The way out of oil price volatility
Organization of the Petroleum Exporting Countries (OPEC) daily basket price for oil was hovering around $58.67 a barrel as on Thursday, 13 December 2018. It was at a peak of $84 a barrel in the month of October 2018. Oil prices have plunged to a new low, pointing out the extent of volatility prevailing in the sector. It is certainly crucial for producing and importing countries alike to devise ways and means by which negative impact of volatile oil prices can be averted.
The current fall in oil prices seems to resemble the three different periods of volatility that jolted the world economy from 1985 to 1986, 2008 to 2009 and 2014 to 2016.
There were some positive effects during the periods of volatility: the drop in oil prices was passed on to the consumers in developed countries. The governments in developing countries like India and China benefitted by reducing the subsidies on oil thereby reducing their fiscal deficits.
But when lower prices become the new normal, the oil-producing countries had to cut the public expenditure to avoid a “fiscal deficit” catastrophe. It also forces policymakers and economists to diversify their economies and find new sources of revenue to meet their expenditures.
The low prices push the central bank and the government of oil-producing countries to bring acute austerity and tight policies to save the economy from bankruptcy. But when oil prices rise, the same austere policies are diluted and reduced to pursue generous spending policies. Higher oil prices obviously improve the current account deficit and reduce the external debt situation of a country, but this phenomenon is transient and the oil prices may descend any time. So the oil producing countries have to be wary of rising prices.
Norway has utilized its oil wealth to become one of the richest and equitable countries in the world with a whopping nominal Gross Domestic Product of $109.8 billion as of June 2018. The exploration of oil and gas (from the North Sea) was a springboard for the country to become prosperous and independent.
To preserve the wealth, Norway didn’t join the OPEC and moreover put a price tag on the natural resources in line with the world markets.
Even while depending on the oil prospects as the sole income, the volatility of oil prices had never affected the high income, wealth and high GDP per capita of the country. This was due to the fact that the revenue from the resources was invested in the Government Pension Fund of Norway which comprises of two distinct sovereign wealth funds owned by the government of Norway. These funds act as a contingency reserve. These were formed with full conviction that the natural resources will cease to exist in the future and the revenue stream is uncertain.
However, oil production in Norway has exceeded the expectations to this day, especially because of the cutting-edge technology. This increased output from the existing oil fields, even leading to a projected positive forecast till 2020.
Even with the abundant supply, when oil prices plunge, as it happened in 2014, it pushed people out of employment and business, reducing the revenue in the state coffers. A huge infusion of funds through fiscal and monetary policies, coupled with an interest rate cut by the central bank, and dip into $1 trillion sovereign funds, saved the nation from huge deficits.
This was a hard lesson for the policymakers and bankers alike. Now with the oil price going to the north, more revenue is coming back to the wealth fund. Both unemployment and inflation are under control. So at this moment, the central bank is wary of a walk down memory lane to 2014.
This was reiterated by Chief of the Central Bank of Norway (Norges Bank), Øystein Olsen when he said:
“There could be a danger that when the oil price gets too high we’ll end up back in the situation where there’s too little cost awareness in the industry. The Norwegian petroleum sector would benefit from less volatility over time.
Moreover, Non-OPEC oil producing countries like the USA are increasing their supply using avant-garde technologies. It is a threat to the OPEC countries, as they are devoid of monopolizing the price.
Furthermore, countries like China and India are economic engines of the world, having the wherewithal to negotiate and push the oil prices downward.
Besides, rich oil producing countries like the UAE and Qatar had already diversified their economies to tourism and financial hubs. The big brother Saudi Arabia has made ambitious plans to transform the orthodox economy into a cosmopolitan one. The odd one out, Iran is supplying oil to other countries for a discount defying US sanctions and fix their supply irrespective of any consensus with OPEC countries. It is another reason for the fall in oil prices.
When oil-rich countries are following an uncharted route, Norway cannot be oblivious to the current trend.
World Economic Forum: What’s behind the drop in oil prices?.
IMF: IMF Country Report No. 18/279 (pdf).
© #Norway Today | Rajesh Trichur Venkiteswaran
Rajesh Trichur Venkiteswaran is a freelance journalist and a regular contributor to Norway Today. He can be reached at this email.