The Fuse

Why Haven’t More Petro-states Failed?

by Matt Piotrowski | June 01, 2017

It has been almost three years since global oil prices tumbled from triple digits. The market meltdown took many stakeholders by surprise, and a number expected a swift recovery. But the collapse probably stunned major petro-states the most, sending shockwaves through governments that rely heavily on oil export revenues to support their economies and fund their political agendas. The market consistently traded above $100 per barrel from 2011 through mid-2014 and petro-states reaped the rewards of consistently high prices. In the aftermath of the 2014 price fall, producer countries have had to reevaluate policy and economic strategy while contending with a persistent glut that may dampen prices for some time, further undermine their budgets, and possibly cause domestic strife.

The implications of the price slump have varied across petro-states. Even though others haven’t seen rioting in the streets, cracks continue to emerge across the oil-producing world and prolonged low oil prices could bring perilous circumstances.

Not all oil-producing countries have remained stable amid the sharp market change in 2014 and the subsequent persistently weak price environment. Venezuela’s economy has collapsed so utterly that the country’s fabric is being pulled apart with hyperinflation, food shortages, and daily protests. It provides the starkest example of the consequences of ongoing corruption and an economy relying solely on revenues from one commodity.

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Why haven’t other petro-states collapsed in similar spectacular fashion? In the case of Venezuela, the country has suffered from gross mismanagement of its government, economy, and oil resources during the reign of Hugo Chavez and his successor Nicolas Maduro. “In Venezuela, politicians acted like the boom times would last forever,” Matt Reed, VP of Foreign Reports, Inc., told The Fuse. “Under Chavez, the oil sector was starved of investment and entrusted to loyalists rather than professionals. That’s why we’re seeing production slip now. He expanded welfare programs that—regardless of their merit or popularity—were unsustainable if the price of oil ever came down. It’s a corrupt, mismanaged and micro-managed system, more so than its peers.”

“Petro-states can tighten their belts, trim welfare, revalue currencies, or turn to debt markets.”

The implications of the price slump have varied across petro-states. Even though others haven’t seen rioting in the streets, cracks continue to emerge across the oil-producing world and prolonged low oil prices could bring perilous circumstances. While oil producers have been able to keep the situation under control for now, worries about unrest will continue to loom as long as oil prices remain low and economies slowly diversify.

Oil producers have used a number of tools to weather the storm, including devaluing their currencies, selling assets, and digging into reserves. Many have also cut fuel subsidies and implemented other austerity measures. Even with these actions, oil-producer economies are hurting. Consider that both Brazil and Russia experienced economic contractions over the past two years, Libya has seen unemployment of above 20 percent, Saudi Arabia’s breakeven is around $90 per barrel, and Iraq’s economy may fall by more than 3 percent in 2017. What’s more, almost every petro-state’s debt levels have risen.

“Petro-states can tighten their belts, trim welfare, revalue currencies, or turn to debt markets,” said Reed. “Some combination of those options is likely good enough to get your economy through a bust. If you’re wise and saved in boom times, like the Saudis, you can draw from sizable cash reserves. Finding that balance between austerity and stability is tricky. When it breaks down, regimes can always resort to violence.”

Gulf countries tap reserves

In the Gulf Cooperation Council (GCC), the countries have parallel economic models and similar fiscal policies. Gulf producers have tapped their massive reserves of foreign currencies and other savings that they have built up over the years. Wealthier GCC economies bailed out the weaker ones, with Saudi Arabia, Kuwait, Qatar, and the UAE pledging money to Bahrain and Oman to keep an economic collapse at bay. The Gulf countries have also cut payments to foreign workers as an effort to implement fiscal austerity measures without dissatisfying their own citizenry.

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“We’re seeing similar dynamics in all GCC countries,” David Weinberg of the Foundation for Defense of Democracies (FDD) told The Fuse. “They are all interdependent, so if we were to see a collapse or default in one or the other, there would likely be a ripple effect.”

Saudi Arabia—the world’s largest producer and OPEC’s de facto leader—is obviously the state to watch in this region. Saudi Arabia’s economy relies on oil for 90 percent of export revenues. However, the price collapse slowed but did not stop growth over the past two years as the ruling regime tapped into available foreign reserves. In 2011, the Kingdom’s GDP accelerated by 10 percent when oil prices soared above $100. Last year, growth was at just 1.4 percent. The International Monetary Fund expects growth of only 0.4 percent in 2017. At the same time, the country’s budget has swung from a surplus to a deficit.

The price collapse has forced the Kingdom to make vital reforms and push its “Vision 2030” plan to lessen its dependence on oil revenue. The problem is that the proposed changes do not provide respite in the current environment. “The efforts to diversify are of course good for the longer term, but they are expensive in the short run,” said Weinberg.

Until diversification efforts are realized, the Saudi government will have to still rely heavily on export revenues and state-owned Aramco for spending, keeping the economy vulnerable to oil price fluctuations and higher debt levels. Aramco, despite the low prices, has continued to finance expansive health and education programs, fund ample fuel subsidies, and back the construction of a sports stadium and other infrastructure projects. The Kingdom hopes that Vision 2030 and the Saudi Aramco IPO will raise revenues for the government, but it still confronts problematic political dilemmas such as dissent from within regarding economic reforms, a rapidly expanding workforce, and an ongoing war in Yemen.

Russia adapts better than others

As a result of international sanctions, Russia was already facing economic headwinds as prices collapsed. The experience ironically helped Moscow adjust to changing market conditions in 2014. “Russia had adapted well compared to other oil exporters,” the World Bank says. “For Russia, growth adjustment happened earlier than for many oil exporters, reflecting the early impact of economic sanctions and the high inflation associated with the introduction of a floating exchange-rate regime.”

After seeing two years of contracting GDP, Russia’s economy should grow by 1.4 percent this year and next. But the country’s outlook is precarious and its performance will be highly sensitive to fluctuations in oil prices.

Russia devalued its currency to fetch more for the volumes it sold on the international market. The Russian ruble has fluctuated considerably versus the dollar since mid-2014. From mid-2015 to early 2016, the ruble fell by more than 70 percent versus the U.S. dollar. Even though it has recovered, it remains well below the levels in the first half of 2014. The strengthening oil price throughout 2016, supported in part by Russia’s cooperation with the OPEC cartel, has allowed Russia to scrape out of a recession. After seeing two years of contracting GDP, Russia’s economy should grow by 1.4 percent this year and next. But the country’s outlook is precarious and its performance will be highly sensitive to fluctuations in oil prices.

Libya, Nigeria face greater instability challenges

Libya and Nigeria are the two countries that are most at risk of meltdowns given the domestic instability that plagues them across high- and low-oil price environments. Infrastructure security is a big issue for all producers, but it provides greater economic anxieties for Nigeria and Libya now that they are trying to grow their output. For Libya, its economy has been fragile since Muammar Qadhafi was overthrown in 2011. Data is unreliable and patchy, but estimates say the economy contracted by six percent in 2015 and unemployment is persistently high. Low oil prices, offline production, warring militant factions, ISIS threats, and an unstable political environment have all undermined economic growth.

Libya and Nigeria are the two countries that are most at risk of meltdowns given the domestic instability that plagues them across high- and low-oil price environments.

Nigeria, meanwhile, saw its economy contract by 1.5 percent last year. That is in stark contrast to growth of roughly 6 percent that comparable low-income developing countries enjoyed. Nigeria depreciated its currency in June of last year, after it was pegged to the dollar, in order to increase exports and attract investment to the country. This supposed remedy led to high inflation and citizens have seen a real deterioration in their quality of living. According to the IMF, the economy should rebound to see growth of 0.8 percent this year and 1.9 percent next year, but that outlook is highly dependent on oil prices remaining elevated.

Will producer countries return to the brink?

Petro-states were on the brink in early 2016 as prices sank below $30—despite most of the countries enjoying very low production costs, some of which are in single digits. With the exception of Venezuela, they have thus far been able to keep the situation from getting out of control, but that could change if the low price environment drags out. Oil-rich countries have given themselves some respite with the OPEC production cut that was set in motion late last year. OPEC, along with non-OPEC players including Russia, agreed last week to keep throttling back through the first quarter of next year in an effort to keep prices propped up and boost revenues to support their economies. Even if today’s oil price continues, it could still exacerbate instability or cause countries to teeter on the brink. Even worse, should fundamentals work against their favor, the oil price could collapse again, putting these economies back in even more precarious situations.

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