The Organisation of Petroleum Exporting Countries (OPEC), is a cartel of 12 countries made up of Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.
Recently OPEC countries have proved skeptics wrong by deciding to cut oil production. Previously OPEC seemed quite content maintaining oil supply levels even with low oil prices – maybe with the intention of driving prices down and putting companies with high costs of extraction out of business. But the collapse in oil prices since June 2014 – see chart – has battered the economies of oil-producing nations as some investment projects are no longer financially feasible and this could result in a new supply shortage within a few years.
However a deal signed in Algiers in September has seen OPEC countries will reduce production for the first time since 2008 by approximately 1.2 million barrels per day (bpd) which means its production is around 32.5 million bpd – see table below:
Agreed crude oil production adjustments and levels*
* Reference base to crude oil production adjustment is October 2016 levels, except Angola for which September 2016 is used, and the numbers are from Secondary Sources, which do not represent a quota for each Member Country.
From the table the big cuts in production are from Saudi Arabia, Iraq, UAE and Kuwait. Iran is allowed to raise output by 90,000 barrels as they have sought special treatment as it recovers from sanctions. It is unclear whether the Opec cuts were wholly contingent on the planned 600,000bpd cuts by non-Opec members, including a 300,000bpd cut by Russia. Mr al-Sada of OPEC said the agreement would “definitely help rebalancing the market”, enabling the industry to “come back and reinvest” in new production capacity to ensure future security of supply.
In simple economics this reduction in supply of a very inelastic product should, in theory, increase the price of oil and on the news of the cuts oil prices surged as much as 10pc to hit $52-a-barrel – see graph opposite.
The Tragedy of the Commons was a title of an article by Garrett Hardin in 1968 although the phrase is more commonly used to name the effect which it describes. It explains what can happen when a number of individuals share a common resource and each individual is presumed to act rationally and in his own interest.
For instance if there 10 different farmers grazing a piece of land then there is an incentive to add one more cow to your herd as you gain all of the benefit of this extra cow and you only have to suffer 1/10 of the cost resulting from the increased degradation of the land. Thus although it is in each individual’s self interest to increase the size of your herd, in the long run the land use will be depleted. This concept can also be transferred to CO2 emissions where countries emit emissions in order to grow their economy but don’t consider the long-term impact of global warming on drought and disease.
Recently a lot of attention has focussed on the fishing industry which is worth $16 billion annually. International law states that 64% of the surface of the oceans are defined as ‘the common heritage of mankind’ although with the advent of technology and bigger and faster fishing trawlers the last 50 years has seen a significant depletion of stock. Approximately 90% of fishing areas are fished to sustainable limits or beyond.
Property rights has been the traditional policy to try and overcome the tragedy of the commons. This gives exclusive rights to coastal states to police and maintain territorial waters but the looting still continues – since 2010 the proportion of tuna and tuna-like species being overexploited has increased from 28% to 36%.
Reducing subsidies is seen as the most pressing policy as they come to $30 billion a year of 70% are given to more developed countries. In giving subsidies you reduce the running costs of operators but it also brings certain fishing fields within reach for trawlers from developed economies. Only 10 countries received the money from high-seas catches between 2000 and 2010 and that is with Africa having more fishermen than Europe and America combined.
Closing off more areas fishing is another alternative and it has been suggested that 30% of oceans should be designated as ‘marine protected areas’. Countries could also take responsibility by creating marine reserves within their territorial waters.
Aquaculture the controlled farming of fish could be the answer – in 2014 more fish were farmed for consumption rather than caught in the oceans. But this area needs a lot more government support as feedstocks are often poor and storage facilities inadequate.
Source: The Economist July 16th 2016
With oil prices being at historically low levels, oil exporting countries have been struggling to generate the revenue that was once apparent not so long ago. In Venezuela, for instance, oil accounts for 95 percent of Venezuela’s export earnings and plummeting world prices have severely hit the government’s revenue stream. The Middle Eastern countries with their abundant supply of oil and the ease at which it extracts it, are starting to look at alternative revenue streams as the rent from oil is no longer sufficient to sustain public goods and services. As noted in The Economist the Arab world can be divided into three broad categories:
- Resource-rich, labour-poor – Gulf sheikhdoms with lots of oil and gas but few people;
- Resource-rich, labour-abundant – Algeria and Iraq, that have natural resources and larger populations;
- Resource-poor, labour-abundant – Egypt, that have little or no oil and gas but lots of mouths to feed (see chart).
To a degree the whole Arab world is an oil-driven economy: all three groups tend to rise and fall with the price of oil. However although some countries have significant reserves of wealth this does not offer an alternative to weaning them off their dependence on the oil industry. Saudi Arabia’s Vision 2030 intends to be free of oil dependence by 2020 and among the proposals is a plan to launch a new defence company, combining Saudi industries under a single company and be floated on the Saudi Stock Exchange.
The country plans to list less than 5 per cent of Aramco (Saudi Arabian Oil Co), which is worth more than US$2 trillion. The sale of Armco would be big enough to buy Apple Inc., Google parent Alphabet Inc., Microsoft Corp. and Berkshire Hathaway Inc. – the world’s four largest publicly traded companies. The plan is for the government to be a lot more prudent in its spending and making sure that the budget deficit doesn’t exceed 15% of GDP which is a very high figure. Furthermore using the private sector to provide education and health care as well as selling valuable land to developers, will reduce the burden of the State. But this will bring about significant social change that the population of Saudi Arabia may not be prepared for. As The Economist said:
A generation of men that expected to be paid for do-nothing government jobs will have to learn to work. The talents of women, who already make up the majority of new university graduates, will have to be harnessed better. But for now even the limited reforms to give women more opportunities have gone into reverse. To achieve its goals, Saudi Arabia will have to promote transparency and international norms, which will mean overcoming resistance from the powerful religious establishment and the sprawling royal family.
Source: The Economist – May 14th 2016
For most economies that have natural endowments like oil (Saudi Arabia) or minerals, there is the risk of the economy experiencing the ‘resource curse’. This is when a natural resource begins to run out, or if there is a downturn in price, manufacturing industries that used to be competitive find it extremely difficult to return to an environment of profitability. According to Paul Collier, Nigeria has a resource curse of its own, the civil war trapin which 73% of the low income population have been affected by it, as well as a natural resource trap- where the so-called advantages of a commodity in monetary value did not eventuate – on average affecting only 30% of the low income population. It seems that in Nigeria there is a strong relationship between resource wealth and poor economic performance, poor governance and the prospect of civil conflicts. The comparative advantage of oil wealth in fact turns out to be a curse. governments and insurgent groups that determines the risk of conflict, not the ethnic or religious diversity. Others see oil as a “resource curse” due to the fact that it reduces the desire for democracy.
Click here for more on the Resource Curse from this blog
Below is a video from the FT that I showed my A2 class this morning. The significance of it is the Australian dollar and how its value is strongly linked to iron ore prices. Recent growth in China has exceeded expectations and this has led to a rebound in commodity prices especially iron ore. The belief is the AUS$ is higher than the equilibrium level suggests and that this rate will not be sustainable. There are two reasons for this:
- Commodity prices have accelerated which has led to more demand for AUS$ which might not be sustained.
- Higher relative interest rates has made the AUS$ strong as ‘hot money’ has been attracted in the country. The Reserve Bank of Australia (central bank) has recently cut the cash rate (interest rates) to 1.75% and there is talk of a further cut this year.
With the fall in the price of oil to under US$30 a barrel, two oil exporting economies in particular have been adversely affected – Nigeria and Russia.
- Oil accounts for 10% of GDP but 70% of government revenue and almost all of Nigeria’s foreign earnings.
- Government revenue has fallen by 30% from this time last year
- Foreign reserves are down by $9 billion in 18 months
- Growth rate for 2015 was 3% which was down from 6% in 2014
- Nigerian bank loans are exposed to ups and downs of the oil market. At present about 24% of Nigerian bank loans are to oil and gas producers and struggling power companies. This exposure could lead to a banking crisis in Nigeria.
How is Nigeria tackling the problem?
The Economist outlined 3 responses to the crisis of which the first is the only realistic measure:
- An expansionary fiscal policy to stimulate aggregate demand
- Protect its hard currency reserves by blocking imports
- Try to crack down on inflation by keeping the naira pegged at 197-199 to the US$.
Nigeria is fortunate to have low levels of public debt – 19% GDP – but it is not helped by high interest rates but high interest rates means that 35% of government revenue is taken up by servicing its debt. Lower oil prices would be the catalyst to a serious debt problem.
Russia’s exports and government revenue are heavily dependent on the price of oil. Since the oil peak in June 2014 GDP has shrunk by approximately by 4%. The Russian budget assumes an average oil price of $50 a barrel, which was to have produced a deficit of 3% of GDP. However the budget deficit rises by roughly 1% of GDP for every $5 drop in the oil price and with the current oil price around $30 a barrel the deficit would probably rise to 7% of GDP.
If the economy does start to run out of cash the option of printing money may be tempting. But with inflation at around 13% this would further fuel inflation and also mean a further weakening of the rouble which wold make Russian imports more expensive for firms and households. Russian economic data does not look healthy:
- real wages fell by 9% in 2015 and 4% in 2014
- GDP per person was $8,000 in 2015 in contrast to $15,000 in 2013
- 2 million fell into poverty on 2015
- the share of families that lack funds for food and clothing rose from 22% to 39%
- retail sales have dropped by 13% last year
The 25% fall in the inflation adjusted exchange rate in the past year brought with the opportunity to diverse away from oil. The weaker double makes exports more competitive and now that labour is cheaper in Russia than in China there is great opportunity. However, it is not going to come from foreign investors as foreign investment has fallen from $40 billion in early 2013 to $3 billion in June quarter of 2015.
The December 2015 edition of the New Internationalist discussed 10 Economic Myths that need to be addressed especially after the GFC. Below is the list and the NI goes through each in detail – click here to go to the NI website.
Myth 1: Austerity will lead to ‘jobs and growth – ‘
It’s wrong to sell austerity as a cure for economic woes
Myth 2: Deficit reduction is the only way out of a slump - Don’t rely on those who caused the crash to resolve it
Myth 3: Taxing the rich scares off investors and stalls economic performance – Taxation creates prosperity just as much as private enterprise
Myth 4: Economic migrants are a drain on rich world economies – Migration follows a demand for labour and benefits the receiving country
Myth 5: The private sector is more efficient than the public sector – There is no evidence of greater efficiency
Myth 6: Fossil fuels are more economically viable than renewables – Not if you look at the environmental costs
Myth 7: Financial regulation will destroy a profitable banking sector – Why should financial markets be accountable only to themselves?
Myth 8: Organized labour is regressive – It can be argued that the opposite is actually true.
Myth 9: Everyone has to pay their debts – We need debt management not reduction
Myth 10: Growth is the only way – why we need to find another way, fast.
Although it is repetitive in places especially when they talk of debt and austerity it does provide some valid arguments. I think that the last myth ‘Growth is the only way’ is of particular importance in that GDP growth at all costs has led to wasteful resource use, particularly by the wealthier countries, on an unparalleled scale and without a backward glance. It is often noted that the economy is a subset of the ecological system, but equally there seems to be a belief that nature can cope with anything we throw at it. However, an assessment by the Global Footprint Network indicates we are running a dangerous ecological debt. Currently the global use of resources and amounts of waste generated per year would require one and a half planet Earths to be sustainable (see graph below). The price to be paid for this overshoot is ecological crises (think forests, fisheries, freshwater and the climatic system), a price that is again paid disproportionately by the poor.
Although Norway is a capitalist country, it is state-owned enterprises that seem to be most prevalent in business circles. Oil revenues have been at the forefront of Norway’s development and it is, behind Luxembourg, the richest country in Europe. Ultimately the economic welfare of the country is heavily influenced by the price of oil and the peak of $150 a barrel in 2008 had huge benefits for the government purse. Oil and gas now account for about 25% of Norway’s GDP and almost 50% of its exports. However with the recent fall in oil prices to below $50 a barrel, oil companies have had to lay off workers – estimated to be 30%. According to The Economist the falling oil price has exposed two weaknesses in the Norwegian economy.
- Bureaucracy is a problem in Norway with the government owning about 40% of the stockmarket. Furthermore, as the vast majority of the country’s top executives attend the Norwegian School of Economics there is an unhealthy cultural uniformity which is not a catalyst to change.
- The welfare state has been too generous. The public sector employs 33% of the workforce (compared to 19% for the OECD countries) and as people enjoy a 37 hour week and sometimes a 3 day weekend there is a concern that the state is undermining the work ethic. In 2011 Norway spent 3.9% of GDP on incapacity benefits and early retirement, compared with an OECD average of 2.2%.
However, the government has been very prudent with its saving in that it now has the biggest sovereign-wealth fund in the world at $873 billion. The country also has a fish industry which is worth $10 billion a year.
Where to from here?
Are we seeing a classic resource curse where an economy has become reliant on a particular resource? Does Norway have a real alternative to oil to generate revenue for its economy?
Norway needs to allow the entrepreneurial spirit more room to grow and also apply some free market reforms to the welfare state. Shrinking the role of the state will help as the private sector cold start to be more involved in the running of schools, hospitals, and surgeries. So far the country’s reaction to the oil price drop is to be become even more left wing especially in the cities of Bergen and Oslo.
Source: The Economist – Norwegian Blues – October 10th 2015