The perils and blessings of low cost oil for growth markets
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The perils and blessings
of low cost oil for
growth markets
PwC’s Growth
Markets Centre
February 2015
The end of an era challenges for their continued growth, though
all for differing reasons. Brazil and India went
Without a doubt, growth markets have presented through elections last year and are in need of
a remarkable story during the past two decades. significant reforms to revive their economies,
Specifically in the aftermath of the global whilst Russia found itself entangled in a
financial crisis, all eyes were on those markets geo-political conflict and is now dealing
that presented a promise of growth, with the with the political and economic sanctions
U.S., Europe, Japan and most other developed that resulted from it. China is in the midst of
economies stagnant or even in decline. Though a major transformation of its economy, meant
many developing countries witnessed high-paced to make it far less dependent on export and
growth, some of the most impressive growth and investment-driven growth while increasing
development happened in the bigger emerging its share of higher value-add activities. Parts
economies, most notably the ‘BRICs’. While at of Africa, in the meantime, had to battle with
the same time, Africa emerged as one of the the full magnitude of the deadly Ebola virus,
world’s new frontiers of growth. regional conflicts, and political change. A
period of fast paced, ‘catch-up growth’ seemed
Recently, it is becoming more apparent that to have ended, with an evident impact on the
economic growth rates in the growth markets world economy.
have begun to slow down. Many of the major
developing economies are facing significantEven though most growth markets were In a world still largely running on fossil fuels
facing stronger headwinds to their rates of and with so many developments and moving
development, it was at least in an environment parts, the question quickly arises whether the
of steadily increasing or stable oil prices which recent oil price development is a good thing or
provided some predictability. The recent not – especially for the growth markets.
dramatic drop in the oil price however, has
removed this pillar of stability and has placed
many growth markets back under a cloud of The impact of lower oil
uncertainty and unpredictability. prices on growth markets
Many of the immediate and medium term
The steep drop in oil prices effects on both developed and developing
markets have been well highlighted in recent
Since the middle of 2014, the oil price witnessed months. It is mostly the longer term effects
an exceptional development and sharply dropped that are leading to further debate. However,
by over 50%, to a level of around US$50 a barrel1 what is clear is that countries, governments,
today. The underlying factors of this ‘sudden’ companies and consumers alike are being
development are widely acknowledged and impacted, though in various ways.
reflect the rationale of the market. While
obviously the decline in economic growth in
Direct impacts
many of the growth markets, especially in China,
In the short term there are some obvious
diminished the demand for oil, it is a combination
‘winners’ – big net importers such as India
of factors that started the sharp supply-driven
and China – and ‘losers’ – net exporters such
price decline we are witnessing today.
as Russia and Venezuela – from this drop in oil
prices. However, not all importers and exporters
With the global demand for oil already
will benefit or suffer to equal measure.
declining, a number of additional factors have
created an oil supply increase and build-up of
Those who lose – Net oil exporters, with
reserves that was not seen in this way before:
economies and national budgets that still very
a massive increase in oil extraction by the U.S.,
much depend on the export of oil and have
a limited impact of ongoing conflicts in the
built up few reserves, are the ones that feel the
Middle East on production (e.g. in Iraq), and
biggest pain. For example, Russia, Venezuela
more recently, the strategic decision of Saudi
and Malaysia all have been hard hit due to the
Arabia and other GCC OPEC members to not cut
proportion of oil revenues as a percentage of
back on oil production and putting the onus of
their overall economy. They – and others – are
marginal barrel pricing on non-OPEC members.
struggling with immediate consequences, such
as reduced government budgets, growing
The dynamics that led to the sudden drop in oil
deficits, and volatile exchange rates.
price had already been in the making for a
longer period. It is the U.S.’s rapid increase in
energy production that is the more surprising The role of the oil majors
event and it has made the increase in supply Not all oil exporting countries are affected
and resulting drop in oil price more dramatic to the same extent, as the ‘oil majors’ are
than previous declines, and less likely to likely to look at the cost of production in
rebound in the short term. these countries and refine their activities
accordingly, by reducing production from
By making use of new – and previously those now less profitable sites. Not only will
uncommercial – techniques such as horizontal these countries be affected by the reduced
drilling and fracking, the U.S. has transformed price per barrel, but also by the volumes now
from a net oil importer into one of the major being produced in their countries. However,
producers in less than a decade. It has made the case is even more dire for those countries
the U.S. one of the biggest oil and gas suppliers which are in the ‘Exploration’ phase, (such as
in the world, ahead of Russia and with Uganda) as CAPEX is one of the first areas that
expectations that it will overtake Saudi Arabia the oil majors will review and those sites which
in the coming years. Compounding all this, oil are not yet producing oil or are in the early
production is also increasing in countries like stages of exploration will most likely be either
Iraq, where daily production has even reached put on hold or exploration activities reduced.
pre-conflict levels again. This means that certain growth markets will
receive less revenue from exploration licenses
and will have to wait longer for revenues from
1 Both the European “Brent” and American “WTI” Price near term oil production.
index are currently in the range of USD 50–60 per barrel,
as per February 2015Those who gain – Growth markets which are Oil and related commodity intensive
net importers of oil on the other hand, are the industries such as Transport and Logistics,
countries that are experiencing the most Agriculture, and Manufacturing will also
obvious immediate benefits. They are spending benefit from these reduced costs, contributing
less on their oil imports and are able to use as said to lower inflation and enhanced
these savings to reduce their trade deficit, production and employment.
improve government budgets, reduce inflation
and redistribute money to infrastructure Cheaper oil does not necessarily mean cheaper
projects. However, even here there are markets electricity, as many growth markets are dependent
which are impacted more than others. China is on coal for energy production. However, most
the world’s biggest importer of oil, but it also of these markets do not have sufficient levels
has significant oil interests in supplying of power available and are dependent upon
countries and some of its savings are offset by large numbers of oil fuelled generators. It is
these devaluated interests. India, on the other here that the financial benefits will be most
hand only has a nascent oil industry, but it is felt by those reliant on back-up power.
the world’s third biggest oil importer and
hence arguably benefiting to a greater extent. These benefits are not a given and growth
markets’ governments who are fortunate to
Indirect impacts fall into the ‘winners’ camp need to act on this
In addition to the more immediate and direct opportunity by employing the right reforms,
impacts, the oil price drop will have various developing more infrastructure, reducing
knock on effects for growth markets’ their dependency on oil, while passing on the
governments, businesses and consumers. positive effects to consumers to reduce their
cost of living. The ‘losers’, will be really forced
Governments, which are now paying to review their dependency on oil at the
significantly less for their crude oil imports, can hardest time.
remove subsidies – such as the fuel subsidies in
India and Indonesia – with much less financial Impacts on key growth markets
impact on and opposition from consumers. Against this backdrop, it is interesting to
In addition, these governments are able to see how some of the world’s major growth
free up more of their budgets to reduce deficits, markets are most impacted by the oil price
gradually increase fuel taxes and improve developments, and how their respective
infrastructure, increase housing, enhance governments are responding.
transportation and increase manufacturing.
Nigeria country’s GDP. With its high dependence on
As major oil exporter, Nigeria has felt a oil, the Nigerian economy is poorly diversified,
significant negative impact of recent events on and its tax base is lower than other economies
its economy. Market growth expectations for at a similar level of development. The negative
2015 have fallen significantly, precipitated by effects of the drop in oil price adds to a set of
a declining oil price and increase in political already existing concerns such as production
instability, most recently seen in a delay to failures, spillages, high bunkering and theft
presidential elections by six weeks. rates which all put downward pressure on
production volumes.
The oil sector has changed the structure of
the Nigerian economy since production began A falling oil price has traditionally placed
in the 1960s. Today it is the main source of significant pressure on the local currency’s
export earnings and government revenue. (Naira) exchange rate band. The Central Bank
In 2013, Nigerian oil accounted for 90% of of Nigeria has responded to the recent oil price
Nigeria’s export revenues, around 70% of the decline by drawing down on reserves and
government’s income, and nearly 11% of the accepting greater exchange rate flexibility.India for additional revenue of up to US$2.4 billion A falling crude oil price is certainly a blessing (INR 15,000 crore) this year. Besides the for India and coming at the right time, as it benefits to the government’s coffers, the public helps macroeconomic management -both sector oil companies’ profitability could benefit budget and fiscal – by improving the macro too from these measures in the longer term. fundamentals such as inflation, fiscal deficit and current account deficit reduction. India A lower oil price will provide room to the imports more than two-thirds of its energy Reserve Bank of India in adopting a growth- requirement, which constitutes around 30% centric approach while reviewing monetary of total imports. A fall of each dollar in oil policy. It results in lower inflation, gives price, saves the country about US$0.64 billion comfort to the Reserve Bank of India in (INR 40 billion). Adding to that, the fall in cutting interest rates and provides flexibilities international oil prices will help reduce in budget and fiscal management. The biggest subsidies that sustain the domestic prices of impact on India can be that the government, oil products (LPG, kerosene) in India. This has if it wants, will now be able to spend more on made it possible for the Finance Ministry to much needed and expected development. increase excise duty rates for petrol and diesel China retail consumers. Chinese consumers are, at As the largest net importer of oil, China any rate, more likely to save, instead of spend a benefits significantly from lower prices. China significant portion of their unexpected windfall is taking advantage of low prices to build up until real estate prices, stock markets, and the it's oil inventory in the Strategic Petroleum economy in general, stabilise and recover. Reserve. Moreover, the negative impact on its own state-owned oil companies is more than Perhaps more importantly, a sustained lower offset by lower operating and transportation oil prices may frustrate Beijing’s attempts to costs in general, while Chinese consumers in achieve greater energy independence through, time will pay less for heating their houses, for example, domestic shale production. It fuelling their cars, and a wide variety of other may also reduce the negative environmental items. In fact, the World Bank estimates that impact of the hyper-growth of the last 30 lower oil prices will boost China’s GDP by years through investments in numerous green 0.1-0.2% and further widen its current energy initiatives, including wind and solar account surplus by another 0.4–0.7% of GDP. power as well as electric vehicles. Nevertheless, the impact on China is much Indeed, the most important impact of lower oil lower than for other oil-importing countries, prices for China may well be that it provides as coal still accounts for roughly two-thirds of Beijing with additional headroom to slow total energy consumption (versus ca. 18% for down further investment-led growth, while oil). In addition, the continued existence of implementing much-needed structural price controls set by the government reduces reforms, upgrading the industrial base, the pass-through effect of lower oil prices to and cleaning up the environment.
Russia is probably impacted more than most
Russia other oil exporters as it is simultaneously
The decline of oil prices globally has had a suffering from sanctions (including a self-
severe impact on Russia. The country is one imposed ban on food imports from the EU
of the largest oil exporters and its economy which has increased inflation). These
has insufficiently diversified. Russia is highly sanctions limit its access to financing in
dependent on Oil & Gas revenues for both tax particular and have had a negative impact on
revenues and further investments into the interest rates, deepening the crisis. As Russia
economy. Over the years, there has been a has substantial reserve funds in foreign
very strong correlation between the rouble currency, it can survive lower oil prices for
and the oil price due to this dependency a longer period if these sanctions are lifted.
leading to a large fall of the rouble against However if oil prices would bounce back to a
other major currencies. The benefit for the level below US$90 (which could very well be
country is that this has in the short term the case given the cost level at which shale oil
softened the decline of income in local producers can operate) then significant longer
currency. However, it will still put the budget term cuts in the Russian budget are required
in deficit and has led to an expected GDP and GDP growth will be limited. Therefore the
decline of 3–5% in the short term with very medium term outlook for the economy is also
high inflation (15–20%) as a result of the low negatively impacted by the shift in the supply
rouble and the high dependency on imports. and demand balance.
It remains to be seen what will happen to the oil that they seize the current moment to reform
price, but it is widely expected that the current and diversify their economies. For those growth
low price level will not be structural and an markets heavily depending on oil imports, it is
increase will occur again eventually. Though equally important to use the oil price windfalls
this might be good news for the net oil exporting wisely and prepare their economies for
countries and their governments, it is essential continued growth and development.
Yeroen van der Leer Andrew S. Nevin, PhD
Growth Markets Centre Assistant Partner, Africa Advisory – Strategy
Leader, Singapore and Operations Consulting Leader
Nigeria Advisory – COO
David Wijeratne
Growth Markets Centre Suman Jagdev
Leader, Singapore Emerging Markets CoE Leader, PwC India
John Jullens Martijn Peeters
Partner, Strategy&, China Partner, Strategy and Operations, PwC Russia
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