The worst oil demand shock in history is unfolding due to the Covid-19 pandemic, and there is no relief in sight for Organization of the Petroleum Exporting Countries (OPEC) states. The debate over responsibility for the recent oil price war—and whether Saudi Arabia or Russia is to blame for the collapse of the OPEC+ framework that curtailed production and supported prices since late 2016—is increasingly irrelevant. The demand impact of the coronavirus outbreak is now so large that, for the time being, any OPEC supply responses are moot.
Some analysts now anticipate a drop in demand of 20 million barrels per day or more in the second quarter, but this will not be a short-lived phenomenon. It is possible that until a vaccine is developed for the virus—perhaps another 18 months or more—severe restrictions on movement will remain in place, and investment, trade, and lending will be sharply curtailed. For the oil industry, a rapprochement between Moscow and Riyadh and an end to the production free-for-all would be a welcome development but will not change this unprecedented demand weakness.
Emergency planning is underway for the major oil-exporting countries, but nearly all of the OPEC+ states are in worse shape now compared with 2014, when oil prices began to decline. States facing consistent deficits have been forced to borrow to meet their spending requirements. Current account balances have also declined sharply as export revenues have fallen, and government debt is on the rise. To cite a few examples, Saudi Arabia has registered annual budget deficits averaging 10 percent of GDP since 2015, and Oman’s gross government debt rose from 16 percent of GDP in 2015 to about 60 percent of GDP today.
Unfortunately for the major oil producers, things are about to get far worse. Economic resilience among the OPEC+ states varies widely, but with Brent crude prices at $30 or even $40 per barrel, all are in trouble, and a number of countries are headed for economic crisis.
No Easy Options
Oil exporters facing a revenue shock have multiple tools at their disposal, but the options dwindle rapidly as conditions worsen. Less politically painful moves include drawing down foreign exchange reserves and national savings funds and issuing more debt either at home or abroad. Saudi Arabia and Russia, for example, both have about $500 billion in foreign currency reserves and can deplete their savings to support government spending. They can also take advantage of low interest rates to issue debt. Saudi Arabia recently raised its government debt ceiling from 30 percent of GDP to 50 percent. Other Gulf Cooperation Council (GCC) countries could follow suit.
Cash-strapped oil exporters can also try to raise more revenue from other sectors, which is always challenging for countries with resource-dependent economies. The Gulf states have made progress in this regard since 2015 by implementing value-added taxes and other receipts—but in this economic climate, new taxes and levies would only hinder growth. Saudi Arabia now plans to eliminate or delay new taxes and fees as part of its Covid-19 response.
Budget cuts are a less palatable option, especially in the GCC states where government spending is such a critical engine of economic growth. Most countries will want to avoid this approach, given the scale of the crisis across their entire economies, but cutbacks may be inevitable for countries facing the most pressure. Generally, governments try to adjust capital spending first rather than politically sensitive salaries and social spending. Another perennial option is to cut fuel subsidies. Both in Asia and the Gulf region, important subsidy reforms have been enacted since 2015, although several oil producers backtracked when revenues rose again and pressures declined.
After states run through these options, the choices become much more painful. Large current account deficits pressure currencies and force governments to either burn through foreign exchange reserves or allow depreciation. The last oil price crash in 2014-15 led to devaluations in Russia, Angola, Kazakhstan, Azerbaijan, and elsewhere. This is a difficult step since it erodes purchasing power for ordinary citizens and can harm investment. Still, the free float has created huge benefits for Russia and its oil sector since 2015, since most costs are denominated in local currency, and the value of export revenues in ruble terms increases when the currency weakens. (Exchange rate adjustment is not an option for the GCC states, which peg their currencies to the dollar, or to a basket of currencies in Kuwait’s case.)
It is important to note that in times of crisis, conditions evolve quickly. As balance of payments pressures increase and government debt rises, wary investors can accelerate this cycle through capital outflows. Already, countries with macroeconomic vulnerabilities are on watch, and for some, the crisis is already here.
The Most Vulnerable
Algeria, Angola, Iran, Iraq, Nigeria, and others face real risks of economic crisis in the coming year. Already the IMF says more than 12 states in the Middle East and Central Asia have approached it for aid as the Fund prepares to mobilize its $1 trillion in lending capacity to help countries navigate the Covid-19 outbreak and economic downturn. On a country level, IMF stand-by agreements or other emergency aid can do a great deal to help restore investor confidence and add to government liquidity. But the scale of economic needs across the region could be unprecedented.
Algeria is one of the most vulnerable. It held more than $170 billion in foreign exchange reserves in 2014, but that figure dropped to $62 billion as of February. The country’s fiscal breakeven oil price (the price required to balance the budget) is thought to be more than $100 per barrel, far higher than current pricing. In late March, the government announced it will cut current spending by 30 percent and aim to cut imports by about 25 percent. Algeria has seen political turbulence over the past year, and as economic conditions worsen, the political class will likely face renewed pressure. Appeals for IMF aid may be inevitable, but policymakers are mindful of the potential repercussions.
Oman’s economic foundations have also been greatly weakened. Wide deficits and growing debt led ratings agencies to downgrade its sovereign debt to junk status last year, and with smaller reserves and less financial firepower than its neighbors, Oman looks far more vulnerable.
Other OPEC states facing acute risks include Angola, the smaller African producers (Republic of Congo, Equatorial Guinea, and Gabon), Iran, Iraq, and Nigeria. In the case of Iraq, the oil market crash will add to the political turmoil of recent months. And of course, all of these countries simultaneously face a potential health crisis that will strain government budgets and sap growth.
The OPEC+ states are relatively powerless in the face of the Covid-19 demand shock, but most OPEC countries have no appetite for the price war between Saudi Arabia and Russia that has added to oil market chaos. Indeed, by most accounts they were blindsided by the collapse at last month’s meeting. In recent weeks there have been reports of mediation efforts by Azerbaijan, the United Arab Emirates, and Iraq to reach a détente between Riyadh and Moscow—aside from President Trump’s overtures. Still, a resolution does not seem to be in the offing, and the standoff could drag on at least until the next scheduled OPEC meeting in June.
Over the longer term, as the impacts of the coronavirus pandemic eventually subside, a key question is whether players aside from Saudi Arabia and Russia can exert greater influence as the producers’ club eventually reinvents itself. In the meantime, intra-OPEC tensions are growing. For now, there seems to be no escape from the worst oil price downturn in a generation.
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