The price of oil and natural gas has roughly halved in the past three years. That’s redistributed about $1 trillion in yearly export earnings — more than 1 per cent of global gross domestic product — from net producers to net consumers.*
A new report from Brad Setser and Cole Frank of the Council on Foreign Relations explains which countries have had to adjust the most in response, which have yet to adjust, and which remain the most vulnerable to further price drops.
Setser and Frank analysed what they call the “external breakeven”: the current account deficit minus the oil and gas trade surplus, divided by net oil and gas exports in barrels of oil equivalent.
As a reminder, exports are things you make that you don’t get to enjoy. The only reason to export is to pay for imports. That includes not just current imports, but also past imports financed by issuing financial assets to foreigners, as well as all the stuff you expect to import in the future by drawing down savings invested abroad. If your exports aren’t worth enough to pay for the things you want, you have to either raise money from foreigners or cut your spending.
Most significant oil and gas exporters have little in the way of domestic industry and most are incapable of feeding themselves without imports from the rest of the world. (Russia is a notable exception.) Some, such as Norway and a few of the smaller Gulf states, amassed enormous foreign reserves to protect themselves from price declines when times were good, but many did not, instead preferring to spend the temporary windfall on everything from military misadventures to experiments in “Bolivarian socialism”.
The major advantage of their approach, in contrast to other research on “fiscal breakevens”, is that it is easy to make comparisons across countries and across time. The Mexican government might be highly dependent on oil export revenues, for example, but the people of Mexico are not. Motor vehicles and televisions are far more imporant as a source of hard currency. (Also, Mexico is now a net importer of energy.) There are also big differences between the impact of the oil price on government budgets in places that peg their currencies to the dollar, such as Saudia Arabia and the Gulf emirates, and places with floating currencies, such as Norway and Russia.
Here’s what the external breakevens of the major oil and gas exporters look like as of 2015:
The countries below the dashed line are able to cover their past and present future imports out of current oil export earnings with room to spare. The ones above the dashed line have to make up the difference between their wants and their purchasing power by selling assets or issuing new claims to foreign investors. About half of the oil and gas supplied to the world’s net importers in 2015 came from net exporters with external breakevens below the market price.
Setser and Frank also looked at these breakevens over time and among groups of similar net energy exporters.
Before the big oil price rally of the 2000s, the aggregate external breakeven for net oil and gas exporters was only $20 per barrel equivalent. That makes sense, since the price of a barrel of Brent crude pretty consistently hovered around $20 until around 2003. Even by 2005, after Brent had gone well above $50/barrel, relatively cautious net exporters had only boosted their external breakeven to $35 per barrel equivalent. The majority of export earnings were reinvested abroad from 2002-2004. In 2005 and 2006, about half of earnings were saved and half were spent.
By 2008, the breakeven price had risen to $60/barrel. That was far below actual prices at the time, which explains the enormous current account surpluses those net exporters were generating and reinvesting in the West. As Setser and Frank note, about 40 per cent of export earnings were saved in 2007 and 2008, rather than spent.
The collapse in world energy prices during the crisis didn’t encourage additional prudence because it was almost immediately followed by a snapback. Perhaps the relatively benign experience of the crisis created a false sense of security about how low oil and gas prices could fall for sustained periods. Perhaps the threat of the “Arab Spring” pushed some Middle Eastern governments to spend more than they would have preferred to prevent domestic upheaval.
Whatever the reasons, the aggregate external breakeven rose to $80/barrel by 2013. This was despite the massive growth in oil and gas supply coming online from the US and Canada and the slowdown in Chinese demand. After energy prices fell, this aggregate breakeven dropped to about $56/barrel, mostly thanks to falling imports.
Setser and Frank divide the ~52 million barrels/day of oil and gas equivalent exported in 2015 into five units.
About 15 million barrels came from countries with low breakevens: Azerbaijan, Bahrain, Brunei, Kuwait, Norway, Qatar, Trinidad and Tobago, the United Arab Emirates, and Uzbekistan. At the height of the boom they were saving about half of their export earnings, keeping the aggregate external breakeven for this group at around $54/barrel in 2013. This has since dropped to $41/barrel as of 2015.
Another 16 million barrels came from countries with high breakevens: Algeria, Angola, Chad, Colombia, Ecuador, Gabon, Iraq, Kazakhstan, Libya, Nigeria, Oman, Turkmenistan, Venezuela and Yemen. In 2013, they needed the world price of oil to be $103/barrel to cover past and present imports, barely below the actual market price. They were spending about 90 per cent of their export earnings during the 2011-2013 boom. They’ve since cut their aggregate breakeven to $78/barrel — still far above the market price.
The chart below, from Setser and Frank, illustrates how these breakevens have evolved over time in relation to the price of oil:
The remaining 21 million barrels equivalent of oil and gas come from Russia (11 million barrels), Saudia Arabia (8 million barrels), and Iran (2 million barrels).
Russia’s breakeven is currently ultra-low at $35/barrel. This discipline is a recent phenomenon, however. In the past it had behaved more like Venezuela than Norway: “the roughly $40 dollar per barrel increase in the price of oil between 2005 and 2008 went almost entirely toward financing greater imports, pushing the breakeven oil price from $30 to $68.” By 2013, Russia’s breakeven price had soared to $101 per barrel, according to Setser and Frank. The change between 2013 and 2015 can be explained by the 40 per cent collapse in the dollar value of Russia’s imports.
Saudi Arabia, by contrast, has been profligate, fighting wars with its neighbours and attempting to purchase domestic political peace. The result is an external breakeven of $70/barrel, according to Setser and Frank. There is precedent for this incontinence: the country consistently had an external breakeven above the world oil price from the early 1980s through late 1990s. However, in the 2002-2013 period — when the Saudi Arabian Monetary Authority accumulated about $750 billion of foreign reserves — Saudi Arabia’s behaviour closely tracked that of its abstemious Gulf neighbours.
Iran never had a chance to fully enjoy the benefits of high oil prices thanks to sanctions. Its import bill never rose, but its oil production (and therefore its exports) collapsed. That pushed up its external breakeven to a peak of $78/barrel in 2012, but the easing of sanctions since the nuclear agreement has helped Iran boost its exports and lower its external breakeven to $41.
Here’s how the breakevens of these three countries have evolved over time relative to the world oil price:
This information is interesting but Setser and Frank note their findings have limited predictive power for state behaviour.
Russia’s high external breakeven before 2014 didn’t prevent it from sustaining its foreign adventurism after the oil price collapsed: “limited foreign currency debts, relatively flexible exchange rate, and willingness to adjust quickly proved more significant”. Meanwhile, Saudi Arabia’s willingness to maintain its production to preserve market share — regardless of what this did to the oil price — wasn’t obviously rational given how much the country depends on high oil prices to cover imports.
One big question is the extent to which things have already changed. The most recent data in the paper are almost two years old, although the oil price is still about the same as it was in 2015. Have the big exporters cut their breakeven price, or are they still bleeding money to cover their imports?
Another big question is what the external breakeven can tell us about where energy prices will (or won’t) go. American shale, Australian natural gas, and Canadian tar sands are all set to dramatically expand supply over the next few years. Does this make the behaviour of Middle Eastern and Russian exporters less important than in the past, even if they end up finding themselves in financially unsustainable situations?
Lots to ponder.
Digging into Canada’s trade balance — FT Alphaville
Dirt, rocks, and sunshine: the story of Australia’s external balance — FT Alphaville
How will the oil crash affect Norway? — FT Alphaville
What is the oil crash going to do to Canada? — FT Alphaville
*The world’s biggest oil producer is the United States. China is the fifth-biggest. Similarly, America is the biggest producer of natural gas, while China is in sixth place. Both are net consumers, however, especially China.