Dropping Oil Prices Affect Emerging Markets Differently

Johnson (JGSM) 2-Year MBA (2MBA) Class of 2015 students.

The falling price of crude oil is helping oil dependent countries, but hurting oil producers

Dropping Oil Prices Affect Emerging Markets Differently

by Jared Woodrey, MBA ‘15

As I write this paper, crude oil prices have crashed through the $80/barrel barrier thanks to a decrease in overall global demand, an increase in US oil increase, and a large jump in supply from Nigeria and Libya. This sudden, and mostly unanticipated, swing from prices north of $105 only six months ago has had disproportionate effect on companies. It has created some winners, specifically price sensitive consumers of oil, and some losers, primarily undiversified producers of crude oil with high cost structures. On a larger scale, countries have come out favorably in response to lower oil prices while other where negatively affected by a drop in price. Emerging markets in particular were particular vulnerable to a change in oil price as many of their economies depend heavily on the production and consumption of oil. This paper will specifically discuss the short and long term effects on some emerging economies around the world.

On the short term, the immediate harmful effects of lower oil prices can be seen in Venezuela where oil and gas (O&G) account for 25% of GDP1. Venezuela’s O&G cost structure requires a break-even price estimated at over $100/barrel2 making the recent drop in price particularly painful. Russia, too, is particularly vulnerable as O&G accounts for 16% of GDP3 and has a breakeven price of $105/barrel4. Russia is particularly vulnerable due to federal revenue being heavily reliant on state run O&G industry (accounting for some 52% of revenue5); this reliance is compounded by the recession in Russia induced by US and EU trade sanctions in response to the conflict in Ukraine. Some prominent oil producers have wisely hedged away their risk to oil prices through sovereign wealth funds (Qatar, UAE) and diversified economies (Indonesia, China). Other emerging economies have seen agricultural commodity prices drop in line with lowered cost of oil inputs creating no significant net change. The economies that benefit most from lower oil prices tend to be the largest importers of oil (China, US, EU, Japan).

The long-term effects of lower oil prices don’t always require sustained low prices. The countries that would benefit the most from an acute price drop are those who heavily subsidize the cost of oil to consumers (Indonesia, Thailand, Vietnam, Malaysia, India all subsidize energy draining 2.3-3% of GDP 6) who have to opportunity to phase out or eliminate fuel subsidies. This ultimately contributes to an accurate pricing of oil-heavy transportation and therefore the emergence of more carbon efficient and economically advantageous transportation substitutes such as rail. Additionally, the lower oil prices might stimulate the desire to further diversify from oil revenues in economies that are particularly sensitive to low prices such as Malaysia whose economy is diversified but correlated to oil prices. The emergence of alternative energy could be seen as a more viable hedge against the volatility of a fluctuating oil market.

Overall, the undiversified oil producers that have the most to lose in a demand starved oil market. Producers that have alternate revenues are less affected, but the real winners might be found in markets that take the low oil prices as an opportunity. The low prices afford a rare time when subsidized products are very closely to real market prices, and an opportunistic government might seize the change to take a long-term improvement of the economy. The ripples stemming from low oil prices will hopefully be seen in an increase in more efficient and economically sustainable infrastructure as well as alternative energy sources. Only time will tell, but I for one am an optimist.

1 http://www.opec.org/opec_web/en/about_us/171.htm
2 http://www.realclearenergy.org/charticles/2012/10/22/opec_median_budgetary_break-even_price_106748.html
3 “World Development Indicators: Contribution of natural resources to gross domestic product”. World Bank.
4 http://www.businessinsider.com/r-falling-oil-price-tilts-political-economic-balance-in-us-favor-2014-9
5 http://www.eia.gov/countries/cab.cfm?fips=RS
6 http://online.wsj.com/articles/fuel-subsidy-cuts-threaten-energy-demand-in-asia-1412855366