Low oil prices have been wreaking havoc on oil dependent economies and are, meanwhile, much appreciated at the gas pump. But while those examples are a bit well-worn, there are a number of other implications of the fall in oil that are perhaps not so obvious.
There are a number of factors surrounding falling prices, but the root of the issue lies with rising supply and diminishing demand.
The world oil supply started increasing heavily when new technology allowed for “fracking,” or (to put it in layman’s terms) the removal of oil from difficult-to-access nooks and crannies. American production is now “neck-and-neck” with Saudi Arabia, according to Angus Downie, head of economic research at Ecobank.
This is by no means an insignificant change: one estimate calculated that falling oil has led to about a 50 percent drop in oil imports to the U.S., with a significant impact on oil-exporting economies.
One estimate of the “trade shock,” or the value of the decline in exports to the U.S., put the value of lost trade for Nigeria at 6.57 percent of GDP. Notably, this estimate is only through 2012.
In January 2013, Nigeria was still export 442,000 barrels to the U.S. per day; today, that number is negative, meaning that the U.S. is actually exporting some products to Nigeria.
Overall, American imports of crude oil and petroleum products have fallen to the lowest levels seen since the mid-1980s.
In addition, The Organization of the Petroleum Exporting Countries (OPEC) decided against supporting prices by limiting demand; instead, OPEC will maintain production levels. This reflects Saudi Arabia’s policy of pursuing market share even at the short term expense of lower prices.
Referring to the nation, which is also OPEC’s dominant member, Downie says, “They’re happy to ride [this] out for as long as they can… by maintaining market share and by continuing to produce at a high level.”
Matters are not supported by stagnation of the world’s demand for oil. Slow growth and a focus on improved technology has softened demand in Europe. Slower growth in China has had similar effects.
“You’ve got very weak growth in the Eurozone, a lot of increased efficiency in the use of oil and refined products… there is more energy squeezed out of every barrel of oil now,” Downie says.
Thus, “Overall, the demand picture for oil is quite depressed in some ways.”
While it’s uncertain what will happen, Downie sees prices remaining low for at least several months going forward before rising, but “not by much.” He expects supply to start dropping from U.S. shale oil producers around the middle of the year as it becomes uneconomical to continue costly fracking operations with persistently lower prices.
“So, there will be a bit of a shakeout with U.S. oil production.”
For oil exporting economies in Africa, the downsides to oil oil prices have been palpable. The Nigerian government has been attempting to protect both its currency and its budget from the fallout, and the situation continues to be tenuous. With three budgets already drafted in response to the fall and a fourth potentially on the way — not to mention a presidential election — the country is between a rock and a hard place in managing the situation.
One less obvious problem is that the situation could exacerbate corruption. “In the short term, I think one of the risks is increased corruption in the country. As some individual realize that the kitty is going to be diminished, there’s an incentive for increased take in the short term,” says Rohm.
On the other hand, there is an argument that the situation could force change that improves governance in the longer run.
Olusegun Ayo Akanbi, associate professor of economics at the University of South Africa, told AFKInsider that being forced to improve tax collection may benefit governance over the long term.
“This may be a strain on the Nigerian citizens as they are not used to paying taxes,” he says, “ But on the other hand may help strengthen the institutional framework and curb corruption on the side of the government, as they will be held more accountable with taxpayers’ money.”
The fall also puts pressure on Nigerian companies. While one would think that they could benefit from lower oil prices, the situation adds uncertainty. Between inflation and a devalued naira, Joseph Rohm, portfolio manager for Investec Asset Management’s Africa Public Equities fund, says, “Expect inflation to increase. That puts pressure on the consumer, [and] if you combine that with the fact that the government will be cutting back on spending this year, we’ve already seen some of our consumer companies under enormous pressure.”
The banking sector could also feel the effects. Depending on exposure to oil prices and the projections banks use for the oil price, banks could suffer.
Rohm said he expected “higher interest rates as [Nigeria] move through the election, loan growth will slow as a result. The main risk for the banking sector is ,what does a low oil price mean for the asset quality of their loan books?”
That being said, there is often a silver lining in times of uncertainty, and Rohm believes this time is no exception. “From an investment perspective, we take advantage of opportunities that present themselves.”
With valuations depressed owing to the current level of uncertainty, and his continued belief in the long-term Nigeria growth story, it’s probably safe to say that Rohm is not going to be observing this possibly tumultuous year from the sidelines.
