Stress test for exporters as oil price slides

A continued slump in the price of oil will show whose financial defences are sound.

When under siege, it is best to assume the enemy will camp before the gates for a long time. Oil exporters are now besieged by lower prices. They recall the last slump, from 1986 to 1999, brought some to the threshold of bankruptcy – with Saudi debt reaching 100 per cent of its GDP.

The current price weakness will probably not be so deep, but it could be as prolonged. This is still no crash – current prices around $80 per barrel remain very high in historical terms. Further geopolitical disruptions and an economic revival may buoy prices, but expanded global production and greatly improved energy efficiency will moderate the market for a long period. Gas prices are often linked to oil, but here oversupply is even more pronounced – another peril for Qatar and Russia.

Some oil exporters had already begun to get their defences in order. The GCC states have built up large sovereign wealth funds. In the past year or two, they began to trim government spending or at least slow its growth. Others – such as Venezuela, already at risk of defaulting on its debt and calling vainly for an emergency Opec meeting – have been less prudent.

Oil producers have three lines of defence against reduced oil and gas revenues.

First is the management of the oil sector itself. National oil companies have had a fairly easy ride over the past decade or so, with high prices and steadily expanding demand. Now they will have to become much more efficient. They need to reconsider how they price their oil to remain competitive in the key Asian market.

With the prospect of budget deficits in Oman, Bahrain, Iran, Iraq and even Saudi Arabia, the energy sector is the best bet for attracting foreign direct investment.

Falling prices make the Middle East’s low-cost fields more attractive – if terms are attractive, flexible and free of undue bureaucracy. Marginal and technically difficult fields require international expertise, as does the gas sector, which is falling well short of potential in nearly every Opec country.

Runaway domestic energy demand will have to be curbed by eliminating subsidies. This becomes easier as the gap between world oil and gas prices and regulated domestic prices is reduced.

Secondly, most oil exporters have attempted over the past decade to broaden their economies beyond hydrocarbon exports. But too often this was fuelled mainly by government-led megaprojects funded from petroleum revenues. Energy-intensive industries and petrochemicals were only a partial diversification from crude exports.

Future economic growth has to depend more on the private sector, and small and medium enterprises. Some sectors, such as aviation, shipping and tourism, benefit from lower oil prices, especially when they target oil-importing countries, such as India and China.

Thirdly, in macroeconomic management, governments will have to cut budgets. Most will probably take the politically expedient step of slashing investment and foreign aid, while protecting salaries and social benefits – but this comes at the cost of long-term growth.

As I have suggested previously, exporters could have hedged production in the futures market to protect against price falls, or taken oil-indexed loans. Large sovereign wealth funds, foreign currency reserves and borrowing will provide a cushion to cover deficits, but this should be a stopgap towards more balanced budgets.

Those countries with the strongest macroeconomic positions are also the best placed to demand Opec discipline. But if the organisation does cut production, this should be only moderate and aimed at a clear and realistic oil price target. Defending market share is probably the wisest policy – but will be very tough for the weaker Opec members.

This slump may be short or prolonged, but if it drags on we will soon discover whose financial defences are sound and who has built their oil economy on sand.

Robin Mills is the head of consulting at Manaar Energy, and author of The Myth of the Oil Crisis