Global oil and gas markets are facing an unprecedented situation: demand is collapsing because of the impact of the coronavirus (COVID-19) while supply, already overabundant, is significantly increasing.
In some countries, large-scale production and exports of oil and gas provide vital income to finance their national budgets, which means volatility in global energy markets can translate almost instantly into macroeconomic pressure. When prices fall, these “producer economies” have often responded by trimming their spending, cutting salaries for public sector employees, and axing or delaying large capital projects. These measures have previously contributed to slower economic growth – or even contraction.
The fundamental concept
Today, many countries are as dependent on hydrocarbon revenues as they were several decades ago. However, the case for change is increasingly difficult to sidestep. Factors on both the demand and supply side have suggested for years that we are entering a period of sustained pressure on development models that rely heavily on oil and gas revenues.
On the supply side, the unprecedented growth in shale production was the primary driver of the significant price drop in 2014, and remains an integral consideration for today’s oversupplied market.
On the demand side, there are profound questions over the longer-term demand outlook as improvements in efficiency and the growing use of electric vehicles dovetail with intensified efforts from governments and consumers worldwide to respond to climate change.
The plunge in the oil price during 2014 and 2015 was a wake-up call for many producer governments. It underlined the need for change but simultaneously undercut the means of supporting it, as many public budgets were reduced sharply.
Today, we are witnessing another shock, this time from both the demand side (the coronavirus impact) and a surge in supply. In many producer economies, public finances are in worse shape today than they were five years ago, leaving them even less able to absorb the shock. And the coronavirus is set to provide a huge test for the countries’ social and health infrastructure.
The IEA has made an analysis using the IEA’s World Energy Model showing what impact the change in market conditions over the last few weeks could have on key producers. Considering also the combined impact of declining overall oil demand in 2020 according to the latest IEA Oil Market Report, a surge in supply by some low-cost producers, and a price assumption for the year that averages USD 30 a barrel.
The results are startling. Under these assumptions, oil and gas income for some key producers would fall between 50% and 85% in 2020, compared with 2019. This would represent these producers’ lowest income in over two decades.
The price 2020
In some cases, the price effect is somewhat mitigated by higher output. But in all cases, there is a sharp drop in income of at least 50% compared with 2019.
The impact of this drop in income will be felt across the board. Producer economies have not fully recovered from the previous price collapse in 2014.
Lower oil prices are expected to put severe fiscal strain on a number of the most important producers. In Iraq, the current price would imply a monthly budget deficit of USD 4 billion simply in order for the country to meet existing obligations for salaries, pensions and other current spending. The country would have to go even deeper into the red if it wanted to proceed with any investments in much-needed capital projects such hospitals, schools, roads and power plants.
As well as the likely widening of fiscal deficits, the countries’ decreased export revenues will impact their overall trade balances, leading to downward pressure on their currencies. For a number of producers that have exchange rates pegged to other currencies, this would require a drawdown of crucial foreign exchange reserves to maintain currency stability.
The impacts would not be limited to the Middle East. For example, Ecuador’s oil and gas income is projected to fall by 85% compared with last year, compounding an already difficult situation for a government that only recently announced a USD 1.4 billion reduction in public spending.
The results of this new analysis underline once again the strategic importance of the broader reform initiatives that have been underway – albeit often in a halting manner – in many of these producer countries. Economic transformation and diversified growth are essential not only to deal with the changing dynamics of global energy.
Change in the energy sector is a fundamental part of the development of more productive, innovative and sustainable economies. The reform process will be complex and challenging, but the IEA’s special report from 2018, Outlook for Producer Economies, underlined that a well-functioning energy sector – based on a wider range of resources and technologies, including renewable energy – can be a durable asset for today’s producers, providing some of the capital and know-how that can support more diversified growth.