A HT to Kanchan Bandyopadhyay for this piece from the Associated Press. Petrol prices in North Korea since February have risen by approximately 14% as it contends with the tougher international sanctions over its nuclear programme which is potentially putting a brake on the emerging market economy. However it is difficult to say what is exactly happening as officials in North Korea don’t discuss issues like this openly
What about supply and demand?
It might be a simple matter of the market. With more vehicles on the road there is more derived demand for petrol putting the price up. It is also possible that more fuel is being used for military purposes or for government construction or development projects. Most of the supply of petrol comes from China and the impact of sanctions is limiting the supplyThe fear that prices will rise further has consumers stock piling petrol coupons. In North Korea customers usually buy coupons for the equivalent amount of fuel that they wish to purchase. To purchase 15 kilograms (petrol is sold by the kilogram in North Korea) it about $12 in Pyongyang which equates to a 20% increase in price. As with most planned economies the supply of petrol is controlled by the state and it decides on who gets what – military and public transportation such as street c
ars and buses are still kings of the road.
Black market currency
Strangely enough North Koreans usually pay for their fuel in US dollars or euros. One kilogram of gas is currently about 80 North Korean won but no one actually pays that.
80 won = 80 U.S. cents under the official exchange rate, but only about eight-tenths of a cent under the unofficial exchange rate most North Koreans use when buying and selling things among themselves – the “real economy,” in other words.
The number of passenger cars has grown rapidly and rather than the typical black limousines or blue Mercedes sedans driven by communist party officials, they are middle of the range cars imported from China.
The growth in traffic in the capital is a visible indicator of economic activity the North generally prefers to keep under wraps. Many vehicles these days are clearly being used in an entrepreneurial style, moving people and goods around for a fee.
Higher gas prices could put a damper on such activities, or at least cut into their profits. The rise of automobiles is focused on the capital, which remains a very special place. Most North Koreans don’t have cars, or even access to cars. In the countryside, major highways are still not very well traveled and often not even paved. And gas, when it’s available, is usually more expensive.
Below is a video clip from the FT outling the reasons for the debt build up in the energy industry which is making investors nervous. Fracking has been partly responsible for the increase in oil output in the US by 400m barrels a day between 2010-2015. It was encouraged by high oil prices and also meant the sector took on a lot more debt – assuming that oil prices would stay above $100 a barrel. However as oil prices collapsed to around $30 a barrel oil extraction companies are finding it increasingly difficult to service their debt. Worth a look and with some very informative graphs.
With the fall in the price of oil to under US$30 a barrel, two oil exporting economies in particular have been adversely affected – Nigeria and Russia.
- Oil accounts for 10% of GDP but 70% of government revenue and almost all of Nigeria’s foreign earnings.
- Government revenue has fallen by 30% from this time last year
- Foreign reserves are down by $9 billion in 18 months
- Growth rate for 2015 was 3% which was down from 6% in 2014
- Nigerian bank loans are exposed to ups and downs of the oil market. At present about 24% of Nigerian bank loans are to oil and gas producers and struggling power companies. This exposure could lead to a banking crisis in Nigeria.
How is Nigeria tackling the problem?
The Economist outlined 3 responses to the crisis of which the first is the only realistic measure:
- An expansionary fiscal policy to stimulate aggregate demand
- Protect its hard currency reserves by blocking imports
- Try to crack down on inflation by keeping the naira pegged at 197-199 to the US$.
Nigeria is fortunate to have low levels of public debt – 19% GDP – but it is not helped by high interest rates but high interest rates means that 35% of government revenue is taken up by servicing its debt. Lower oil prices would be the catalyst to a serious debt problem.
Russia’s exports and government revenue are heavily dependent on the price of oil. Since the oil peak in June 2014 GDP has shrunk by approximately by 4%. The Russian budget assumes an average oil price of $50 a barrel, which was to have produced a deficit of 3% of GDP. However the budget deficit rises by roughly 1% of GDP for every $5 drop in the oil price and with the current oil price around $30 a barrel the deficit would probably rise to 7% of GDP.
If the economy does start to run out of cash the option of printing money may be tempting. But with inflation at around 13% this would further fuel inflation and also mean a further weakening of the rouble which wold make Russian imports more expensive for firms and households. Russian economic data does not look healthy:
- real wages fell by 9% in 2015 and 4% in 2014
- GDP per person was $8,000 in 2015 in contrast to $15,000 in 2013
- 2 million fell into poverty on 2015
- the share of families that lack funds for food and clothing rose from 22% to 39%
- retail sales have dropped by 13% last year
The 25% fall in the inflation adjusted exchange rate in the past year brought with the opportunity to diverse away from oil. The weaker double makes exports more competitive and now that labour is cheaper in Russia than in China there is great opportunity. However, it is not going to come from foreign investors as foreign investment has fallen from $40 billion in early 2013 to $3 billion in June quarter of 2015.
Following on from my previous post, the increase in the supply of oil is starting to cause problems with regards to storage. According to The Economist (see graphic) US petroleum stocks rose by 4m barrels last week which is an 80 year seasonal high. Add this to the anticipated increase in supply from Iran after the sanctions were lifted and you have a significant increase in supply. However with reduced demand where is the supply going to housed? At this time of year, with the Northern Hemisphere winter, oil stocks usually dwindle but supply actually increased in Q4 2015 by a record 1.8m barrels a day according to the International Energy Agency. It wasn’t so long ago that investors were buying oil and keeping it in oil tankers waiting for the price to rise.
With lower oil prices below is a table looking at the winners and losers.
Ken Rogoff (Harvard University) recently wrote a very informative piece on the Project Syndicate website. He discussed the relationship between the drop in oil prices and its impact on economic growth. The price of oil has dropped from US$114 in June 2014 to $45 in December 2015 but the global GDP increase has only been around 0.5%. Over the last 20 years there have been a number of rapid fall in oil prices.
1985-86 – OPEC members decided to ignore quotas in the hope of regaining market share
2008-09 – The GFC saw a demand shock which shouldn’t have a significant impact as in the past the supply has adjusted to the reduced demand.
2014-2015 – the reduction in the price of oil has both demand and supply factors. A slowing Chinese economy has seen a downward movement in commodity prices – less demand for oil. This has been accompanied by increasing oil supply mainly from the fracking industry in the USA:
2008 – 5 million barrels a day.
2015 – 9.3 million barrels a day
Lower prices = more disposable income.
With lower prices consumers should have greater disposable income but it hasn’t stimulated a significant amount of extra demand. However Rogoff does mention that the emerging-market importers have a much larger global economic footprint than they did in the 1980’s, and their approach to oil markets is much more interventionist than the advanced countries.
China and India subsidise retail energy markets to keep prices lower for consumers but the drop in oil prices has meant that lower subsidies are now required and what government’s have saved has gone towards other areas of spending.
Oil is now seen to be less of a driver of global business cycles and even with investment in exploration falling by $150 billion in 2015 futures market have oil prices rising to $60 a barrel only by 2020.
2016 brings its challenges to oil producers with a forecast of tightening monetary conditions.
Below is a very good video from the FT about how the fall in oil prices poses big problems for the Venezuela government already trying to cope with a shortage of basic goods. Some key points from the video:
* Venezuela has the largest oil reserves in the world
* 95% of Venezuela’s export revenue is from oil
* For every $1 fall in the oil price Venezuela loses almost $700m. A $20 drop in oil prices would result in a $14bn loss in gross revenues for the country.
* With falling oil revenue and therefore foreign currency the government has less money to buy imports. The reduction in imports includes: toilet paper, maize flour, sugar, powdered milk, medical supplies.
* People have been queuing for 2 to 3 hours for three weeks trying to get basic provisions. The further the oil price drops the longer the queues become.
* The Government have introduced mandatory finger printing in some supermarkets so people don’t try and hoard basic foodstuffs.
* The government, in trying to rally support, are slashing the prices of Chinese imported goods like fridges.
* At the heart of the problem are Venezuela’s price and currency controls
* Printing local currency (Bolivar) will keep widening the government deficit and fuel further inflation – see graph below.
* Oil exports aren’t enough to subsidise everything else
The recent drop in oil prices from $115 per barrel in June last year to $58 per barrel today (10th March) has asked the question why don’t oil producers cut back on supply? This would seem to be the logical policy to pursue as the revenue of oil producers has been cut significantly. However Saudi Arabia has allowed big oil surpluses to grow and as a result the price has fallen. As Saudi Arabia can extract the oil from the ground at a much lower cost than its oil producing counterparts they have a greater ability to absorb the lower oil price. Those that have a high cost of extraction – US shale producers, the tarsands of Canada, Russia, Venezuela – are now finding the return from oil is much lower. Therefore, the plan being to force high costs producers out of the market leading to an increase in the market share of the Gulf states.
Excess Oil Supply
There has been a growing amount of oil in storage which is absorbing the glut. World stocks have increased by approximately 265m barrels last year and is suggested to increase by a further 1.6m-1.8m barrels a day in the first six months of 2015 which adds about 300m barrels to the total. Oil producers are hoping that the demand for oil will increase next year and that the accumulated stock will satisfy that demand. However the restocking cannot continue for long as storage facilities in Europe and Asia are already at 80-85% capacity. Companies are going as far as renting oil tankers to store the excess oil. And what happens if storage facilities start to reach full capacity, then producers will be forced to dump supply onto the market dropping the price even further. There is the belief that oil prices will drop in the long run which will mean a restructuring of the industry.
Source: The Economist February 21st 2015
Over the last year oil prices have fallen by 55% with the price of a barrel of oil around the US$48 – see graph. China is the world’s second largest oil consumer (behind the United States) and largest net importer and is set to benefit from lower oil prices as consumers have more disposable income. Firms can also take advantage by reducing costs and boosting profits.
Since 1995 China’s oil consumption has been driven by the country’s rapid rate of growth especially in the manufacturing sector. By 2002 China had overtaken Japan as the second largest oil consumer. However oil’s share of China’s primary energy consumption has declined since this time – from 23% in 2002 to 18% in 2013 – as other energy sources have grown more rapidly. For most developed economies oil makes up approximately 37% of energy needs. China is still quite reliant on coal for around 70% of the country’s energy needs – see graph.
Last year China imported oil to the value of US$228bn which equates to 19% of total imports and 2.5% of GDP. With the lower oil prices there will be a reduction in money leaving the Chinese economy which should boost more domestic consumption.
Source: National Australia Bank
A widely used measure of the impact of oil prices on major producers’ governments is the fiscal breakeven price. That’s “the average price at which the budget of an oil-exporting country is balanced in a given year,” according to Standard & Poor’s. Estimates of fiscal breakeven prices can vary considerably based on a variety of factors including actual budget expenditures, and differences in oil production forecasts.
For most countries oil needs to be above $100 a barrel to balance the budgets of major oil producing countries. Venezula which has major deficit problems and accelerating inflation needs oil at $151 a barrel in 2015 to balance its budget. For Iran, which has yet to agree to curb development of nuclear weapons and heavily subsidizes gasoline for its citizens, needs oil at $131 a barrel. And Russia needs oil at $107 for a chance of getting its finances in order. As for Libya a whooping $317 per barrel is required for them to start to improve their fiscal position. See graphic below.