Wednesday 18 May 2016

Oil isn't only presenting an economic risk with its price decline

If you've been an avid reader of this blog you'd have noticed the topic of oil has come up often in my daily commentary with my belief that the development of this theme will not cease to exist for some time yet. I can recall commenting on the sudden drop in oil prices and subsequent bounce expressing my opinion that oil was a sector that would become a pool of interest in the next few years. Needless to say the commodity hasn't disappointed the skeptics who have been flooded with material to write about in their debates and arguments around its production.

Much of the focus this year has centred around the growing tensions between Saudi Arabia, the defacto leader of OPEC and its rival Iran who has recently been unshackled from international sanctions that prevented it from trading its most valuable product, oil, with the rest of the world.

However the last few days has seen that attention being taken away from the impending blow up of relations between both nations and directed towards supply interruptions that's seemingly fuelling (for a lack of the word) the price of oil in the last few weeks. We've seen the devastating wildfires in Canada halting a significant proportion of oil production due to the quickening pace with which the fire has spread that posed a risk of potentially huge damages if it reached oil fields but it looks as if authorities have got the situation under control.

Although the supply interruption from this event was grave enough to cause a spike in price, it's not the type of event that will be ongoing over the medium term. I stress this because if we are to see oil prices recover fully from the slump they've experienced we'll need to see a sustained situation that would support the price recovery.

In saying this and having closely followed the oil crises since its beginning in 2014, I've taken note of two important oil producers who were the first member nations in OPEC to make an appeal to Saudi Arabia to find resolve at the height of the plunge. Both Nigeria and Venezuela have borne the most economic damage following Saudi Arabia's decision to expand production in its efforts to push out US shale gas producers.

I've previously stated that if Saudi Arabia failed to get Iran to commit to an oil production freeze it could be seen as the former overlooking the defiance of the latter with the need for close cooperation being top priority when maintaining stability in a collusive agreement. The failure to do so would cause other nations to frown upon their weighting of views and possibly cause fissures between the relationship between OPEC and themselves.

This exact implication is what I believe to be happening in OPEC at the moment with both Nigeria and Venezuela stirring up fear amongst international investors over the economic dilemma each find themselves in with the outcome leading to oil production cuts.

Nigeria's cost curve means it requires higher prices to break even, a scenario that hasn't been present for some time. Together with this the added pressure of terrorist group Boko Haram's reign of villainous attacks on the Nigerian community in fighting for a wider acceptance of Muslim minority in the country.

However the problematic situation Nigeria finds itself in at present is as a direct consequence of suppressed oil prices, bleeding the country's foreign currency reserves to near zero causing economic despair as never seen before.

The change of guard in government is left stagnant in its progression as the new cabinet along with president Muhammadu Buhari grapple with a serious cash drain on fiscal accounts as most tax revenues are raised from oil income. Although tough talking in their way to winning the election, the party sits toothless in its defence against terrorism placing it on the back burner as higher priorities take precedent over everything else.  

But neglecting to defend its people, the country has become vulnerable to more terrorist attacks with the latest attacks taking aim at oil pipelines in an effort to sabotage the benefits of foreign receipts. The growing concern amongst the international community has led to a number of leaders, most notably the United States coming to the aid of Nigeria to stop the incursion of further attacks that could risk stability in the region.
Venezuela has had a long history of disrupting foreign investment into its oil sector being a nation that holds the world's largest reserves. The countries insistence of stated owned oil assets has led to oil production being poorly developed, an often cited argument in the debate over whether stated owned production is the right economic body in producing black gold in the country.

The country's reliance of oil as a means to raise government revenue is even greater than that of Nigeria translating into a detrimental impact on the economy when the price of oil exhibits shocks that can't be smoothed out. The situation on the ground has become so unbearable that fresh water is being rationed and electricity outages are a common occurrence as government tries in vain to get a hold on an epidemic atmosphere hanging over the country.

Similarity exists between Venezuela and Nigeria in foreign reserves having been depleted however the extent of the crises differs in that the Venezuelan government has restricted the access of dollars from importers coupled with price controls meaning mass shortages of basic necessities such as food, medicine and even toilet paper! The government's unwillingness to loosen its hold on the economy has meant that tensions are rising to a point where rumours of unseating president Nicolas Maduro have rooted themselves in the public as clashes with security forces increases on escalated agitation.
In concluding, one needs to consider not only the economic risk an uncertain oil environment presents to oil producers but also the political instability that becomes born into the economies whose over reliance and ill-equipped government policies lead their nations into economic distress. OPEC's relevance might be fading slowly with petty squabbles but its impact on smaller nations of which its own policies were suppose to uplift them is suddenly tearing them apart.
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