With the demand for oil dropping over covid-19 and the over supply in the market, oil prices have collapsed. Brent crude fell by more than half in March to below $23 per barrel. For many years OPEC – Organisation of the Petroleum Exporting Countries – has manipulated supply to maintain higher prices. Since 2017 both Saudi Arabia and Russia have been working together to prop up oil prices but have had a falling out over Saudi Arabia’s insistence on cutting oil supplies by 1.5 million barrels per day.
Cost of extraction v Price of a barrel
Like any business you need to consider costs relative to the price of your good or service. Some shale oil wells in the US may have a break-even point of $40 a barrel despite the high fracking costs. However some sources say that it is above $60 a barrel with the higher-cost wells coming in at over $90 a barrel. These industries cannot survive in this environment of such low oil prices. Also the Canadian tar sands are another costly method of extracting oil and this could lead to a shut down of production.
By contrast in Saudi Arabia the extraction cost is around $9/barrel with Russia coming slightly higher at $15/barrel. The Middle East and North Africa are also very efficient, producing oil as cheaply as $20 per barrel. Worldwide, conventional oil production typically costs between $30 to $40 a barrel.
Nevertheless countries like Venezuela and Nigeria depend hugely on oil revenue for their spending. Although Russia and Saudi Arabia have significant foreign reserves the more the virus persists and demand keeps falling the greater the damage. Useful video from Al Jazeera below.
Below is a very good video from the FT outlining the latest disagreement between the USA and Saudi Arabia. Since 2017 both Saudi Arabia and Russia have been working together to prop up oil prices but have had a falling out over Saudi Arabia’s insistence on cutting oil supplies by 1.5 million barrels per day.
China the biggest importer of oil has cut back on oil consumption because of the coronavirus outbreak was bringing the economy to a standstill. Oil prices had their biggest one-day fall since the 1991 Gulf Crisis – some are expecting prices to go to $20 a barrel. What is at the heart of the fallout? Russia’s anger over sanctions targeted at its oil giant, Rosneft Trading. Washington imposed the sanctions last month over its continued support in selling Venezuela’s oil. Moscow was hoping to get Riyadh on its side to inflict economic pain on US shale producers, who Moscow feels have been getting a free ride on the back of OPEC+ production cuts. Shale production has pushed the United States into the number one spot as the world’s biggest producer of oil. Moscow hopes it could lead to the collapse of some of those businesses, if oil prices remain below $40 a barrel.
Part of the excellent Al Jazeera documentary series about Russia, which addresses the problems facing many Russians today. The global economic crisis, conflicts with neighbouring countries and the drop in oil prices all played their part in the demise of the Russian people. There is a very good interview with the former Central Bank Chairman Viktor Gerashchenk who held the position during Yelstin’s reign. He explains very simply how you grow your economy and that there must be money in the banks so that companies can borrow and invest. Buying US Treasury Bills was loaning money to the US and paying for their deficit. Meanwhile the infrastructure and public services declined rapidly causing a lot of anguish amongst the people. You can’t suddenly jump from a socialist system into the free market. Worth a look.
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.
With oil prices heading to below $60 per barrel and inflation on the rise the Russian economy is bracing itself for some difficult times ahead. Oil is imperative to Russian growth rates and The Economist reported that in 2007, when oil was $72 a barrel, the economy managed to grow at 8.5%. Additionally between 2010 – 2013, when oil prices were high, the country’s net outflow of capital was $232bn – 20 times what it was between 2004 and 2008. See graph from The Economist.
But as oil prices drop so does the currency which mean imports become more expensive – the bigger the drop the more expensive they are. Russia imports a lot of goods – the value in 2000 was $45bn compared to in 2013 $341bn. This lower value of the Rouble fuels inflation and it is expected to reach 9% by the end of the year. To maintain peoples spending power the government will need to intervene in the economy and run bigger deficits.
But there is another problem a weaker Rouble makes debt servicing more expensive so in the long-term more money needs to be found. When there was a high oil price instead of increasing their reserves, money was spent on salaries and pensions and especially the armed forces where spending increased by 30% since 2008. One wonders why they spent so much on the Sochi Winter Olympics. However drastic steps are being taken to reduce the decline of the Rouble with priests blessing the servers at the Central Bank with holy water.
A hat tip once again to colleague David Parr for this piece on buckwheat prices. As Russia comes to term with falling oil prices, a depreciating rouble, high inflation and sanctions over the Ukrainian crisis there is one other indicator that is worth a mention – buckwheat prices.
Buckwheat is seen as part of the Russian staple diet and can be eaten with any meal in Russia – porridge, served with liver, stuffed inside a roast piglet. It was when rumours started that buckwheat supplies were running low that shoppers rushed out to supermarkets to fill their trolleys. A drought in Russia reduced the buckwheat harvest from 700,000 tonnes to under 600,000 tonnes but this could hardly cause the rapid increase in prices. However media reports were enough to act as a catalyst for panic buying amongst consumers -it took only four days for the town of Penza to be stripped of buckwheat stocks which normally last for two months. In Moscow buckwheat rose from around 30 rubbles to 50 rubbles. Furthermore with the introduction of Western sanctions people are starting to stock pile buckwheat as they are unsure of what will eventuate. It is estimated that over a third of the population have stocked up on buckwheat over the last month.
It seems that buckwheat is a sacred food for Russians and it tends to be in very short supply when there is any sign of crisis in the economy. But it is not just buckwheat which has increased in price. There has been a 30-40% increase in basic foods such as eggs, fish chicken, and sausages as Russia enforces retaliatory embargo banning Western food imports.
A hat tip to colleague David Parr for this interesting item. With Russia being in the news over the Ukraine situation and President Putin coming under a lot of pressure at the G20 Conference in Brisbane (in fact he left early), the Russian stock market – number 20 in the world – was surpassed in value by the iPhone maker last week. According to Bloomberg’s Mark Barton Apple could use the change to buy every Russian a 16GB iPhone Plus.
The value of Russian equities = $531 billion
The value of Apple = $667.2 billion
Singapore and Italy are now worth less than Apple as well. And with Christmas approaching who will be next?
With four months to go till the Winter Olympics in Sochi Russia the characteristics of a planned economy are still prevalent. In the old Russia of the communist-era concerns about corruption, the cost of a project, the effect on the environment and the working conditions of the labour force were brushed aside. However it seems that nothing much has changed, according to The Economist.
When the bid was placed Russia proposed to spend $12 billion. The estimated cost now is $50 billion – most expensive games in history. According to The Economist Olympics tend to have overruns of about 180% – Sochi is now at 500%
The closeness of the Government with the construction companies involved has led to corruption. Olympstroy, which oversees the construction, are run under the informal influence of a rent-seeking group of people for whom extraction of government funds is the main purpose. Furthermore one of Putin’s friends and judo partner has been awarded$7.4billion – more than the budget on the 2010 games in Vancouver. A road contract worth $9 billion went to the Russian Railways which is headed by a former KGB general and friend of Putin.
There has been little concern for the environment with construction waste polluting the Black Sea and protected forests being cut down to make way for facilities.
Low-skilled migrants get paid $500 a month and work 12 hour shifts. There is no protection for them in the form contracts, minimum wage, health and safety, and insurance. Wages are not always paid in full and sometimes not paid at all according to Human Rights Watch.
Former prime minister Yegor Gaidar once wrote about how the Soviet Union had wasted its money on construction projects whose main purpose was to utilise government funds. One wonders has much changed?
What is also quite strange is the fact that Sochi has a sub-tropical climate and is one of the few places in Russia where snow is scarce. This has led organisers to store snow.
With the CIE A2 Paper 4 exam approaching I thought it would be useful to update what is happening in the BRIC countries – remember developing countries is a popular area that is examined. I was very fortunate to attend the Tutor2u 10th Anniversary Conference in June this year where one of the keynote speakers was Jim O’Neill of Goldman Sachs who coined the acronym in a 2001 paper entitled “Building Better Global Economic BRICs”.
The BRIC’s are struggling hard to ease policies and maintain economic growth in the face of a slowing global economy not of their own making. Although you might think that these rates are high in a developed nation for these 4 developing countries growth rates need to be maintained at much higher levels in order to keep apace with the factors of production that are coming on stream.
One of the reasons for the slowdown is the economic situation in Europe and the downturn on the USA followed by their own uncertainty associated with the coming fiscal cliff. There are also consequences of the BRIC slowdown are on the commodity market. BRIC countries were the reason behind the economic growth in the past decade, which meant they had a great affect on commodity prices. As economic growth decelerates rapidly in these countries, so does energy and commodity demand. Downward pressure on oil prices and other key commodities, such as copper, are likely to continue until one can be sure that the growth trend in the emerging market countries is moving higher again. We are not at that stage yet. BRIC nations, in their own
Other reasons for the growth slowdown is the ever worsening economic situation in Europe, followed closely by the general lack of economic leadership and market confidence coming from the aging industrial countries. One cannot, however, lay all of the economic challenges in the BRIC countries at the doorstep of Europe’s debt crisis and the massive policy uncertainty associated with the coming fiscal cliff in the US.
BRIC currencies represent high-risk, high- return carry trades, due to the near-zero level of interest rates in the U.S., Europe and Japan compared to the much high rates in the emerging market world. When BRIC currencies start to appreciate it will be a sign of confirmation of two important new trends.
1. A necessary, but not sufficient, condition for BRIC currency appreciation is that the global deleveraging process is abating.
2. To complete the scenario, economic growth and the ability to attract capital needs to return to the BRICs.
Source CME Group Market Insights – 25th July 2012
BRIC’s in 2011 – Source: The Economist – 29th Sept 2012
Ever wondered why money isn’t worth the paper it is printed on? Why currencies float and occasionally sink? What ever happened to gold as the cornerstone of the currency market? There are some who believe that the world should return to aligning currency to a gold standard – in other words being able to redeem paper money for fixed weights of gold. For much of the 19th century and part of the present century, the exchange rates of the world’s most important trading countries were fixed in terms of gold. The system was known as the gold standard system of fixed exchange rates. Why return?
Some economists are very optimistic with regard to gold prices for a variety of reasons:
• The US dollar is trending downward against other major currencies, which increases the US dollar price of gold.
• The quantitative easing by central banks around the world will most likely lead to inflationary pressures which ultimately will increase the price of gold
As a result of this bullish behaviour gold is initially recovering some of its lost standing as the world’s reserve currency. What is more, with many countries now holding significant amounts of US dollars as reserves there is the probability that preference will be given to hold something else that maintains its value – gold is likely to be part of the mix. As a result many countries would favour the inclusion of gold in a currency basket that would make up of a new world currency based on Special Drawing Rights issued by the IMF. Although from 2009 The Daily Telegraph (UK) has an interesting article entitled Russia backs return to Gold Standard to solve financial crisis. It also has a video interview with Arkady Dvorkevich, the Kremlin’s chief economic adviser.