Decrease in Global Oil Prices and Implications

A brief review

admin, 25 Dec 2014

Decrease in the Price of Oil and Implications- a brief summary
Ibrahim Athif Shakoor
25th December 2014

Note: A Dhivehi version of this article has been published on Haveeru on the 29th. http://www.haveeru.com.mv/dhivehi/opinion/164955?o=hm_m


Most analysts seem to converge on the theory that the collapse of the price of oil from a mid-June high of 116 $ US/barrel to below 60 $ is due to geopolitics rather than a drop in demand or an oversupply situation. One version of the geopolitics is succinctly explained by Edward Lucas; the Energy Editor of the Economist titled "How Oil's become the world's most portent weapon published on the Daily Mail on 23rd December. (The URL is http://www.dailymail.co.uk/news/article-2884454/How-oil-s-world-s-potent-weapon-Forget-nuclear-arms-U-S-Saudis-oil-price-crash-topple-regimes-Russia-Iran-sabotage-Scot-Nationalists.html)

Instead of venturing into the why’s and wherefore territory, let us take a moment to understand the implications of downward spiraling oil prices.

Impact on Net Exporters of Oil
For Net Exporters of Oil, the collapse of oil prices by 50% cannot but be a blow to their economy, especially if the economy and national income is highly dependent on oil revenues. Countries that fall into this territory include Russia and Iran and conspirator theorists largely believe that this action is aimed at weakening the economies, and therefore the regimes in power in both Russia and Iran. The effect on the Russian Economy, in the short term is largely visible and commented on by many parties and need not be elaborated here.

Saudi Arabia, while being heavily dependent on oil revenue, have over the past, built up a reserve of over 900 billion (that’s with a “b) US $ and many strategic investments. Therefore, pundits claim, Saudis can play the game for quite some time. The resilience of Saudi policy and determination is neatly captured by the statement of the Saudi Oil Minister Al Naimi last week, stating that even if prices drop to 20 US $, they would not reduce supply.

Impact on Net Importers of Oil
The World Economy consists more of net oil importers then exporters and therefore the steep drop in oil prices cannot be but good news to the economy at large. And IMF has already declared that the global economy would receive a minimum 0.7% boost next year exclusively due to lowering oil prices. Major economies like China and India would therefore, be able to perform even better, dependent as they are on imported oil.

Impact on Maldives
While many countries are net importers of oil, some of them produce energy through nuclear, hydro, wind, solar and other means. Whilst some gains have recently been made in solar energy production here in the Maldives, we are still, very much a country that is totally dependent on imported oil. This includes the generation of power for electricity and fuel needed for transport; always a sizable consideration for a geographically challenged country like ours.

Maldives is not just a net importer of oil, it is a net importer of everything except tuna with 60% of received foreign currency being spent on imports, another 18% on services and 9% to pay the salaries of expatriates. Running a current account deficit of 0.2 billion US $, the country spends 22% of its import bill to pay for oil related items; which is higher than that 18% spend on food related items. Import statistics show that for the period January to October this year, the country has spent more than 500 million US $ for oil related imports.

Additionally, energy produced from oil is used in the production of most other items especially manufactured items. Even food grains require energy for harvesting, processing and packaging. Therefore, it is not unlikely that prices of other goods would also decline, albeit not as steeply, with the fall of oil prices. Hence with direct oil imports accounting for 500 million US $ until October this year, and with anticipation of lower prices of oil and other imports, it is not unreasonable to estimate that the country can estimate a saving of 300 million US $ which would otherwise have been incurred.

It is important to note here that this article refer to a potential saving of 300 million US $, an amount that would, if not for the steep decline in recent prices, would be spent. It can only be seen as a saving in comparison and need to be actually saved in order for it to be, well .. savings.

Impact on the 2015 National Budget
The National Budget for 2015, when originally submitted included half a billion MRF to be raised by changing the import duty structure and 340 million from Green Tax. However, over the course of discussion and negotiation several changes have now been agreed to proposed revenue raising measures. These include the reduction of the proposed Green Tax from 10 to 6 US $, the non-imposition of Green Tax for those tourists who stay at Guest Houses, the removal of the proposed duty in food items and zero duty on items imported for the Construction of Resorts. All these measures, agreed to after the budget was submitted, would no doubt, impact negatively on the anticipated state revenue.

Additionally, import duty being calculated on CIF value, the sharp drop of oil prices would mean that the amount initially estimated to be collected from the 10% imposition of import duty on oil, would now be less than estimated.

All of which indicate a lower than estimated revenue flow to the state than originally estimated at budget submission. Yet, it is also important to note that lower oil prices could, ceterus paribus, lead to a more energetic economy over the medium term. With businesses doing better and better employment, income from GST and BPT could indeed lead to better state revenue over the medium term.

What seems to be clear is that recent drop in oil prices is not due to market prices of supply and demand and while playing geopolitics might be exhilarating, even the Saudi’s will not be able to bite the bullet forever. Therefore, lower oil prices experienced now would not be stable over the medium to long term and analysts predict the oil prices will be closer to 100 US $ in the medium term.

As a country, we will always be dependent on imports and will feel the heat when oil prices cross to the north of the 100 US $/barrel territory. While some economies are hurting because of the drop in oil prices we here in the Maldives stand to gain while big boys play politics in the oil market. Therefore, and understanding that it is a short term phenomenon, let us collect the proverbial rain water while it is raining. Instead of using the windfall for consumption, let us look to allocate this dividend for long term development of the economy like shoring up our reserves to more cozy levels or investing in diversifying the economy.

 

 

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