Monday, May 9, 2016

GDP Growth Trends during the Glut

The widespread effects of the oil glut have been well known in the corporate arena as multinational firm's earnings reports dominate the headlines of the financial news. National banks across the globe have drawn most of their concern from the dwindling of profits and the shrinking of prices. The WTI and Brent spot prices for crude are followed every day as well as their implications for the next quarter's bottom line. Meanwhile, several nations are being brought to their knees as a result of the downturn while others have pushed through. The internal dynamics of this unique period has once again separated the global economy into two factions: the oil-exporters and the oil importers.

Oil shocks can have numerous effects on the global economy, but typically, there are two different economic reactions that occur in oil exporters and oil importers. The price collapse we have seen can be characterized as a supply shock with flooding markets weighing heavily on spot prices across the world. Naturally, the changes in spot prices affect the buyers and the sellers differently. The chart on the left shows the top ten oil importers as well as their most recent quarterly growth rates. With China and India leading the way, GDP expansion has continued at a stable rate at or above 2 percent (with the exception of Japan and Netherlands). The average quarterly growth rate for this group of countries is recorded as 2.96 percent, a healthy expansion despite the volatility in markets and fluctuations in manufacturing capacity. Oil importers usually have the advantage of lower input prices and lower motor fuel prices which reflect positively on corporate profits and personal income. Governments also see a decrease in their spending as their own costs fall as well. Trading deficits fall for these countries as the value of their petroleum imports. Emerging economies like China and India tend to enjoy more efficient growth at lower prices, other beneficiaries are Brazil and South Africa who are in this key development stage as well. Some may argue that these benefits were not realized this time around because of the Chinese stock market crash, but do they stop to think how much worse things could have been if struggling Asian manufacturers were paying over $100 for crude oil? The low energy price environment could have done much to cushion the correction that was always going to happen. A 3 percent average growth rate across the importing world speaks to the expansionary effect of the oversupply of crude oil amidst struggling stock markets in China, the United States, and Europe.

One might suspect that low oil prices have the opposite effect on oil exporting nations where the petroleum industry accounts for large parts of revenue in the economy. He wouldn't be too far off. The chart on the right describes the most recent quarterly growth rate for the top ten oil exporters. Although three countries record quarterly GDP growth of about 4 percent, the average was calculated as 0.83 percent. Russia is one of the oil exporters that is experiencing a recession caused by the devaluation of their economic staple. Poverty and unemployment are increasing, and consumption falls as well. Similar dynamics define the effects on other exporting economies. Governments lack the funds to spend on social programs and public sector jobs. Corporate profits taper off, which translates to wages dropping in tandem. The "resource curse" sets in for emerging economies who rely on the energy industry as a singular source of revenue. Often times, economic stability can spill into political vulnerabilities especially in the geopolitics of OPEC. This oil shock is especially troubling because OPEC's member nations have found they don't have control over the production that has caused the oversupply. For that reason, tension in countries where growth rates have fallen below zero like Venezuela, Kuwait, and Iraq has risen. With no freeze deal or output quota on the table, the length of the depressing effects is indefinite.

David Goldwyn, president of his own Goldwyn Global Strategies LLC said last year, "At $40 a barrel, everybody's budgets are underwater, and some quite dramatically. It's increasing the fiscal deficit and requiring countries that were already facing low growth to suffer even higher pressures." He emphasized that these countries that are short on cash begin to have problems with civil unrest. Venezuela, sustaining GDP contractions of -7 percent, is one particular country that is feeling the squeeze. According to the International Business Times, the Venezuelan government needs oil prices of over $100 a barrel to break even. The same source estimates that Nigeria needs $119 per barrel for its budget to break even. The scary truth is that numerous economies are collapsing because of the debt accumulated at high oil prices which were thought to be sustainable with OPEC's power. The macroeconomic effects of this position are frightening in hindsight.

Oil exporters with peaceful societies are feeling the cash crunch as well. Saudi Arabia's vast cash reserves are draining fast as the price of oil fell over 50 percent in a year. The wealth available to the princes and their people is waning causing policymakers to be more conservative in government and personal spending. The old oil minister al-Naimi, heralded for his able control of the oil market, was just recently fired to be replaced by Saudi Aramco's chairman, Khalid al-Falih, who will be tasked with ending the Saudi dependence on oil. The World Policy Blog estimates that $70 billion of the $660 billion of cash reserves were used to cover new deficits caused by depressed oil prices. The large social programs put in place to persuade the younger generation to accept the Saudi lifestyle are now shrinking. While a the coffers and production capacity of Saudi Arabia can allow its government to resist economic collapse, any whiff of vulnerability sensed in its social fabric could have implications within the region. The "Saudi-Iranian oil race" that officially started in mid-April hints more at regional religious sectarian issues that could spillover into the Syrian conflict. Saudi Arabia should separate their oil production and geopolitics if they want to avoid domestic economic conflicts.

In both camps, the interest rate policy of most national banks has elicited negative effects described by an IMF paper about real interest rates earlier this year. Because inflation has slowed down to near zero, nominal interest rates set by banks and monetary institutions are having a more contractionary effect even though they haven't changed. The economy in Brazil has responded negatively to this implicit tightening of credit in most developed countries. Loans with U.S. and European banks are suddenly becoming more expensive and harder to finance when Brazil's blossoming private sector seeks to thrive amidst unrest in the government. Petrobras, the local nationalized oil major, has succumbed to many of the pressures that oil exporters are facing especially debt-riddled financials. The loss of the oil company's revenue has brought with it threats of stagnating growth that could compromise an already unstable social environment. Petrobras is just one example of energy corporations struggling to adjust to the new environment; over 50 have gone bankrupt in the United States.Going forward, interest rate policy and monetary cohesion will play crucial parts in the development of inflation and a new crude oil market.

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