Who Suffers from Cheap Oil?

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Dec 11, 2014 3:09:58 PM

and tagged In the News

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cheap oilAs I wrote the other day, the U.S. stands to benefit considerably from cheap oil. The question now is who will suffer—and what might that mean for the U.S.?

Oil exporters in trouble

Who gets hurt is quite simple: look no further than the major oil exporters. Saudi Arabia and Russia export as much as the next eight countries combined, so we’ll start with them.

Absolute levels of exports are one thing; what matters is how much of the country’s economy depends on oil exports. To determine that, we can look at the World Bank’s statistics for oil rents as a percentage of GDP, expressed as the difference between the value of oil production at world prices and the cost of production. For Saudi Arabia, oil added just under half of the total economy, while for Russia it represented about one-seventh. The U.S., by comparison, is just under 1 percent.

Based on this statistic alone, you might expect Russia to be much less exposed to price declines, but you'd be wrong. Saudi Arabia has far lower marginal production costs, so it can be profitable at much lower prices than Russia can. The Saudis may be making less, but they’re still making money. Saudi Arabia also has a deep reservoir of cash to draw on, which can support lower prices. Finally, it can dial up production—cheaply—to increase revenue, which Russia can’t do.

Looking further down the list of oil exporters, we see the usual suspects—the OPEC countries, which largely share Saudi Arabia’s advantages. Countries in the headlines include Iran (with oil representing 22 percent of the economy), Nigeria (just over 15 percent), Norway (just under 10 percent), and Colombia and Egypt (8 percent). Closer to home, we have Mexico at nearly 7 percent, and Canada at slightly over 3 percent.

What to watch
  • Russia is under enormous economic pressure, which will likely only grow if oil prices stay low. That may well drive it to do unpredictable, damaging things, especially in Europe and in its borderlands. Expect more potential aggression.
  • Africa may also suffer from another wave of instability.
  • Mexico may come under pressure, which could directly affect the U.S. Although it has less exposure, Canada could be meaningfully affected as well.
  • Damage to the economy of Egypt could further hinder the Middle East peace process.

For the U.S., the downside of lower oil prices isn’t the economic damage it would do here, but what it could do to countries we’re exposed to, with Mexico at the head of the list. Even so, any such damage could potentially be offset by damage to countries we’re in conflict with, such as Russia, Iran, and Venezuela.

Make no mistake, there is a downside to lower oil prices—it just doesn’t seem to show up much here in the U.S. We are particularly lucky in this respect, but we must also be prepared to support our less-fortunate allies.

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