Oil-price volatility exposes risk differentials of top producers

With oil prices now hovering around $40/barrel, the market has much improved from its low point in April, assisted by Opec-inspired production cuts from May through to the end of June.

Demand has increased, with economies reopening and vehicle usage rising, but is still down on year-earlier levels – and with storage capacity burdened, Opec may decide to extend its production cuts beyond June.

Its meetings on Tuesday and Wednesday will be closely watched in that regard.

Many risk experts believe the oil-price recovery can continue, gradually perhaps, but they also warn of the risks in a world of disease control, sub-optimal output, less air travel and rapid take-up of renewables.

However, there is little sense of homogeneity for investors in oil-exporting countries that display dissimilar political and policymaking frameworks and macro-fiscal metrics.

Risk differentials

Take Russia, a country 77th out of 174 countries in Euromoney’s global risk rankings, in comparison with, say, Kazakhstan, lying 96th. The two rely on oil, and to a certain degree on each other, but show distinct, often subtle differences in risks highlighted by their 19-place differential.

What is interesting amid all the fluctuations is that Russia’s score has been trending higher on a five-year basis, with Kazakhstan’s moving in the opposite direction, signalling Russia offers the better bet, according to the crowd-moving consensus of hundreds of analysts taking part in Euromoney’s quarterly risk survey.

Aside from GDP – which is predicted to fall more in Russia this year than in Kazakhstan, according to the IMF – Russia outranks its neighbour on most other macroeconomic risk indicators. Its political risk is marginally better, and it also excels on capital access and debt ratings.

These relative strengths are also prevalent in the Gulf region, with Qatar, a heady 29th in the rankings – and still enjoying a budget surplus – outshining Saudi Arabia (46th) on almost every risk indicator, where the IMF predicts a tripling of its fiscal deficit to 12.6% of GDP this year.

It is surprising that the price of domestic refining is equated to the price of imported fuel, including transport costs 

 – Emmanuel Nwosu, University of Nigeria

Similarly, subtle differences in economic, political and structural indicators exist in other areas where oil producers are exposed to rising debts and social instability from the dual shock of the coronavirus Covid-19 and low oil prices.

Iran, now 154th in the global risk rankings, and Iraq, 150th, were both heavily downgraded in Euromoney’s Q1 2020 survey, as were Mexico (62nd), Malaysia (63rd), Egypt (108th), Angola (128th) and Congo Republic (155th). Libya was unchanged, but at a lowly 148th it was already considered a high risk for investors.

And yet clearly differences exist.

Mexico and Malaysia remain medium-risk emerging markets, despite the concerns caused by coronavirus lockdowns, the negative oil price shock and country-specific political and policymaking nuances.

Nigeria, however, is a much higher risk, lying 94th in the rankings, with hydrocarbons accounting for 85% of total exports, struggling with a weakened economy, where authorities have been forced to devalue and request financial support from the IMF.

And, in turn, Nigeria is different to Venezuela, which languishes in 167th place. There, the economy has been shrinking for the past six years and is expected to continue to do so in 2020-2021, whereas Nigeria will likely endure a single year of contraction.

Venezuela has hyperinflation and large double-digit fiscal-to-GDP deficits. Nigeria’s macro-fiscal metrics are worrying, but considerably less severe.

Nigeria

Low oil prices are affecting Nigeria negatively in several ways, says Emmanuel Nwosu, senior lecturer, development economist and economic policy management consultant in the department of economics at the University of Nigeria.

The first is directly in terms of the fiscal budget, “which is now fraught with uncertainty since there is no specific benchmark oil price to anchor the budget estimates on”, he says.

The IMF predicts a rise in government borrowing to finance the budget, with the fiscal deficit seen widening from 5% of GDP in 2019 to 6.4% in 2020.

Nwosu says a second problem is that Nigeria, as an oil-exporting nation, does not have any comparative advantage over its non-oil producing neighbour’s in terms of refined petroleum product prices. Crude oil is exported and most of the proceeds are used to import refined petroleum.

“It is surprising that the price of domestic refining is equated to the price of imported fuel, including transport costs,” he says.

This doesn’t make sense to Nwosu, who believes that if it can be demonstrated that oil refining can be done more cheaply in Nigeria, “it would be a source of disincentive to imports draining foreign exchange and causing exchange-rate instability”.

A third problem is that of inter-state lockdown in a vulnerable economy.

“This will continue to impact negatively on the income of farmers as most of them are no longer able to market their produce and there are inadequate storage facilities,” says Nwosu.

“Government palliative measures may help to mitigate the effect, but not significantly, and this has to be properly targeted for there to be any positive effect at all.”

Venezuela

However, Nigeria’s problems are not as acute as those facing Venezuela, mired in a long-standing crisis due to continuing mismanagement, corruption and lack of investments in the upstream and downstream sectors ever since the Hugo Chávez era.

All of this has been reflected in the survey in recent years, with Venezuela, one of the world’s highest risks, having lost almost 17 points during the past decade and crashing almost 60 places in the process.

José Chalhoub, freelance political risk analyst and contributor to Euromoney’s survey, sees low oil prices lasting for the rest of the year, which is a problem for the refining sector and one that is already causing a severe shortage of petrol in the country.

“This is prompting Venezuela to import more fuel from Iran and is pushing president Nicolás Maduro to hike the prices of petrol for the first time since the onset of the Bolivarian Revolution to 0.50$ per litre, when gasoline supplies and sales in the black market controlled by military and police officials are being sold at $2 to 4$ per litre,” he says.

“This is certainly a move by Maduro to try to obtain funds from a long-standing situation of heavily subsidized petrol in Venezuela and transmitting the burden now to the people, where the minimum wage is around 3$ per month in an almost completely dollarized economy.”

With a cost of oil production per barrel of around $35, and dwindling forex reserves of around $7 billion, Chalhoub sees Venezuela’s risks remaining heightened without financing from a multilateral institution and a thorough internal reform of PDVSA, the national oil company.