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Economic Exposure to Oil Price Shocks and the Fragility of Oil-Exporting Countries

Figure 3. Map of oil exporting countries (2014).
  •     Upper right: high exposure of the economy and government revenue, but high reserves that can act as a long-term buffer for the economy. This group gathers most of the Middle-Eastern exporters. Oil exports are in particular very high compared to GDP for Iraq (IRQ) and Saudi Arabia (SAU), even though their high reserves per capita may give some longer-term resilience to oil price changes. The value of oil exports nearly matches the size of government revenues in Iran (IRN), hinting at a strong relation between the state’s fiscal capacity and the oil price. The conflict in Libya (LBY), a country with very high reserves per capita that is shown in this category, has origins that go beyond the oil market. With high reserves per capita, Venezuela (VEN) also features in this group, with more favorable conditions with respect to exposure and resource availability (including nonconventional oil), although the country is facing an economic downturn as of recently. The latter two examples highlight that oil markets are not the only determinant of political and economic stability.
  •     Lower left: limited reserves but limited exposure of the economy. This group actually gathers only Mexico (MEX) and Sudan (SDN), two large countries where oil exports are small, making their economies comparably less dependent on the oil market.
  •     Lower right: high reserves and low exposure of the economy. This is the group with the expected highest economic stability with respect to oil price: small oil exports compared to GDP and high reserves per capita. In this group we find Canada (CAN), which does not come as a surprise based on the high political stability and human development statistics displayed in Figure 4.

Macroeconomic Performance and Government Revenue

Whereas the descriptive statistics in the previous section focus on one single point in time (mainly the year 2014), here we perform an econometric analysis spanning the period of 1990–2014 to provide insight into the impact of oil price fluctuations on macroeconomic performance (GDP) and government revenue in oil-exporting countries. Results (estimates for elasticity parameter β are presented in Figure 7 and Figure 8 and Table 3 for the following regression equation:

to provide insight into the impact of oil price fluctuations on macroeconomic performance (GDP) and government revenue in oil-exporting countries

Figure 7. Elasticity of GDP per capita to oil price (1990–2014). Size of the bubbles indicates population size in 2014. GDP per capita and oil price are expressed in current USD.

Figure 7. Elasticity of GDP per capita to oil price (1990–2014). Size of the bubbles indicates population size in 2014. GDP per capita and oil price are expressed in current USD. Data source: oil price [19], oil exports [19,20], GDP [25], and population [21].

 Figure 8. Elasticity of government (Gvt) revenue per capita to oil price (1990–2014). Size of the bubbles indicates population size in 2014. Government revenue per capita and oil price are expressed in current USD.

Figure 8. Elasticity of government (Gvt) revenue per capita to oil price (1990–2014). Size of the bubbles indicates population size in 2014. Government revenue per capita and oil price are expressed in current USD. Data sources: oil price: BP (2015), oil exports: BP (2015) and Enerdata (2016), government revenue: IMF (2015), population: UN (2015).

 Table 3. Regression of GDP and government revenue (per capita) to oil price. Source: oil price is from BP (2015), oil exports are from BP (2015) and Enerdata (2016), GDP from World Bank (2016), government revenue from International Monetary Fund (IMF) (2015), and population from United Nations (UN) (2015).

Table 3. Regression of GDP and government revenue (per capita) to oil price. Source: oil price is from BP (2015), oil exports are from BP (2015) and Enerdata (2016), GDP from World Bank (2016), government revenue from International Monetary Fund (IMF) (2015), and population from United Nations (UN) (2015).

Two estimations are performed, in which the dependent variable is either the GDP or the government revenue. An elasticity value of 1 implies that an x% change in oil price is matched by an x% change GDP per capita (or government revenue per capita). By expressing the dependent variable in per capita terms, we account for the size of the country. Furthermore, we do a trend-corrected estimation by including a variable that captures linear trends over time.

Both Figure 7 and Figure 8 show that the elasticities of GDP and government revenue with respect to the oil price rise with the dependency on oil exports. The reactivity of GDP per capita to oil price, shown in Figure 7, appears high (above the average over all exporters of 0.55) for five Sub-Saharan African exporters, two North African exporters, and three Middle-Eastern countries including Iraq (IRQ) and Iran (IRN).

For countries like Congo (COG) and Angola (AGO), the elasticity of the GDP per capita with respect to the oil price approaches 1, indicating strong comovements between macroeconomic performance and crude oil prices. The other Gulf Cooperation Council exporters (0.4–0.5), Nigeria (NGA, 0.4), and Sudan (SDN, 0.3) display a lower reactivity of GDP to oil price, in the order of magnitude of other exporters like Canada (CAN), Norway (NOR), and Venezuela (VEN) (all below 0.4). The low elasticity of the United Arab Emirates (ARE) may be explained by a more diversified economy, with Dubai developing its services sector beyond the oil and gas industry (see Figure 6 above and [27]). The low elasticity of Mexico may be explained by the comparably small value of oil exports compared to GDP, improving resilience to oil price shocks.

Government revenue can perhaps be considered as a better indicator than GDP in terms of short-term political stability, since it connects to the capacity of the state to deliver basic public needs such as health, infrastructure, or security. Although on average, the value of the elasticity of government revenue is comparable to that of GDP (due to relatively large government revenue in Mexico, Norway, and Canada), region-specific estimates show elasticity values that exceed unity for several countries, particularly in Sub-Saharan Africa (five countries), but also in Iraq.

Furthermore, North African exporters and large Middle-Eastern countries also show a very high elasticity (above 0.8), suggesting substantial dependency of the state budget on oil price fluctuations. As an illustration, Angola (AGO, with an elasticity of government revenue above 1) has sent on April 6, 2016 [28], a formal letter to the International Monetary Fund (IMF) for support to deal with the impact of low oil price on the fiscal revenues of the state. Smaller Gulf Cooperation Council exporters and Gabon (GAB) show a lower ratio (around 0.6), which remains higher than for other exporters (Mexico, Venezuela, Canada, and Norway).

As with GDP, the singular behavior of the United Arab Emirates (ARE) may be explained by its diversification towards a service economy, which helps in providing alternative revenues to its government—see Figure 6 on the share of oil-related sectors in the economy and other work [27] for a discussion on Dubai and the United Arab Emirates.

Macroeconomic Impacts of a Drop in Oil Prices

Methods: Scenario Definition and Model Description

This section presents the two scenarios analyzed in Section 3.2. The type of analysis presented here is based on a comparative static approach, which means that a scenario is compared to a baseline for a given year (2015), which differs from a projection or forecasting exercise. We study a low oil price scenario that is ceteris paribus in nature: the change in oil price is the only difference between the scenario and the baseline, such that the resulting macroeconomic impact can be uniquely attributed to the oil price shock and corresponding general equilibrium feedbacks. The “baseline” considers “business-as-usual” development, with oil prices remaining around 100 USD per barrel in 2015. The “60% scenario” assumes an oil price of 40 USD per barrel in 2015, which is 60% lower as compared to the baseline in dollar terms.

The macroeconomic impacts of the oil price scenarios are analyzed with the JRC-GEM-E3 (General Equilibrium Model for Economy-Energy-Environment) model (for a recent application see [29]). It is a multiregion computable general equilibrium model that covers the interactions between the economy, the energy system, and the environment.

JRC-GEM-E3 covers the entire economy and can be used to evaluate consistently the distributional effects of policies on the national accounts, investment, consumption, public finance, foreign trade, and employment for the various economic sectors and agents across the countries. The model includes all 28 member states of the European Union (EU) and all major non-European countries. The whole economy is represented in 21 economic sectors. The countries are linked through endogenous bilateral trade. The JRC-GEM-E3 results are of comparative static nature, and reflect the annual impact of imposing the lower oil price during a full year with the economy fully adapting to the new situation.

In other words, the lagged impacts of oil price changes are observed to be spread over a couple of years, whereas in the JRC-GEM-E3 model they are assumed to happen immediately in the same year. Further, this methodology also assumes that the EU economy is in equilibrium. The model is calibrated using the GTAP 8 (Global Trade Analysis Project) database. The JRC-GEM-E3 model has been used to analyze the macro economic effects of the climate, energy, and air quality policies to support EU policymakers. Other applications [30,31,32] use earlier versions of the JRC-GEM-E3 model to simulate the impact of high oil prices (the latter focusing on the cross-relation with climate policies) and to analyze a number of scenarios of the 2012 Iran crisis and the boycott imposed by the Western world.

Simulation Results: The Key Role of Oil Trade Dependence

This section presents the macroeconomic impact of the 60% scenario with the JRC-GEM-E3 model. Both consumption and gross domestic product (GDP) are presented as a percentage difference from the baseline. The global consumption and GDP increases in the world are around 1%. As expected, the economic impact on oil importing countries is positive, while oil exporting countries are negatively affected by lower oil prices.

Figure 9 and Figure 10 and Table 4 and Table 5 show that the economic impact on oil price drop is not uniform across countries. Consumption decline in oil exporting countries would range from 2.1% to 12.8%. The fall in the price of oil results in a steep decline in consumption in Middle East countries, particularly Saudi Arabia. In Sub-Saharan Africa, a 60% reduction in the price of oil would lead consumption to fall by 7.25%. Given that Sub-Saharan Africa is analyzed as a whole, the impact on oil exporting countries is expected to be even higher.

Table 4. Impact of a 60% oil price drop on private consumption. Source: JRC-GEM-E3 model.

Table 4. Impact of a 60% oil price drop on private consumption. Source: JRC-GEM-E3 model.

The effect on North African countries is lower than that on the rest of oil exporting countries (a 2.1% contraction) due to their relatively low consumption level and their economic structure not excessively depending on oil exports. In general terms, consumption impact differences could be partly explained by the degree of economic dependence on oil. Figure 9 shows the relation between consumption variations and oil exports. Perhaps unsurprisingly, the effect of oil prices on consumption is strongly correlated with export dependence.

Figure 9. The impact of the low oil price on consumption vs. export dependence. Source: JRC-GEM-E3 model. Abbreviations: 28 Member States of the European Union (EU28), North Africa (NOAF), Sub-Sahara Africa (SSAF), Rest of Middle East (MIEA).

Figure 9. The impact of the low oil price on consumption vs. export dependence. Source: JRC-GEM-E3 model. Abbreviations: 28 Member States of the European Union (EU28), North Africa (NOAF), Sub-Sahara Africa (SSAF), Rest of Middle East (MIEA).

Thereby, countries where the share of oil in total exports is very high are more vulnerable to lower oil prices. Although this is an important determinant for the results, a country’s net trade position for crude oil is not the only factor influencing the macroeconomic impact shown here.

Table 5. Impact of a 60% oil price drop on real GDP. Source: JRC-GEM-E3 model.

Table 5. Impact of a 60% oil price drop on real GDP. Source: JRC-GEM-E3 model.

The impact on GDP incorporates oil consumption in all sectors in the economy. Canada, although being a net exporter of crude oil, experiences a macroeconomic benefit from the drop in oil prices, which could be explained by the high rate of oil use per capita in the country, combined with a potential positive effect of increased global economic output on Canada’s exports of goods and services.

Figure 10. The impact of the low oil price on GDP vs. export dependence. Source: JRC-GEM-E3 model.

Figure 10. The impact of the low oil price on GDP vs. export dependence. Source: JRC-GEM-E3 model.

Similarly, Figure 10 shows that the sharp decline in oil prices affects the GDP of oil exporting countries in a heterogeneous manner. A 60% reduction in the price of oil results in a 15.2% decline of the GDP in Central Asia and Caucasus, while the GDP of North Africa would decline by 2.8%. The GDP of Middle East and Sub-Saharan African countries would decline by around 8.5%.

The impact of the low oil price on GDP is strongly correlated with import dependence (Figure 10). For instance, in Saudi Arabia where crude oil exports represent 35% of the GDP, a 60% fall in the price of oil leads GDP to decline by 14.3%. On the other hand, Mexican crude oil exports represent 3.4% of the GDP and therefore, the decline of the GDP would be substantially lower (3.9%).

Discussion

Between mid-2014 and March 2016, the price of crude oil fell around 65%, likely caused by a combination of drivers: (i) the U.S. tight oil evolution pushing up production levels, and the OPEC’s (Organization of the Petroleum Exporting Countries) lack of intention to stabilize prices; (ii) an unanticipated slowdown of economic growth in Asia; (iii) supply and demand dynamics resulting in rising levels of oil stocks; and (iv) the increase in the value of the U.S. dollar compared to other currencies, making crude oil more costly for other countries.

Low and volatile oil prices pose challenges for regions with a strong economic reliance on oil production. This paper combines an econometric analysis with a model-based assessment to explore the relation between macroeconomic outcomes and oil price fluctuations in regions that are net exporters of crude oil.

Firstly, estimates reveal the strong connection between oil prices and GDP (and government revenue) over the period of 1990–2014 in several oil-exporting regions. Several Sub-Saharan African exporters, in particular, show a vulnerable position that combines a relatively strong economic dependence on oil prices, limited buffer capacity through sovereign wealth funds, low oil reserves per capita, and comparably low indicators for political stability or human development. Adding high projections of population growth, the economic and political stability in Nigeria could be susceptible to oil market disruptions.

North African producers Algeria and Libya share several of these characteristics, rendering the countries vulnerable to a lasting period of low oil price, particularly in the light of ongoing conflicts in the region. Many countries in the Middle East strongly depend on oil production, but appear less vulnerable to low oil prices because of low marginal production costs, the presence of a SWF, and relatively high reserves per capita. The United Arab Emirates appears less sensitive to the oil price, due to economic and fiscal diversification, a large SWF, and a relatively high political stability.

Secondly, the economy-wide impact of a 60% reduction of the oil price is analyzed with the JRC-GEM-E3 model, contributing to the literature on oil price shocks and macroeconomic performance [33,34]. This model-based assessment complements the historical analysis by comparing a situation with and without the drop in oil prices, thereby isolating the price shock from other events that may occur in the same time horizon in a real-world setting.

The results show that an oil price drop can have substantial effects on oil-exporting countries, with regional impact differentiation strongly correlated with import or export dependence. While crude oil importers experience relatively small benefits from lower prices, countries with a high share of oil in total exports appear economically vulnerable to short-run oil price decreases, with simulated GDP decreases ranging between 2% and 13%.

Although the macroeconomic analysis does not account for the potential use of SWFs, results (Section 3.2) suggest lower elasticities of GDP to changes in the crude oil price compared to the backward-looking regression analysis (Section 2.2). Apart from differences in regional aggregation, the macroeconomic modelling assessment excludes price shocks of other commodities, while the econometric analysis did not control for the economic impact of other commodities or natural resources. This could be explored in further research, incorporating a fully-fledged econometric analysis and addressing endogeneity issues that arise because of the two-way influence between oil price and GDP.

Emanuel Martin
Emanuel Martin is a Petroleum Engineer graduate from the Faculty of Engineering and a musician educate in the Arts Faculty at National University of Cuyo. In an independent way he’s researching about shale gas & tight oil and building this website to spread the scientist knowledge of the shale industry.
http://www.allaboutshale.com

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