Nearing the brink: the dangers of persistently low oil prices

Two years of low oil prices have wrought considerable stress across major oil and gas producing countries.

Oil and gas producing countries with the highest dependence on oil and gas for government revenues and export earnings, and lowest financial cushions have been most affected by persistent low commodity prices. Low prices primarily affected producers in non-core OPEC and in non-diversified economies (identified as the most vulnerable producer categories in our previous quarterlies).

The result is, those countries have seen a significant worsening in their fiscal and current accounts, many of which have gone from balance or surplus to deficit. The chart below shows the extent of those falls for some of the most vulnerable producers. In contrast to 2013, when most of those producers (except Venezuela) were close to balance on their fiscal account and balanced or in surplus on their current accounts, many are now in deficit on both.

The Response

The first port of call for most producers after the downturn has been at the economic level: public spending cuts, efforts to restrict imports, currency devaluations, and/or drawdown of financial reserves. These actions have often been coupled with increased borrowing, and, in some cases, oil-backed loans that will stymie immediate gains from any price recovery.

Upstream oil and gas policies have also come under review, leading to adjustments in exploration and production terms and conditions, both near term, where cost cutting has been a particular focus, and longer term, where taxation and state participation are under review.

Several producer countries are now exhausting the possibilities of where individual policy initiatives can take them. However, with contradictions and pressures mounting to the extent that governments are struggling to balance domestic spending with other obligations, including the treatment of foreign investors. A failure to strike that balance will have serious consequences for government stability and investment prospects moving forward, a situation that could significantly shift the investment risk calculus for a number of projects when oil prices recover.

That's not the end of the story though. Even where states are under extreme economic pressure, governments with a high level of political legitimacy and/or capacity may have greater flexibility in previously unthinkable policy choices. This factor helps explain the relative ability of Nigeria to make difficult changes in the current crisis, for instance cutting fuel subsidies, in a context where there is some level of public acceptance on the need for change and a level of support for the new administration (albeit within limits, as evidenced by growing Niger Delta violence).

Those which are likely to face the toughest challenges in identifying further necessary policy adjustments include Iraq (including the semi-autonomous Kurdistan region) Nigeria, and Venezuela. In all of these cases, investors face uncertainties as to the ability of current state partners to formulate and implement a consistent oil and gas policy, adhere to contract terms, and ensure operational stability.

In the most extreme cases, the survival of the state may itself be at risk in the context of rising political and social unrest, providing a long-term shadow over state capacity and, with that, oil and gas production and investment prospects. This isn't something that will rebound in short order with any price rise - these vulnerabilities have become entrenched in some instances. While there is nearly always a way out - how that exit plays for investors will be the continued focus for our research and analysis over the coming period.

IHS Petroleum Economics and Policy Solutions (PEPS) is a complete and integrated package of information and tools that enable in-depth understanding and holistic cross-country comparison of E&P activity and results, upstream investment terms, and petroleum sector risk worldwide. The PEPS Oil & Gas Risk module provides forward-looking analysis on above-ground petroleum sector risks in hydrocarbon producing and frontier countries. Our analysis is built around a proprietary risk methodology, which evaluates 130 countries and territories against 21 factors to offer clients an objective and systematic way to compare risk between countries and at different stages of the investment cycle.

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This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.