Oil-producing countries face severe financial and political risk as the world transitions away from oil.
Source: The Fuse, by Nick Cunningham
“Time is running out for a number of countries,” according to a new report. Major upheaval lies ahead without dramatic overhauls to the economies of oil producers.
Political instability could “engulf” an array of oil-producing countries, Verisk Maplecroft, a political risk firm, said in a new report. As the world transitions away from fossil fuels amid a global decarbonization effort, it represents a “political risk nightmare” for states dependent on oil.
The political upheaval could arrive as soon as the next three years, although the risks remain for the next few decades. “[T]ime is running out for a number of countries that have failed to diversify their economies away from exporting fossil fuels,” Verisk Maplecroft wrote.
As global decarbonization efforts gather pace, the long-term outlook for crude oil demand continues to darken. But peak demand scenarios are hotly contested. Some analysts predict one last boom lies ahead, as the lack of upstream investment creates a supply crunch before the energy transition truly gathers momentum.
Nevertheless, as oil demand peaks and plateaus, prices will remain muted or may even decline. A shrinking oil market also removes the upside potential to prices to a large degree.
As the energy transition proceeds, the credit risk profile for oil-dependent countries deteriorates. But a worsening credit and fiscal outlook only poses deeper problems for these countries. With shrinking revenues, how do they finance diversification and transition? There are no easy answers and the recent track record of diversification does not lend confidence to the notion that a smooth transition is likely.
Alarmingly, many countries have even gone backwards in their diversification efforts since 2014, the year that saw a deep oil price crash. This set of countries includes Saudi Arabia, Nigeria, Iraq, Libya, Angola, Kazakhstan, Venezuela, and Azerbaijan, among others. They saw export revenues as a share of total revenues increase since 2014. In other words, their economies became even less diverse as oil entered a period of sustained volatility.
Squeezed financially, oil producers tend to double down on oil production, hoping to make up for in volume what they lost on price. Since 2014, OPEC+ constraints (i.e. taking oil off of the market) was one of the few strategies that has had some success in pushing prices back up. But many within OPEC+ are itching to return their volumes to the market.
Even as producers want to ramp up supply, as Covid-19 illustrated, demand destruction presents extreme dangers for oil-dependent economies. The pandemic has been something of a preview of the energy transition, only it unfolded abruptly, while the transition will likely see more of a protracted and gradual destruction in demand.
A “slow motion” disaster
Even though the energy transition is likely to unfold slowly, gradual decline for oil does not stave off disaster. Oil-dependent countries could “enter doom loops of shrinking hydrocarbon revenues, political turmoil, and failed attempts to revive flatlining non-oil sectors,” the Verisk Maplecroft report says.
The report identified Algeria, Iraq and Nigeria as the likely first causalities of this “slow-motion” wave of instability. For them, serious trouble is not far off. But other countries in a similar predicament include Angola, Gabon and Kazakhstan.
The timing of disaster, Verisk Maplecroft says, depends on three things: breakeven costs, the capacity to diversify, and political resilience. The firm produced a Political Stability Index, incorporating other variables such as corruption and access to finance, and ranked the world’s oil-producing countries in terms of risk. The highest cost producers, with the most oil-dependent economies, little ability to diversify and weak political systems are the most at risk.
Countries that can’t cover their budgets at a particular oil price are forced to burn through cash reserves, take on debt, devalue their currency and/or impose severe austerity. Saudi Arabia has some of the lowest-cost oil in the world, but still has high budgetary obligations, forcing it to burn through half of its foreign exchange since 2014.
But at least Saudi Arabia had foreign exchange. Nigeria had fewer resources to fall back on. Since 2014, Nigeria has suffered severe capital flight, currency devaluations and an overall decline in living standards.
Saudi Arabia and other richer producers will likely be able to weather the turmoil better than others. “If a storm breaks, it will break first in Algeria, Nigeria, Chad and Iraq,” the firm warned.
Low-cost producers such as the UAE, Qatar and Saudi Arabia do not face an imminent crisis, and indeed to some extent they are betting that they will be left standing in the long run, even in a shrinking market. High-cost oil, such as U.S. shale, for instance, will be forced offline, not Saudi crude.
But even Gulf countries face a potential reckoning. “Authoritarian political stability is anything but stable over the long term and, as lower-for-longer oil prices cut into social spending, additional pressure will pile on these deceptively fragile political systems,” Verisk Maplecroft’s Head of Market Risk, James Lockhart Smith, said in the report.
Whereas the report focused on political instability, it echoes that of a separate analysis from Carbon Tracker from earlier this year that looked more narrowly at government revenues. In that report, Carbon Tracker estimated that the world’s top 40 “petrostates” could see a budgetary gap of $9 trillion over the next two decades.
Whether looking through a political risk framework or a government revenue analysis, the thrust is the same. Global efforts to cut fossil fuel use could potentially push oil prices down and keep them down, collapsing revenues for many of the world’s most oil-dependent and politically fragile producers.