Analysis: The effect of sliding oil prices on Nigeria & the world economy (Part 1)

by Mondiu Jaiyesimi and Victor Ajayi

Petrochemical Plant

Oil-producing countries like Nigeria, Venezuela and Russia will bear the brunt of the collapsing prices as they are already facing difficult challenges in sustaining their economies due to a major revenue shortage.

The volatility of crude oil price is making the news again, this time, with a more severe and devastating effect on countries and businesses heavily reliant on the revenues accruable from the world’s most traded commodity. While some stakeholders are relishing this current state of affairs, the Economist magazine sums it up by saying “cries of woe are outnumbering the shouts of joy”. This assessment will look at the key elements affecting oil price today, its damaging effect and the historical background of the vital subject.

In simple terms, the major determinants of price of oil are the market forces of demand and supply. In more intricate terms, it encompasses a broad range of factors such as weather, market expectations, geopolitics (e.g. diplomatic sanctions and wars) and economic growth to name a few. The implications of the falling oil prices on the world economy could be analysed from different perspectives.  While oil-importing countries such as China, India and Japan stand to gain significantly from the decline in the price of crude oil (as it would mean cheaper energy to drive these economies), oil-producing countries like Nigeria, Venezuela and Russia will bear the brunt of the collapsing prices as they are already facing difficult challenges in sustaining their economies due to a major revenue shortage. However, the impact portends to be mixed in the case of the United States of America as the country stood as the world’s largest consumer, importer and producer of oil according to US Energy Information Administration (EIA) in 2013. The net impact will eventually be determined by the magnitude of fall in the oil prices and the flexibility of the North American country.

 

A History of Shocks

The history of oil price dates back to the 19th century, approximately from 1861 but events from the 20th century tell two major stories. First, the rise of the seven sisters (the seven oil giants that formed a cartel in 1920s to control oil price) and the emergence of the National Oil Companies leading to the founding of the Organisation of Petroleum Exporting Countries (OPEC) in 1960.

Between 1920s and 1960s, the International oil companies were able to keep oil price stable, notably below $40 per barrel until the 1970s when OPEC started its ploy to influence oil prices.  The cartel’s first attempt to exert this control was in 1973 when an oil embargo was placed on the Netherlands and the United States for supporting the state of Israel in the Yom Kippur war- oil price rose by 400% within a year in nominal terms.

The Iranian revolution followed and between 1978 and 1982, oil price doubled from $46. 13 to $93.41. A rise in non-OPEC oil production and a decrease in global oil demand between 1983 and 1986 sent oil price crashing down to $14.92. Despite a few shocks to the market between 1988 and 1997, oil price averaged around $17 to $18 per barrel before it crashed again in 1998 to $12.72 due to the Asian financial crisis.

Post 2000 events saw the invasion of Iraq, 9/11 attacks on the US and the devastating economic downturn in 2008 have their respective effects oil price. There was a steady increase before 2008 (besides a minor dip in 2007) towards the $150 mark before the recession sent it crashing back down to below $50.  It recovered afterwards, with the effect of the Arab spring in 2010 to keep prices above $100 before this recent slump.

 

Shale Oil Production- The American Dream

The United States has recorded a significant boost in domestic crude oil production and a corresponding reduction in oil importation in recent years as a result of the discovery of fossil fuels from shale formations.  The exploitation of shale oil and gas was considered a much needed progress towards energy security to mitigate the damaging impact of oil price instabilities on the US economy in future and to offer a long term solution to world energy demand and the environmental consequences notwithstanding.

This unconventional oil extraction has been aided by hydraulic fracturing and horizontal drilling which involves blasting underground rocks with a mixture of water, chemicals and sand.  As a result of this, the USA, the largest consumer of crude oil (19.9% of world total in 2013), has seen a downward steep its net importation. According to US Energy Information Agency, its net oil importation dropped by record levels of 22.59% in thousand barrels between September 2010 and September 2014 as opposed to being the biggest oil importer of crude oil in 2010. Nigeria exemplifies this drop in US imports as the North American country cutback its oil importation from Nigeria by 94.71% in the same period.

The US, a non-OPEC member, which has been partly responsible for this global supply glut and continued weak demand, accounted for 96% of all the increase in output generated by non-OPEC countries relative to the previous year. With this increase in supply and reduction in imports from such a key economy, it is inevitable that this trend will begin to have some adverse effect on crude oil prices.

 

Reduction in Demand in Europe

Before the recent fall in crude oil prices, its demand has been on the decrease in Europe. In 2013, 51% of global oil consumption came from non-OECD countries and OECD consumption has witnessed a decline for the last 8 years now recording a fall in 7 out of 8 years. The reasons are not far-fetched- the continent has the most members in the OECD and has been spearheading the campaign for energy efficiency, reduction in carbon emission and the increased use of renewable energy for years now.

While forecasts suggest that oil will still dominate the energy mix in Europe for the next 30 years, its leading role will be challenged by natural gas and the role of other renewable sources will only increase. Hence for security of supply and environmental sustainability, it is only reasonable to expect this trend of reduced demand from Europe to continue especially with stricter policies on carbon emission being introduced and technological advancement influencing the way people consume energy.

In the same vein, the current sluggish economic growth in Europe has been responsible for its low oil demand. Giving that economic growth has a positive correlation with demand for energy, the lingering economic recession in Europe has reduced their demand for oil to a great extent causing global supply, in part, to outstrip demand with the resultant effect of a drop in the price of oil.

 

China’s Slow Growth

The situation with China has never been this lucid. A dip in economic performance in the second largest country in the world has the potential to affect the price of oil. Rising oil consumption in China, thanks to its excellent economic growth, was partly responsible for the sustained high price enjoyed over the past years with the price hovering around $100 per barrel since 2010 until its recent plunge. Indeed, China consumed the most energy in 2013 and is the third largest consumer of crude oil behind the United States and Russia.

Having usurped and overtaken the USA’s GDP based on purchasing-power parities estimate at the end of 2014 as reported by IMF, the Chinese economy is now the biggest in the world.  However, growth in the key Asian country has not been as impressive as the levels recorded few years ago. The economic growth has slipped in the past several quarters with a projection of further decline in 2015 due to the slowdown in the global economy which triggered a fall in its manufacturing exports.

More so, China is adjudged a world leader in renewable energy generation and has recorded substantial growth in this area which is progressively replacing a portion of its share of fossil fuels consumption; a measure not only considered as a sound carbon emission reduction strategy but also as an alternative source of energy for security of supply. Effectively, just like its OECD counterparts, this has led to China’s systematic switch away from oil to other fuels in its energy mix with a knock-on effect of declining net oil importation.

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The concluding part of this piece will be published by 4pm today.

 

Op-ed pieces and contributions are the opinions of the writers only and do not represent the opinions of Y!/YNaija.

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