By Mahinaz El Baz
Crude oil prices have reached high levels as global oil inventories have generally declined from January 2017 through April 2018. The fluctuating prices are affecting both importing and exporting countries. Exporting countries, especially the members of the Organization of the Petroleum Exporting Countries (OPEC), are facing production swings after signing the oil production cut deal and its extensions. The latest amendment on the deal was approved after OPEC’s meeting on June 22.
On the other hand, oil importing countries are facing many socioeconomic hazards. Egypt, as a net crude oil importing country, is facing intensive economic pressure due to the latest increase in oil prices. The budget deficit is expected to exceed the planned 8.4% of GDP in Fiscal Year (FY) 2018/2019, according to the pre-budget report issued by the Ministry of Finance.
What Really Caused the Price Increase?
Oil is a commodity that tends to see larger fluctuations in price than more stable investments, such as stocks and bonds. There are several influences on oil prices. Experts believe that some of those factors caused the latest increase in international oil prices to the extent of exceeding $80 per barrel in April 2018 for the first time since 2014.
Kamiar Mohaddes, senior lecturer at the Faculty of Economics & Girton College at the University of Cambridge, told Egypt Oil & Gas that the main reasons behind the hiked oil prices are geopolitical risks, higher demand – due to lower oil prices in 2015-2017 and the pick-up in global economic growth – and supply shocks. All these factors have driven prices higher. “The question is for how long,” he added.
Having a similar opinion, Jenik Radon, Adjunct Professor at the School of International and Public Affairs at Columbia University, explained to Egypt Oil & Gas that “global-economic-political insecurity is the dynamic at work and the main driver of oil price fluctuation.”
Radon further mentioned that “predicting oil prices is not a science, as much the market law of supply and demand is not the only governing factor in the determination of oil prices. And the fluctuation of oil prices is certainly not art. Therefore it is also not possible to accurately explain all the reasons why there is a hike, let alone a sudden hike, in oil prices.”
Referring to the current status of global oil demand and supply, he declared that “global demand for oil is strong, in fact it has increased, but supply is also now increasing. However, there is a significant economic insecurity at present as the US wants to re-impose an embargo on Iran, which will cut Iranian oil exports.”
Radon believes that Venezuela is imploding, and, even in the absence of political turmoil and chaos, the country has not maintained its oil producing facilities with the consequence that oil production is decreasing and foreign investment, which could revitalize the Venezuelan oil industry, is absent. “OPEC plays, as best it can, a monopolistic game, which means it seeks to optimize prices, especially as the budgets of many oil producing nations depend on the sale of oil. Moreover, with a constantly threatening global trade war, economic insecurity and uncertainty reigns. With political economic insecurity comes speculators and those who want to simply lock in prices,” he added.
Affirming Mohadde’s and Radon’s opinions, Kenanah Shereih, a petroleum economics researcher, told Egypt Oil & Gas that the recent “geopolitical tensions have increased and put the oil prices under pressure; increased instability in the Arabian Gulf alarming the global oil market; tensions between Saudi Arabia and Iran have emerged; intensifying Libyan conflicts, and the considered sanctions on Venezuelan oil industry from the United States. Beside that OPEC and other top oil countries including Russia have been limiting crude production.”
Oil Price Forecasts
OPEC’s 2017 landmark production agreement has been a game changer for oil markets, as Saudi Arabia agreed to cut production (and implicitly exports) and Russia agreed to postpone the increase of its record high and steadily rising liquids output.
The OPEC deal removed more crude than originally intended from the market because of the collapse of the Venezuelan energy industry. With oil inventories in developed countries back to their five-year average and fuel prices approaching painful levels for consumers, Saudi Arabia and Russia have started pushing OPEC to boost output again, prompting Brent to slide back toward $75, according to Bloomberg.
On June 22, OPEC oil ministers and an ad hoc alliance with several non-OPEC producers, notably with Russia, Kazakhstan, and Azerbaijan (OPEC+), gathered in Vienna to discuss the status and future of their production limitation agreement, which was initiated in November 2016 and runs until the end of December 2018. After the meeting, OPEC announced it would pump more crude oil — a move that should help contain the recent rise in global energy prices. One day later, OPEC nations and oil-producing countries not in the cartel said they have agreed to share increased oil production a day, according to ABC News.
OPEC and non-OPEC countries noted that they would increase supply by returning to 100% compliance with previously agreed output cuts, after months of underproduction. Saudi energy minister, Khalid al-Falih, said OPEC and non-OPEC countries combined would pump roughly an extra 1 million barrels per day (mb/d) in the coming months, equal to 1% of global supply, according to Reuters.
Commenting on al-Falih’s statement, Ann-Louise Hittle, a veteran OPEC watcher at consultant Wood Mackenzie Ltd told Bloomberg that “The only country that can increase production is Saudi Arabia, so its interpretation of the deal is the one that matters.” A few days later, The US President Donald Trump twitted that King Salman of Saudi Arabia had agreed to increase oil production by up to 2 mb/d.
Since the Vienna agreement, experts’ and industry institutions’ forecasts have been divided. Some predicted oil prices to increase, while others argued that most probably it will fall, as countries are aiming to boost their production.
Mohaddes believes that in the medium term, oil prices will fluctuate in the region of $60-$80 per barrel. “But we also have to remember that global upstream oil and gas investments have been falling sharply since 2014, which will have implications for future supply and prices. Therefore, in the long run, we should expect higher prices.”
Having a similar opinion, Shereih said that “as long as geopolitical crisis continue to escalate, the price of a barrel is not expected to fall. It may achieve some sort of stability in the short term in case of increase global daily production.”
Radon explained that “as global-economic insecurity, with ever threatening trade wars across the globe, especially as a consequence of the turbulence of the disastrous G7 meeting in Canada, will continue, it seems fair to say that oil prices will follow suit and will fluctuate, probably with an upward spiral.”
“Oil prices will certainly not stabilize and will not be driven just by the market law of supply and demand. Accordingly, as geopolitics rules, oil prices will probably continue in an upward direction unless a trade war breaks out, which will dampen demand for oil and accordingly dampen prices. So we can expect at least a moderate roller coaster oil price ride for the rest of 2018,” he added.
Meanwhile, US Energy Information Administration (EIA) forecasts Brent crude oil prices to average $71 per barrel in 2018 and $68 per barrel in 2019, according to the June 2018 update of EIAs Short-Term Energy Outlook (STEO). The updated 2019 forecast price is $2 per barrel higher than in the May STEO.
On the other hand, Energy Commentator Nick Butler explained in his Financial Times’ opinion article that “instead of rising to a $100 as some commentators have suggested, the price is more likely to fall towards $50 per barrel. This seems to be the level at which some US shale production becomes uneconomic. If it gets too low the Saudis and others will try to reassert their production quotas and so a reasonable bet on where the market balances would be around $50-$60.”
How Will Oil Prices Affect Egypt’s Budget?
Egypt’s Ministry of Finance has drafted the budget for FY 2018/2019 on the assumption that oil prices will settle at around $67 per barrel. The Ministry further explained in its pre-budget report that an increase of one dollar in oil prices will cost the government EGP 4 billion in expenditures and will thus be translated into a wider budget deficit. Moreover, this increase in expenses would limit the money available to the government to finance capital and social expenses in the light of the increases in international prices, eating up the health and education allocations.
In early June, Egypt’s cabinet approved the request of the Finance and Petroleum Ministries to contract with some international insurance banks against the risks of increasing oil prices. Both ministries are already moving forward with the procedures of contracting with the insurance banks. It is worth noting that the oil quantities and appropriate pricing mechanisms will be agreed upon by a working group from the two ministries. Furthermore, the working group is expected to develop a framework for a future vision to hedge against the risks caused by fluctuating oil prices and settle the target price of insurance based on international forecasts and studies.
In the same context, the House of Representatives approved the Ministry of Finance’s request to pump an extra EGP 70.3 billion budget appropriations to eliminate the budget deficit in FY 2017/2018, due to the hike in oil prices.
“We expect to see positive growth effects (albeit small) for energy-importers, which have strong economic ties with oil exporters, through spillover effects. In particular, for most oil-importers in the MENA region (including Egypt), losses from higher oil prices are offset by an increase in external demand/financing by MENA oil-exporters given strong linkages between the two groups through trade, remittances, tourism, foreign direct investment and grants. These economies are on average expected to experience an increase in real output of about 0.28%,” according to Kamiar Mohaddes and Mehdi Raissi’s International Monetary Fund (IMF) working paper entitled “The US Oil Supply Revolution and the Global Economy”.
What Are the Implications for Egypt’s Economy?
Oil price fluctuations, in particular price increases, on oil importing countries hurts their national economies. What is spent on the importation of oil cannot be spent on other goods and certainly cannot be invested. Oil price payments are an expense which cannot be recouped or fully recovered from product price increases, according to Radon.
“In the case of Egypt, the same rule will apply. Oil price fluctuations will have a negative impact on the Egyptian economy and will dampen Egyptian economic growth outlook, which has already slowed recently. It will hurt Egyptian balance of payments as Egypt will have to use its limited dollar reserves to pay for any oil price increases. In short, the Egyptian economy will be hurt and will be in for bumpy ride, which is not good for business, let alone the people of Egypt,” Radon added.
Pascal Devaux, senior economist MENA at BNP Paribas, told Egypt Oil & Gas that in oil-importing countries, an increase in oil prices entails inflationary pressure and deteriorates external balance as the import bill is increasing. Moreover, it causes an increase in cost for energy-intensive industries – petrochemicals, cement, and heavy industries – and it can have a negative fiscal impact if fuel prices are subsidized.
Offering a deeper analysis of the Egyptian case, Devaux explained that the increase in oil prices happens at the same time than the government policy to cut in subsidies for oil products. “For FY 2018/2019, the consequences of higher than expected oil prices will be negative for fiscal performances. Nevertheless, the cost for the budget will depend on the willingness of the government to limit the increase in oil prices for the consumers. The government can choose to limit the price increase in increasing allocation to subsidy expenditures, and thus the fiscal deficit,” he noted.
Discussing the latest cuts to energy subsidies, Devaux mentioned that “subsidy cuts will impact inflation. This impact on inflation has consequences on interest rates as the rate policy of the Central Bank of Egypt (CBE) is linked to inflation. A higher than expected increase in oil price for consumers would slow the easing cycle of CBE.”
Regarding external accounts, he highlighted that the consequences of higher oil prices are mixed. The impact on trade balance is negative as Egypt remains a net oil importer. However, it is positive on Suez Canal income and maybe on remittances as many expatriates are in oil-producing countries (GCC) and can benefit from increasing oil prices in those economies.
Oil prices change quickly according to many factors. Experts argue that geopolitical factors have played a more effective role than market dynamics in many occasions. Thus, oil-importing countries – including Egypt – should pay attention to other factors determining the prices in order to achieve the desired growth rates and have more balanced budgets.