Price crash is a short-term shock for Latin America’s oil producers THE RECENT precipitous decline in the price of oil has changed the energy panorama in Latin America. Broadly speaking, the crash is the result of a surprising increase in supply combined with an unexpected drop in demand, writes World Review expert Dr Noel Maurer. World production increased rapidly in 2013 and 2014, driven by Libya’s return to international markets, and horizontal drilling and ‘fracking’ to extract hydrocarbons from shale in the United States. Will the price decline last? In the long term, over two years, almost certainly not. Oil demand would have to suffer a permanent shock to cause prices to settle below US$60 a barrel for an extended period. Prices will probably remain low for a year or two. First, US unconventional production is still relatively small. Second, roughly half of all tight oil plays in the US have breakeven costs below US$60 a barrel. The end result for Latin American countries with significant oil resources is an unchanged long-term prognosis but a somewhat worse short-term one. Mexico is least likely to be affected - its economy is not generally dependent on oil, but the federal government’s finances most certainly are, with 31 per cent of revenues from hydrocarbons. That said, the first thing to note is that Mexico is fully hedged for 2015. What if the oil price decline lasts for more than a year? Experts at the Council on Foreign Relations think-tank say that if the price falls to US$40 a barrel in 2015 and remains there for two years before recovering in 2018 - a larger drop for a longer time than is likely - Mexico would face a cumulative revenue shortfall of US$113 billion. That represents only nine per cent of the country’s GDP, spread out over four years. Borrowing that amount is well within its capacity. Mexico also has a US$72 billion line of credit with the IMF. Colombia and Ecuador face more significant problems. In 2013, the Colombian government earned US$33.8 billion from taxes on hydrocarbons. An exercise using the same CFR methodology indicates that Colombia would face a cumulative shortfall of US$42 billion, or 11 per cent of GDP. Colombia budgeted for a US$98 per barrel price for 2015, whereas more prudent Mexico projected US$83. Colombia does, however, enjoy a very low debt-to-GDP ratio of 23 per cent and a US$28 billion flexible credit line at the IMF. Unlike Mexico, it is unhedged. The price decline will therefore directly take almost US$8 billion out of revenues for 2015. The fiscal pressures should be manageable, but Colombia has become in effect a petro-economy over the past decade. The nation is in for an unpleasant 2015, but its overall stability should not be threatened. Ecuador in general resembles Colombia in terms of its fiscal and economic dependence on hydrocarbons. However, it faces three problems which Colombia does not. First, it has only recently returned to international debt markets after its 2008 default. With the Ecuadorian element of OPEC’s oil ‘basket’ dipping below US$50 a barrel, Ecuador’s financing needs are sure to exceed US$11 billion. It is far from clear that foreign investors will have the appetite for risk. Second, Ecuador uses the US dollar as its national currency. A loss of confidence can cause nations which lack their own currencies to become mired in deflation and depression. Third, it will almost certainly have to begin paying Occidental Petroleum for the properties it expropriated in 2006. Ecuador’s saving grace is its relationship with China. Beijing’s loans are made on generally commercial terms. Payment is in oil, but booked at market prices. Since Ecuador will remain a good risk once oil prices recover, it is entirely possible that the Chinese will agree to help it through its current difficulties. The other main recipient of Chinese funds in Latin America, Venezuela, is in no position to weather the price crash. But its economy was facing collapse even with oil prices above US$100 a barrel. The government has been applying ever-stricter capital controls. As a result, severe shortages of imported consumer goods have become commonplace. What is left of the country’s non-oil manufacturing sector has collapsed in the face of the difficulty in importing capital and intermediate goods. Price controls have been imposed on almost everything, so many cheap goods illegally flow out into Colombia. Finally, US President Barack Obama has signed a sanctions bill which will target individual Venezuelan officials. In short, of the four oil producers, Mexico is set to withstand low oil prices, Colombia and Ecuador should be all right as long as the slump does not last more than a year and, in Ecuador’s case, China agrees to help, and Venezuela is in for a collapse even if prices miraculously recover.
Posted on: Tue, 06 Jan 2015 12:40:53 +0000
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