Oil Prices and Implications for Africa
Jul 23rd 2013
Oil prices have remained persistently high and volatile in the past few years and according to estimates they may remain so at least until 2014. The Brent crude spot price, which averaged US $112 per barrel in 2012, is projected to remain above US $100 per barrel at an average of US $108 and US $101 per barrel in 2013 and 2014, respectively (U.S.). High oil prices may dampen the global economy which is still struggling to recover from the 2008 financial crisis. High oil prices above US $100 can be explained by many factors and they may affect economies in an uneven way with an unclear outcome for the global economy as a whole. According to estimates by the International Monetary Fund, a 50 per cent increase of oil prices due to a supply shock would lead to a one to 1.5 per cent decrease of output in many regions of the world.
Rising oil prices will affect African economies differently depending on whether they are net exporters or net importers of the commodity. For oil-importing economies, high oil prices could translate into high import bills with adverse effects on inflation, production and employment. In contrast, oil-exporting economies could benefit from high oil prices because an increase in oil revenues improves their balance of payments. In addition, price volatility may harm both importers and exporters of oil as it lowers, for instance, the predictability of marginal costs of production for companies. The uncertainty regarding their cash flows may induce companies to reduce their investments and limit job creation which can consequently harm economic growth.
Recent trends in oil prices
Oil prices have increased since 2003 from less than US $40 to more than US $100 per barrel today. Oil prices fell sharply in 2008 before recovering steadily since then. Prices of oil were volatile during 2011 and 2012 mainly because of the Arab Spring and events in Libya and conflict between Sudan and South Sudan. Many uncertain and conflicting factors on both supply and demand sides are contributing to the persistent high oil prices in recent years.
Supply-side factors: Geopolitical factors are the main causes that drove up oil prices in producing countries. In the past decade, wars in Iraq and political tensions in the Middle East and North Africa have affected the oil market. More recently, disagreements between Western nations and Iran, one of the largest oil producers and exporters in the world, have fuelled risks of sharp disruptions in oil supplies globally which in turn had a significant impact on prices of the commodity. In contrast, OPEC countries and mainly Saudi Arabia may not be able to boost production and to cover losses elsewhere as their capacities are reaching their limit. The decline in aggregate oil inventories and high costs of oil extraction and production are other supply-side factors affecting oil prices.
Demand-side factors: Increasing demand from major emerging economies such as China and India has also played an important role in keeping oil prices persistently high in past years. The Asian continent surpassed the USA and is now the largest consumer of oil in the world. Despite the slowdown in economic growth in China and India, demand will remain higher which will keep oil prices at high levels. Furthermore, as growth is resuming in the U.S. and as the crisis in the euro area seems to ease, global demand for oil may increase.
Development of shale gas: Recent advances in extracting shale gas notably in the U.S. are changing the dynamics of global energy markets. The projected development of shale gas in the world is expected to affect global energy prices. However, oil-exporting African countries will not be threatened as much by the shale gas as the depletion of traditional oil fields will not be totally covered by new discoveries of shale gas. In addition, the impact of lower demand for African crude oil by the U.S. will be compensated by the boom of energy consumption by developing countries including mainly China and India.
Impact of high oil prices on Africa
High oil prices do not benefit all African countries. Only a quarter of African countries produces oil and have run financial surplus. In contrast, African oil importers have to pay substantial amounts when oil prices increase. Thus, 15 per cent of the income of countries such as Liberia, Seychelles and Sierra Leone is used to pay for imported oil. High oil prices may affect economic growth; agricultural and manufacturing sectors; exploration and production activities; social and political stability, as well as fostering the creation of sovereign wealth funds.
Impact on economic growth: Over the past decade, the African continent recorded unprecedented high growth rates. For many African countries, economic growth was mainly driven by high commodities prices especially oil prices. Thus, African economies will be vulnerable to variations in oil prices and growth may sharply fall in case of a reversing trend of the oil market. The impact of oil prices on growth may be transmitted through other channels. In Nigeria, Africa’s largest oil producer, the increase in world oil prices has led to higher budget revenues which have created room for lower tax receipts which in turn have boosted investment spending in other sectors.
Natural resources curse: Due to persistent high oil prices and large discoveries of oil and gas reserves, resource-rich African countries may face the Dutch disease phenomenon. In fact, large exploitation of oil, gas and minerals may lead to the decline in productive sectors such as manufacturing and agriculture. In Ghana, for instance, where large commercial production of oil has begun in the past two years, the economy started showing signs of Dutch disease. In fact, recent evidence indicated that the growth of the country’s agricultural sector declined.
Increasing exploration in Africa: High oil prices are driving growth in exploration activities in Africa. In some parts of the continent, high oil prices and the arrival of new exploration techniques have created incentives for major oil and gas companies to intensify their presence in the continent. This growing interest may transform Africa into a new hub for natural resources especially for oil exploration and production. The East African region is particularly enjoying a boom in its oil and gas industry through massive investments undertaken by global energy companies and by countries including China.
Social and political stability: As an input for many products used daily by millions of people, increases in oil prices may affect significantly the cost of living of Africans. This could trigger social protests and threaten political stability of a country. In addition to the issue of youth unemployment, high cost of living was considered one of the issues that fuelled the uprising in Egypt and Tunisia. Food prices are particularly vulnerable to increases in oil prices, as the cost of production in the agricultural sector are linked to energy prices. Persistent high oil prices will further worsen the situation of the poorest as food represents the bulk of their consumption basket. In 2008, many African countries experienced social unrest following a significant spike in food prices.
Sovereign wealth funds: High oil prices generate more oil revenues for oil producing countries. In the recent years, many African countries established their own sovereign wealth funds to better manage rising revenues from energy exports. These funds aimed essentially to manage resources for future generations and to stabilize government fiscal and foreign exchange revenues. In the few past years, Africa has known a wave of sovereign wealth funds creation especially in oil-rich countries such as Nigeria, Angola and Ghana. Sovereign funds may contribute to the development of the continent through promoting intra-African investments and enhancing productivity.
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Professor Mthuli Ncube is the Chief Economist and Vice President of the African Development Bank, and holds a PhD in Mathematical Finance from Cambridge University, UK, on “Pricing Options under Stochastic Volatility”.