By Avril Harvey & Kumbirai Gundani
This year, Saudi Arabia increased oil production from 9.7m barrels a day, which had been the norm for the past 6 months, to a record high of 10.3m barrels per day in April. This increase in oil production came on the backdrop of a 50 percent increase in oil price from its record low price of approximately $46 per barrel. This is a strong signal from Saudi Arabia that it will continue its strategy to squeeze out US shale producers from the market, states Frost & Sullivan. The global effect of the low oil prices has been well covered on a macro level; however the question that has not yet been addressed is what the impact of low oil prices will be on sub-Saharan African economies.
In the aftermath of the drop in oil prices, it seems the country affected the most in sub-Saharan Africa is Nigeria. After rebasing its economy in 2014 and becoming the biggest economy on the African continent, Nigeria has experienced a sharp decrease of its excess crude account. The primary driver of this has been the drop in oil price and lower productivity levels, caused by production issues. The secondary driver has been the loss in market share of Nigerian sweet crude, in the American and Chinese markets, to Saudi oil. The low oil prices are not the only factor spelling doom for Nigeria. Nigeria had an opportunity to follow the moves of other petro states to drop the subsidisation of gasoline. However, due to elections, the Nigerian government has missed this opportunity and, as a result, the cost of transportation on diesel will drop initially in the commercial arena. With expected inflation on the up; however, food and transportation costs are expected to rise.
From a monetary perspective, the Naira has been severely affected by the decline in petrodollar inflows. This has contributed to currency instability, though potentially providing some short-term benefit to exporters. The negative effect on the fiscal and monetary policy has a severe consequence on Nigeria’s infrastructure. For the past decade, Nigeria has been slowly working to cut its infrastructure back-log (power generation, road, rail and more); low oil prices will make it challenging for the country to use capital imports in order to improve its infrastructure. Nigeria also faces policy challenges in the midst of low oil revenues. The delay in the long-awaited finalisation of the Petroleum Industry Bill (PIB) will continue to bedevil the investor community in Nigeria. The Bill will, inter alia, redefine the role of the state within the industry, and the role and level of local participation will essentially reshape the risk/reward metrics for the investor.
Closer to home, Angola is in a similar position, finds Frost & Sullivan. Although GDP dependency on petroleum has dropped from 65 percent in 2009 to around 40 percent in 2014, the country has a 2015 budget predicated on an average Brent Crude price of $81 per barrel. As a consequence, the government budget had to be revised in early 2015, cutting $14 billion of planned public spending. As Angola has traditionally had one of the highest fuel subsidies in the world, this has included a substantial slash on fuel subsidy.
The price of liquid fuels had already been adjusted in 2014, based on pressure from IMF to raise funds for social investments. It has been increased once again in 2015 to mitigate the loss of fiscal revenues caused by the crude oil price crisis. Temporary suspension of payments abroad means that companies operating in Angola will no longer be able to repatriate profits or dividends, making it challenging to work with foreign/global suppliers in the short term. The trade relationship between Angola and most other countries – especially those with higher trade volumes – will slow dramatically for as long as the oil price remains at a low level.
Though South Africa is not an oil producing state, the drop in oil prices carries its own dynamics as many large industries in the country have oil as a major input. The petrochemicals sector – specifically paints and coatings, and plastics – are especially affected. The low oil prices will benefit these sectors due to lower raw materials costs, though benefits may be outweighed by other operating costs. Furthermore, for many years, plants have been allowed to age and many plants in Europe are expected to close. Demand is expected to climb in parallel leading to a possible delay in impact by several quarters.
The concept of accurate, or specific, crude price forecasting is not easy or successful. However, understanding the direction it is likely to move in, and why, is probably the best that corporates could do. Historically – in 1986, the oil price collapsed. It took 20 years at 2013 prices for the oil price to get back to the 1985 price level. One cannot draw direct parallels between the 1986 collapse and the oil price decline in 2014/2015 as other events, such as the Asian Financial Crisis (1997/1998), also took its toll on the oil price. The general consensus is that the oil price will recover to between $60 and $70 per barrel in the shorter term (depending on the US-Iran nuclear discussions).
Some of the key indicators of oil price change can include:
- Drill rig count in the United States – an indication of activity, particularly in the shale gas or shale oil area. Shale gas producers require approximately $65 dollars a barrel to be viable, so levels of activity and price will be closely linked.
- Energy mix used in transportation. There is a lot of interest in electric vehicles. The important factor to watch is battery technology – until there is a new technology in batteries, electric vehicles will not represent a game changer in the fuel arena.
- Macroeconomic environment state. Big economies, such as China, are worth watching as any growth in economy will drive the demand for oil. Also, activity by the stateheld entities, such as Sinopec and the majors, where deals and partnerships can lead to strong threats to the smaller players.
- Increases in supply. The outcome of the US / Iran nuclear negotiations need to be monitored carefully, as if Iran puts its oil back on the market, this will add large volumes of oil in the market. There are also a number of new, large refineries that are planned to come online, and these will also impact supply of oil on the market.
Frost & Sullivan concludes that the oil price is expected to remain at a low level for the next 2 to 3 years only, although it is believed that OPEC could sustain itself despite the low price for longer. There is a school of thought that believes that the price will ultimately, after 2 to 3 years, rebound to the price level before the oil crash. Whether these schools of thought are correct or not, one certainty is that the oil price has entered a period of volatility for the next 3 years, and corporates and governments will need to be prepared to operate in such an environment.
Avril Harvey & Kumbirai Gundani are Consulting Associates at Frost & Sullivan Africa