Low oil prices, budget deficits and OPEC

In November 2014 the OPEC countries met in Vienna and agreed to keep pumping oil to maintain their market share rather than cut production to support the oil price. In a post written a month later I addressed the question of how these countries were positioned to withstand an extended period of low oil prices and high budget deficits. More than a year has now passed, so it’s time to take a look at how they have done so far and to see what their actions presage for the future.

Results to date:

OPEC is known to have suffered economic damage as a result of low oil prices, but exactly how much? I made the following estimates from the October 2015 IMF World Economic Outlook Database. They include all the OPEC countries except war-torn Libya, where the data are not particularly meaningful. All the figures given in this post are in (or estimated from) US dollars unless otherwise specified:

GDP, 11 OPEC countries combined: Down from $3,392 billion in 2014 to $2,849 billion in 2015, a decrease of $543 billion.

Budget deficit, 11 OPEC countries combined: Up from $17 billion (0.5% of GDP) in 2014 to $278 billion (9.8% of GDP) in 2015, an increase of $261 billion.

The economic damage has clearly been serious, but how much of it was a result of lower oil prices? Data from the 2014 OPEC Annual Statistical Bulletin indicate that OPEC exported about 8.5 billion barrels of oil in 2015 at an average “OPEC basket” price of $49.49/bbl. This is  $46.80 lower than the $96.29/bbl average basket price in 2014 and represents almost $400 billion in decreased revenue. Allowing for the damping effect on other sectors of the OPEC economies it’s reasonable to assume that most if not all of the damage was done by lower oil prices.

The next question is, which countries have suffered the most? According to Figure 1, which plots the percent decrease in GDP between 2014 and 2015 by country, Venezuela, Iraq – and Kuwait suffered the largest GDP decreases and Qatar, Iran and Ecuador the least. The rankings are, however, potentially skewed by country-specific factors and by devaluations, as discussed later:

Figure 1: Percent decrease in GDP, 2014 to 2015.

The question of greatest importance, however, is the impact of low oil prices on OPEC budgets. The OPEC countries have historically used their oil wealth to keep their citizens happy by means of generous subsidies and handouts, and the Arab Spring highlighted the importance of keeping the citizens happy (as does the renewed unrest in Tunisia, where the Arab Spring began).

The impacts of the oil price collapse on OPEC budgets are summarized in Figures 2 and 3. Figure 2 shows budget balances in 2014 as percentages of GDP, calculated from IMF revenue and expenditure data. Kuwait, Qatar, the UAE and Saudi Arabia ran healthy surpluses – Kuwait and Qatar very healthy ones – and Angola, Algeria, Iran, Nigeria, Ecuador and arguably Iraq had small but manageable deficits. Venezuela alone had a budget problem, but this was a result of economic mismanagement, not oil prices:

Figure 2: Budget balance as percentage of GDP, 2014

Figure 3 now shows the 2015 data. Only Qatar and Kuwait were still in surplus. Iran, Angola, Nigeria, Ecuador and the UAE had small but probably still manageable deficits, but Algeria’s deficit had increased from near-zero to almost 15% of GDP and the deficits of Saudi Arabia, Iraq and Venezuela had ballooned to over 20% of GDP. Collectively the 11 OPEC nations went from a 3% budget surplus to a 10% budget deficit between 2014 and 2015 according to the IMF data:

Figure 3: Budget balance as percentage of GDP, 2015

Low oil prices have clearly left the OPEC nations with budget problems that pose a potential threat to their stability. In the next section we will look at what they have done about them.

OPEC’s actions to date

OPEC has had a number of budget-fixing options at its disposal, with the obvious one being to cut production to bring global oil supply and demand back into balance. This was of course politically impossible in 2015 but may become less so in 2016.

The second option was to increase government revenues. This, however, is also not a realistic solution in undiversified oil-dependent economies, where decreases in oil price inevitably send revenues in the opposite direction. Government revenues in fact decreased by more than 20% between 2014 and 2015 in all OPEC countries except Iran and Ecuador. The OPEC-wide decrease was 33% (Figure 4):

Figure 4: Percent change in government revenues, 2014 to 2015

The third option was to cut government spending, which is more easily done than increasing revenue although it does carry the risk of upsetting the public. As shown in Figure 5, however, results have still been mixed. Saudi Arabia and Iran actually increased spending between 2014 and 2015 and Qatar spent the same amount as it did in 2014. Modest cuts were achieved in Iraq, the UAE, Kuwait, Ecuador and Algeria but substantial ones only in Nigeria, Venezuela and Angola. Overall the OPEC governments cut their combined government expenditures by only 8% between 2014 and 2015.

Figure 5: Percent change in government spending, 2014 to 2015

Or did they even do that well? The Figure 5 numbers are in US dollars but national budgets are done in national currency, and when we convert to national currency we get the results shown in Figure 6. The numbers change for the four OPEC countries whose currencies are not pegged to the US dollar and which have responded to low oil prices by devaluing their currencies or by having the market it do it for them. The countries are Iran, which now shows a 26% increase in government expenditure between 2014 and 2015 rather than the 2% increase shown in Table 5, Algeria, which now shows a 9% increase instead of a 12% reduction, Nigeria, which shows a 7% reduction instead of a 22% reduction and Angola, whose spending reduction is now 27% rather than 40%. OPEC’s total 2015 spending now shows effectively no change over 2014:

Figure 6: Percent change in government spending, 2014 to 2015, national currency.

There are of course questions as to what these devaluation-adjusted numbers signify (Angola, which has an active black market that values the kwanza well below the official exchange rate, is a borderline case, and the devaluation-adjusted results for Venezuela, where the bolívar is officially at parity with the dollar, are effectively meaningless and are omitted for this reason.) Taken at face value, however, they indicate that the OPEC nations have so far made little real effort to reduce expenditures, possibly because they believed  Saudi assurances that the US shale producers would soon be driven under and that no belt-tightening would be necessary. Certainly none of the delegates who attended the November 2014 OPEC meeting foresaw that the oil price crash would be as deep as it was or last as long as it has. But devaluing a currency after unpegging it from the dollar does offer an option for managing a budget deficit, and OPEC countries with dollar-pegged currencies are coming under increasing pressure to consider it.

The fourth option is to draw on foreign reserves. Saudi Arabia is understood to have financed most of its official $99 billion 2015 budget deficit with gradual foreign exchange reserve withdrawals, as shown in Figure 7. (The data are from Trading Economics and Knoema/World Bank. The two data sets give very similar numbers and combining them maximizes monthly coverage, so both are plotted in the following figures):

Figure 7: Monthly foreign exchange reserves, Saudi Arabia

As far as can be gauged from the incomplete data plotted on Figure 8 Algeria also probably financed its deficit with gradual foreign reserve withdrawals (Algeria’s 2015 budget deficit is reported as being around 12% of GDP, which with a GDP of $175 billion works out to about $20 billion. Despite its pleas for help Algeria’s healthy foreign reserve balance in fact puts it in a better position to withstand an extended period of low oil prices than most other OPEC countries):

Figure 8: Monthly foreign exchange reserves, Algeria

Angola also slowly drew down its foreign reserves by about $5 billion between December 2014 and July 2015 (Figure 9), which would have financed some of its budget deficit over this period:

Figure 9: Monthly foreign exchange reserves, Angola

But not all OPEC countries show clear evidence of systematic reserve withdrawals. As shown in Figure 10 monthly foreign exchange reserves in the UAE have remained essentially unchanged while reserves in Kuwait and Qatar have oscillated up and down with no clear trend visible. Nigeria’s reserves declined through March 2015 but have remained stable since. (Monthly reserve data for Iraq are incomplete and there are no data for Iran):

Figure 10: Monthly foreign exchange reserves, Kuwait, Nigeria. Qatar and United Arab Emirates

Finally we have Ecuador and Venezuela (Figure 11). If Ecuador continues to deplete its foreign reserves at post-July 2015 rates it will run out of cash by May. Venezuela, on the other hand, has somehow managed to leave its foreign reserves intact since June despite its accelerating economic meltdown:

Figure 11: Monthly foreign exchange reserves, Ecuador and Venezuela

Ecuador and Venezuela now bring us to the fifth budget-balancing option – borrow money from China, OPEC’s lender of last resort. Venezuela’s oil industry has been kept afloat by the $46 billion in oil-for-cash it has received from China over the last decade. So to a lesser extent has Ecuador, whose foreign reserves dwindled rapidly in the second half of 2015 most likely because it expected to receive $4.2 billion from China this year but as of May had received only $900 million (although having just signed a $970m credit line with the Industrial and Commercial Bank of China it has now “breathed a sigh of relief”.) When “a halving of oil prices left a gaping hole in Angola’s finances in this year President Jose Eduardo dos Santos knew exactly where to turn ”. And Algeria , “hit by oil price drop”, is now seeking Chinese help too. (Nigeria has also received loans from China, but for infrastructure development, not oil.) Whether China plans to continue bailing out OPEC countries is uncertain, but its bailouts to date have given it some measure of control over a substantial fraction of the world’s oil reserves.

What will happen in 2016?

The table below compares the oil prices assumed by OPEC countries in their 2016 budgets with the prices they assumed in their 2015 budgets (data from numerous sources). If nothing else the numbers will be of interest to those in the oil price prediction business. No data are available for Libya or the UEA, which notes only that a 2016 price of $80/bbl would be “ideal” and leaves it at that.

If the 2016 OPEC basket oil price does average around $35/bbl it will be about $15/bbl lower than the $49.49/bbl average basket price in 2015, meaning that OPEC will lose yet another $130 billion in annual oil revenues if it maintains production at current levels. Can OPEC survive another hit like this? Well, those waiting for a prediction are going to be disappointed because I’m not going to make one. There are just too many unknowns. We’ll just have to wait and see.

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21 Responses to Low oil prices, budget deficits and OPEC

  1. Euan Mearns says:

    Roger, thanks for the interesting roundup. One of my takeaways is that most OPEC countries seem to be managing OK. Its not so catastrophic as one may have assumed. Devaluation is an interesting mechanism to provide a degree of protection. It will of course make importing goods a lot more expensive – which is a good thing when your exports have recently tanked.

    On reading this I’d assess that capitulation by OPEC is less likely. The industry is going to have to wait for demand to rise and OECD production to fall.

    And China is out there buying alliances, support and energy security while the OECD sleep walks into a shale and renewable wonderland.

    • Euan: Over the last year OPEC has split into two factions:

      Five countries that want to keep pumping in an attempt to maintain market share, specifically Saudi Arabia, UEA, Kuwait, Qatar and Iraq.

      Five countries that want to cut production to increase oil prices, specifically Algeria, Angola, Ecuador, Nigeria and Venezuela. (Iran and Libya don’t fit into either category.)

      It’s the Gulf Arabs versus the rest.

  2. Luís says:

    Thanks for the details Roger, this is all valuable information. Just a pity the usage of American units instead of international standards.

    One of the problems Angola is facing right now is an acute shortage of dollars. This means most contracts with foreign companies can no longer paid. GDP could contract more in 2016 that it already has in 2015.

    http://frontiermarketscompendium.com/index.php/news-commentary/entry/angola-s-dollar-shortage-deepens

    One interesting twist to this story might be the planned Chinese petroleum exchange (or petroleum benchmark). Exporting countries like Angola will be more than glad to price their petroleum against a yuan denominated benchmark if that means regained access to foreign reserves markets.

    http://www.reuters.com/article/china-crude-futures-idUSL5N11F04A20150910

    Cheers.

    • Thanks Luis.

      If the oil price is lower in 2016 then it was in 2015 (OPEC forecasts an average basket price of $26.71/bbl, little more than half the 2015 average price, by the way) then OPEC GDPs will indeed contract again. Countries like Angola will be happy to peg their oil to a yuan benchmark if that’s the only way they can stay afloat.

      But what are these “international standards”?

  3. Jacob says:

    You seem to imply that there is a “painless” alternative: OPEC can cut production and keep prices high.
    This is obviously not correct.
    And OPEC is irrelevant, only Saudi Arabia matters. Only she is able to cut production by an amount that matters.
    Cutting production also reduces revenue,and causes pain.

    So, the question is: which alternative is better for Saudi Arabia?
    The above data shows the problems of the alternative that was chosen (by Saudi Arabia), but it is difficult to estimate the pain of the other alternative (imaginary), and to compare.

    • Jacob: I’m having difficulty following your logic here. If OPEC cuts production by ~5% across-the-board the global oil supply-demand imbalance disappears and the oil price goes up – maybe not back to pre-crash levels but certainly by a lot more than 5%. So every OPEC country finishes up with increased, not reduced, revenues. Pain would be felt by only the architects of the “maintain market share” strategy, whose heads would roll. In some cases quite possibly literally.

      • Jacob says:

        The 5% cut in production scenario by OPEC members depends on many uncertain factors: on OPEC members not cheating, as they usually do, on Iran abstaining from increasing production from sanctions levels, on Russia, and the US and Canada not increasing their production, despite high prices. It is by no means sure that a 5% cut by OPEC would have been enough to sustain high prices.
        This is a normal business cycle: high prices, new investment (or over-investment – spurred by the high prices) in new production, then the prices fall amid over-supply. The belief that such cycles can be flattened out by careful and powerful central planning has never worked.

        • Roger Andrews says:

          Yes, of course everyone is going to cheat. I wasn’t disputing that. Just your claim that an OPEC production cut wouldn’t send the oil price up.

          • Jacob says:

            There are always the quantitative uncertainties: how much of a cut is needed, how much higher prices will go, how much revenue is lost in the process.. it’s difficult to assess.

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  5. Wm Watt says:

    Here in North America the cuts are to capital expenditures (and labour) in oil producing companies. Would those not be cuts to government expeditures in countries where all the production is government-owned, and the population in general would not notice?

  6. GV says:

    Just what I needed. Thanks.

  7. cgh says:

    Roger, this is a key section in your analysis:

    “Taken at face value, however, they indicate that the OPEC nations have so far made little real effort to reduce expenditures, possibly because they believed Saudi assurances that the US shale producers would soon be driven under and that no belt-tightening would be necessary. Certainly none of the delegates who attended the November 2014 OPEC meeting foresaw that the oil price crash would be as deep as it was or last as long as it has.”

    I would note first that reduction in expenditures is not possible for some of them, particularly Saudi Arabia. It is involved in what is now essentially a two-front war with one of the other OPEC nations, Iran. And there is no sign that military demands of either of these two nations is going to taper off any time soon.

    There’s been a lot happening in the region over the past 14 months. The Yemeni government collapsed, the US was driven out in a rout, none of which could have been foreseen easily at the time of the November 2014 decision. Also, ISIL has proved much more resilient than was thought, at least by some military opinionators in the US. ISIL’s capture of Ramadi last year must have taken at least a few by surprise. Hence, I suggest a remorseless demand for increased military expenditures regardless of the oil price situation. And this is not at this point likely to change in 2016. Wars are expensive.

    I agree with you strongly about US shale producers and other non-OPEC sources like Canadian oil sands. The results have been trimming of capital expenditures, not reduction in existing production.

    On balance, I agree entirely with your analysis with the caveat of military expenditures required by some of the largest of the OPEC nations.

    • cgh: According to http://www.presstv.com/Detail/2015/12/29/443712/Saudi-Arabia-economy-minister-Yemen-war-budget/ the Yemen war cost Saudi Arabia $5.3 billion in 2015, or a little over 5% of its $98 billion budget deficit. The recent gasoline tax increase will net them less than $1 billion/year, according to my calculations. It looks like another year of pilfering the piggy bank if the oil price doesn’t go back up.

      • cgh says:

        Roger, they’re expecting, according to your link, an $87 billion deficit in 2016. Compared to their $750 billion total GDP, that’s huge. You’re right. With low oil prices, they can only sustain this by continuing to draw down foreign currency reserves. This in turn means liquidation of overseas holdings which I understand started last year. Increased taxes and levies are probably out of the question. Their increases last year are already making things restless.

        It’s probably reasonable to say that Saudi Arabia is in the best economic shape for the conflict compared to the others involved. Does ISIL care much whether its opponents are militarily defeated or whether they collapse economically? Probably not in the slightest. The result will be much the same in either case. Collapse of existing Middle Eastern regimes is their prime objective.

  8. rd says:

    How is Russia being affected by the reduction in prices? Their economy includes oil exporting, and after they annexed Crimea from Ukraine they were hit with some sanctions. Is their economy suffering, or is everything peachy?

    Iran and Russia are also allied together in Syria, and Russia now has a military presence in Syria. I think Putin is ruthless enough to achieve goals he thinks are important. What if he decides higher oil prices are important?

    A little Iranian inspired Shia uprising in the Western KSA, or ISIS inspired Sunni violence in Iraq, Kuwait, or the KSA could affect oil prices. And it would be hard to discourage Iran if Russia is backing them. Do you think the EU and the current US mis-Administration will deter Putin and Iran if they decide to cause trouble?

  9. Joe Aldridge says:

    Roger, Thanks for the study and the article. Very well done. One consideration that I think should be considered is an import tariff on oil imported into the US. (There is definitely a price war going on and is being produced at a loss) If we have a tariff that covers the difference between $65 and the current price on the market then we would do two things. Support the oil price to some extent in the US and if the money from the tariff was dedicated to the National Debt then there would be a win-win situation. Any comments would be appreciated.

  10. Joe says:

    Roger, Great article. My question is: Since there is a price war with OPEC would an import tariff on oil imported into the US be appropriate? They are producing at a deficit or dumping on us to maintain market share. The logical response would be a tariff to maintain jobs in the industry. It seems that a tariff that supports a price of $65 would support the US Industry and if the money derived from the tariff were dedicated to paying down the debt then it would be a win-win. Any comments would be interesting.

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