Living with low oil prices

FATİH MACİT

The decade-long high prices in oil have significantly changed the macroeconomic dynamics both for energy-exporting and energy-importing countries. Energy-exporting countries like Russia, Saudi Arabia, Azerbaijan, etc. have experienced a rapid increase in their GDP per capita and they have accumulated large amounts of current account surpluses. On the other hand, countries like Turkey, India, South Africa, etc. that are largely dependent on imported energy have faced a large increase in their trade deficits. World economy has entered a new episode of low oil prices and the energy-exporting countries need to adopt appropriate economic policies in order to be able to deal with this new economic environment.

In the past, there has been five other periods in which oil prices have experienced a decline similar to the one seen the second half of 2014. Four of these episodes were observed when the global economy significantly slowed down and therefore oil demand weakened. The 1990-1991 and 2001 U.S. recessions, 1997-1998 Asian crisis and 2008-2009 global financial crisis are the four episodes in which oil prices declined by more than 30 percent in less than a year. The recent decline in oil prices does not resemble these episodes as the world economy is not facing a recession. 1985-1986 is the other period during which oil prices experienced a sharp decline in a relatively short period of time and the 2014-2015 oil bust has some similar aspects to this episode. The increase in unconventional oil production coming from the North Sea and the Gulf of Mexico and the shift in OPEC policy could be cited as the main reasons for the decline in oil prices that was observed in 1985-1986. The low prices continued for more than a decade and the prices turned back to their previous levels early in the 2000s. The 2014-2015 oil bust is similar to this episode in terms of the recent increase in the U.S.’ unconventional oil supply and the change in OPEC policy in November 2014. Taking into account this similarity, there is the possibility that it may take more than a decade for the oil prices to turn back to three digit levels and it will take some time for the market to come into a new equilibrium. Therefore, an important priority for oil-exporting countries will be adopting this new economic environment.

The decline in oil prices and the perspective that these low prices may continue for a long period of time creates two important problems for energy exporting countries and their macroeconomic policies should be directed towards solving these problems. The first problem is related with the increase in budget deficits. Oil-exporting countries are significantly using their sovereign wealth funds in order to finance government spending. For instance, in Azerbaijan, more than 50 percent of state budget revenues come from the State Oil Fund of Azerbaijan (SOFAZ). Russia has used almost 20 billion dollars over the last year from its reserve fund to finance its increasing budget deficit due to low oil prices. Saudi Arabia has announced that the budget deficit amounted to 98 billion dollars in 2015 and the government took some significant measures to cut back spending and increase budget revenues. These examples reveal that the deterioration in fiscal balances will be an important problem for oil-exporting countries over the next couple of years. Therefore, there should be a serious overview of state expenditures and those that do not have an economic priority should be delayed. 

The second problem that needs to be considered due to the decline in oil prices is related with the developments in balance of payments. Oil and gas constitute a major part of total exports in many energy-exporting countries and the decline in prices may put a downward pressure on current account balances. Letting the national currencies to freely float may be a solution in terms of avoiding sharp losses in official foreign reserves.


*Assoc. Prof. Fatih Macit is a senior fellow at the Hazar Strategy Institute and head of the economics department and director of the Center of Economic Studies at the Suleyman Shah University (fmacit@ssu.edu.tr).