By Thomas Lassourd and David Manley, Natural Resource Governance Institute
Probably the most dramatic aspect of the early 2015 global economy is the historically low level of commodity prices. Crude oil prices have fallen by 50 per cent since June. But oil is not the only commodity that has stumbled. Since their peak in February 2011, copper prices have dropped 38 per cent and iron ore prices have fallen a staggering 63 per cent.
Predicting the future is a dangerous occupation. Most observers – and the market -did not foresee the dramatic fall that has occurred. Some analysts and the forwards market expect prices to go even lower, before increasing to $65 per barrel in the next two to three years, while others believe prices will slowly rise to $100 per barrel within the same time frame.
These forecasts are dependent upon many geopolitical and market uncertainties, and the trajectory of prices for different commodities will also depend upon specific market factors. We can only be sure of one thing, with geopolitical tensions and industry turmoil, volatility will remain the norm in commodity markets.
For consumers and corporations in energy importing economies, low prices are a boon. But the current drop in commodity prices is already impacting the wellbeing of citizens in developing, resource-rich countries, and governments around the world are struggling to manage expectations unmet by their oil and mineral sectors. What will the consequences be for governments of these often poor, but resource-rich countries?
Budget deficits and increased borrowing
Most oil- and mineral-dependent governments will run budget deficits in 2015. This is not unusual, but the size of their deficits this year will take many by surprise. Saudi Arabia expects a deficit of $38.6bn (5 per cent of GDP), and the US state of Alaska $3.5bn (7 per cent of GDP). Luckily, both have oil funds they can draw on to stabilize expenditure. Venezuela, with an expected deficit of 17 per cent of GDP, and Yemen, with an expected deficit of 9.5 per cent of GDP, are less prepared since they must borrow internationally to maintain current spending.
Painful fiscal adjustments and the need for systems to manage it
Governments that have not put into place effective protective mechanisms, including those of Alberta (Canada) and Malaysia, face painful cuts, higher borrowing costs, steep tax increases, and even the risk of default. However, well-prepared economies, like Chile’s and Norway’s, will demonstrate that prudent macroeconomic management, fiscal rules and fiscal stabilization mechanisms (like sovereign wealth funds) can be critical tools for avoiding painful adjustments when commodity prices drop unexpectedly.
Lower exchange rates: higher inflation, and opportunity for non-oil exports
Many commodity exporters are experiencing large reductions in their exchange rates, and increasing inflation. While there will be short-term costs for consumers, this could boost the competitiveness of other sectors like agriculture or manufacturing. With an additional push in the form of public investments and trade policies, this could pave the way to more diversified economies in the future—meaning less exposure to commodity price shocks.
Opportunity for fuel subsidy reform
Gasoline prices are decreasing, along with the costs for governments that imprudently committed to subsidies. Countries like Indonesia are already seizing this as an opportunity to roll subsidies back for good, with long-term positive prospects for public finance, and more targeted social programs. Governments of other countries, like Nigeria, seem to be missing the opportunity to wean consumers off of artificially cheap fuel.
Higher carbon-based fuel consumption
Cheaper gasoline also means higher fuel consumption and weaker efforts at energy efficiency, which could undermine the global struggle against global warming. Now could be a good time for governments to introduce carbon taxes and other energy-efficient policies to counter the trend.
Lower capital investment, and delayed or canceled projects
Share prices of major oil, gas and mining companies have fallen, and capital is moving out of the sector. Many developing countries are placing high hopes on new natural resource-based investments: growth corridors in Guinea and Mozambique, anoil refinery in Uganda, natural gas in Tanzania, oil license allocations for new or prospective producers such as Liberia or Uganda. As investors review their capital expenditures for the next several years, the promise of some of these developments might not materialize for more than a decade.
Lower rent generation and pressure for fiscal incentives to maintain investment
Only a couple years ago, many industry observers blamed the high commodity prices for a rise in so-called resource nationalism—when governments use the high-price environment to renegotiate contractual terms. As the trend reverses, we expect to see cases of countries under pressure to slash royalties and taxes under threats of closure from industry.
Risks and opportunities for state-owned enterprises
We are already seeing state-owned enterprises pushing to reduce their contributions to government revenues or forced to clean up their act, under pressure from lower revenues. However, as private capital becomes less available, some governments with deeper pockets could see an opportunity to step in and finance more exploration activities. Industry costs are going down, with lower energy costs and increased competition among subcontractors. In those commodities markets where prices are expected to rebound in the longer run, now could be an opportunity to advance public exploration of subsoil assets to make the most of future booms.
Important governance reforms could be under threat
Budget cuts should encourage some governments to pursue efficient administrative processes, increase commercial competitiveness, and communicate more honestly with citizens, including through strong implementation of the new EITI standard. But it is also possible that the “inconvenient timing” of the price downturn could pose a threat to the short-term success of ambitious institutional reforms in established producers such as Mexico, where leaders have staked their reputations on the benefits that competition will bring to the oil sector.
A rise in political competition that could worsen repression and conflict
It is yet too soon to say whether lower commodity prices will mitigate or exacerbate political repression in countries like Azerbaijan, and ongoing resource-related conflicts in Libya, South Sudan and Iraq. A reduction in the proceeds available for governments to buy social peace may spark conflict in countries such as Bahrain, where leaders have used resource revenues to keep a lid on looming dissatisfaction. A decline in natural resource prices will reduce the incumbency advantages held by the leaders controlling the tap, perhaps opening the space for political dialogue and for the influence of traditionally underrepresented constituencies.
Thomas Lassourd and David Manley are economic analysts at the www.resourcegovernance.org (NRGI), a New York-based non-profit, international, independent organization helping people to benefit from their countries’ oil, gas and mineral endowments.
This post is the result of the authors’ consultation with several colleagues at NRGI.
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