s going on exactly?
Veteran oil and gas industry consultant Charles K. Ebinger has a pretty good idea.
“The fact is, we have falling energy demand in almost the entire world. Europe is dealing with its euro crisis and teetering on recession,” said Ebinger, who directs the Energy Security Initiative at Brookings. “There’s no growth in Japan, and falling demand in China and other major energy-importing countries like Brazil and India.”
At the same time, U.S. production has skyrocketed in places like Texas and North Dakota, thanks to hydraulic fracturing and other technologies that have made it more economical than ever to extract petroleum from shale rock. The result: a world oil glut that has turned the United States into the world’s largest oil producer — surpassing even Saudi Arabia and Russia — with U.S. output now exceeding 11 million barrels a day.
In fact, U.S. crude supply is now at its highest levels in 80 years. As of Feb. 6, oil was trading at around $50 a barrel, marking a slight recovery after falling as low as $46 a few days earlier. But the extreme volatility in petroleum prices is making it difficult for governments to plan for the future.
The Canadian government says its income will tumble by $4.3 billion this year, with provincial tax revenues to fall by $5.2 billion, particularly in the oil-producing provinces of Alberta, Saskatchewan and Newfoundland & Labrador. In December, the Bank of Canada warned that lower oil prices would slice 0.3 percentage points off Canada’s growth rate for 2015.
Losses from lower oil exports could cost the Middle East and Central Asia hundreds of billions of dollars this year, said the International Monetary Fund in a report issued Jan. 21. The six-member Gulf Cooperation Council alone will see its combined GDP fall 21 percentage points, or about $300 billion, said the IMF, while non-GCC countries in the Mideast will see losses of $90 billion. Central Asia, meanwhile — led by oil exporters Kazakhstan and Azerbaijan — could see losses of $35 billion.
In Libya, which not only faces a drop in oil revenue but is also battling internal violence, the budget crisis has led that country to close several embassies and reduce diplomatic staff at Libyan missions around the world. The continuing bloodshed has cut oil output there to less than 400,000 barrels a day — a quarter of what Libya was producing before 2011.
Things are also quite difficult for countries like Angola, Iraq and Venezuela, which like Libya are almost completely dependent on oil exports for foreign exchange.
Iraq is now pumping a record four million barrels a day, adding more new oil to already saturated global markets than any other supplier in OPEC, just to compensate for falling prices. An accord signed in January between Iraq’s federal government and the semi-autonomous Kurdish region will boost those exports by another 550,000 barrels a day, according to Bloomberg News.
Iraqi Prime Minister Haidar al-Abadi warned that national revenue lost due to the nosedive in global oil prices may hinder Baghdad’s ability to battle Islamic State insurgents, warning that the drop has been “disastrous” for Iraq. For this reason, his government is considering the possibility of buying necessary weapons and munitions while deferring payment until petroleum prices recover.
“Overdependence on oil is not the way out of this,” said Lukman Faily, Iraq’s ambassador to the United States. “Historically, Iraq was the breadbasket of the region. We need to get out of our comfort zone and develop our country.”
In Africa, falling oil prices are playing havoc with the national budgets of Algeria, Angola, Equatorial Guinea and other countries that depend on oil to balance their books.
In Nigeria, Africa’s most populous country, crude petroleum exports account for about 14 percent of GDP and 70 percent of fiscal revenue, though Nigeria’s ambassador to the United States, Adebowale Ibidapo Adefuye, told The Washington Diplomat last month that he’s not particularly worried.
“Because of Nigeria’s size, everything is blown out of proportion. I’m not saying we don’t have problems, but we have a tremendous ability to survive. Measures have been put in place to assure that this doesn’t affect the smooth running of our economy,” Adefuye said. “We are trying to minimize the effect [of dramatically lower oil prices]. It would not be realistic to say it won’t have an impact, but the government is embarking on some austerity measures and honoring our obligations to the people.”
It’s even worse for two oil-exporting countries now facing global economic sanctions for very different reasons: Iran and Russia.
“Iran is the biggest loser from this sharp decline in oil prices,” said Suzanne Maloney, senior fellow at Brookings’ Center for Middle East Policy. “It comes at a time when the Iranian economy has been battered by years of sanctions. These sanctions targeting the Iranian financial sector have had an enormous impact on exports and the government budget. It’s forcing them to engage in price discounting, trying to match the Saudis as they’re dealing with the drop in prices.”
Maloney pointed out that Iran’s profit margin is a lot lower than it is for fellow OPEC members Saudi Arabia and the United Arab Emirates, which enjoy huge production and relatively low populations.
“We’ve heard a lot of rhetoric from Iran that this is, in fact, a blessing that plays into Iran’s strategy to wean itself off of oil,” she said. “But that’s unlikely to be achieved except under pressure. The question for many in Washington is, will the drop in oil prices force Iran to capitulate on the nuclear issue?”
The answer is maybe. “Today, the president of Iran is willing to say publicly that the country needs to alter its foreign policy in order to address this economic crisis. While I don’t think we’ll see a framework by the July deadline, there is a set of individuals who are prepared to end this crisis, and sanctions will play a major role in that.”
Russia, which faces U.S. and European sanctions over its continuing military aggression against Ukraine, is also in dire straits as world oil prices could bottom out at around $36 to $38 a barrel and stay there for some time, said Ebinger.
“There’s a very stark possibility that OPEC will continue its policies. There’s nobody else on the horizon who can challenge the Saudis,” he said. “Russia will produce as much as possible, exporting four million barrels a day. With the decline in the value of the ruble, Russians are now actively stepping up coal exports.”
Clifford G. Gaddy, an economist specializing in the former Soviet Union, is co-founder of the Russian-American Center for Research on International Financial and Energy Security (CRIFES), based at Penn State University.
“For the current term, this is real crisis mode in Russia,” he said. “The budget is being revised almost daily, and that’s the plan: don’t make any commitments at this point because we have no idea. The uncertainty has never been this great.”
The problem for President Vladimir Putin, who admits that a “catastrophic” further slump is “entirely possible,” is that Russia was hit by a double whammy at pretty much the same time.
“At this point, it’s very difficult to separate the effects of lower oil prices and the effects of sanctions — and yet, it’s not really important to do that. They’ve been together from the beginning,” said Gaddy, a senior fellow at Brookings. “The sanctions targeted Russia’s gas sector, banning all Western investment in Russian Arctic and offshore production so they would feel the economic pressure. Even more significant in the broader picture is the financial sanctions, and not just because of the letter of the law, but because of the climate it has created for all investors.”
The government in Moscow was smart enough to salt away $600 billion in reserves (an amount that’s now down to $400 billion), said Gaddy, though he suggested that “they should have saved even more” — like maybe establish a sovereign wealth fund of $1 trillion to tide the country over until prices recover.
In the meantime, he said, Russia is “radioactive” for potential foreign investors.
“You don’t know exactly how the rules will be enforced, so to play it safe, you stay away from Russia. You just don’t touch it,” said Gaddy, projecting Russian GDP to fall by up to 8 percent in 2015 and eventually level off at 1-2 percent growth per year for the foreseeable future.
Such lackluster performance would be a dream come true for Venezuela, which boasts the world’s largest proven oil reserves yet suffers from its highest inflation rate —64 percent last year.
Venezuela, which depends on oil for more than 95 percent of its hard-currency income, is now in an economic free-fall. The country’s economy fell by an estimated 4 percent last year and its populist president, Nicolás Maduro, faces considerable political turmoil as shortages of everything from milk and soap to diapers and even condoms forces average Venezuelans to stand in line for hours.
“For every dollar the price of oil drops, Venezuela loses $775 million of earnings per year. It also has very low cash reserves, so that’s not much of a cushion,” warned Harold Trinkunas, senior fellow at Brookings and director of its Latin America Initiative.
“Venezuela’s credit rating has just been downgraded again. It’s practically junk, and the likelihood of Venezuela defaulting on its international bonds is near 100 percent next year,” he said. “The Chinese have not been particularly forthcoming. They’ve already loaned Venezuela $40 billion, which is being repaid by shipments of Venezuelan oil, though they’ve refused to confirm any figures.”
At the moment, Venezuela’s state oil monopoly PDVSA is producing 2.5 million barrels a day, down from a high of 3.1 million barrels a day in 1998, before Maduro’s predecessor, the late Hugo Chávez, came to power.
Even before the current fall in petroleum prices, the Venezuelan economy was tanking as foreign investors fled the country and Maduro imposed protectionist policies that only made things worse. Yet there doesn’t seem to be an easy way out for this country, which for years subsidized oil exports to Cuba and 17 Caribbean and Central American nations through its Petrocaribe program.
One Washington-based Latin American ambassador, speaking off the record, said he feared an “implosion” in Venezuela as the situation worsens.
Last month, Maduro embarked on a global tour, meeting with key OPEC and non-OPEC producers in a bid to raise oil prices back to around the $100-a-barrel mark and help plug a growing budget gap that has so far cost Venezuela untold billions of dollars.
“But despite visiting China, Russia, Qatar, Iran and Algeria, he failed on both counts,” Trinkunas said. “At best, he got promises of future investments by these countries, and the $20 billion he announced in China looks like a re-announcement of deals that had been promised in 2010 but not fulfilled.”
Despite the havoc they’re wreaking in global markets, oil price volatility may have some positive repercussions in the long term, said energy consultant Ebinger.
“Indonesia bit the bullet after a long hard fight and significantly raised oil prices,” he said. “India has taken the very difficult decision to eliminate diesel fuel subsidies. Pakistan has done the same. As the subsidies get removed, there’s going to be less demand in those countries.”
In Venezuela — where gasoline still costs the equivalent of 5 cents a gallon, the world’s cheapest — subsides are a touchy subject, and Maduro has so far resisted any substantial move to end them. The country’s current woes may have, at least indirectly, pushed its strongest ally, Cuba, into the arms of the United States as the Castro regime worries about long-term dependence on shaky Venezuelan supplies.
But the possible collapse of Petrocaribe could have serious consequences for the region, the Atlantic Council cautioned in a report last month.
“As Caracas deploys the army to police grocery stores lacking basic goods, the government’s financial problems spell trouble for neighboring countries that rely on Petrocaribe to meet energy demands. Despite Maduro’s promises, the possible reduction in Petrocaribe transfers in 2015 may precipitate a fiscal crisis in the Caribbean and Central America, as countries will be forced to roll over decreasing shares of high energy costs into long-term debt to Venezuela,” the report said.
The United States must work together with the IMF, the World Bank and other financial institutions to offset Petrocaribe’s decline, it said, warning that “without a sustained focus on the next chapter for the Caribbean, the United States could soon face a crisis off its shores.”