WHO WINS, WHO LOSES AS GLOBAL CRUDE OIL PRICES DECLINE, NOW AT FIVE-YEAR LOW?

An oil rig. There are concerns that lower oil prices may hurt capital-intensive extractive industries in the medium term.

Global crude prices, which have fallen to a record five-year low, could hurt East Africa’s nascent oil and gas industry, but economists and industry experts remain positive that lower oil prices will benefit non-oil producing nations and boost their economies.

There is a growing sense of optimism that the historic decline in oil prices will reduce inflation, the oil import bill, fiscal deficits and interest rates.

READ: Economies to grow as global oil prices plummet

But while households stand to benefit almost instantly through cheaper petrol and other fuels, there are concerns that lower oil prices may hurt capital-intensive extractive industries in the medium term.

“The fall in crude prices will affect our oil and gas exploration activities. Investors in this sector will have to spend more on drilling plants and the recovery period as it will take longer to recoup their investment,” said Scholastica Odhiambo, a lecturer at Maseno University in western Kenya.

“Investors in the oil industry may demand tax exemptions from governments and be tempted topull out if these subsidies are not assured.”

The world price for crude has declined from $107 per barrel in June last year to less than $70 currently, with US crude standing at around $55.74 last week.

How long the dip will last remains anyone’s guess. But there is speculation that as long as Saudi Arabia is happy to use oil as a weapon against its political opponents in the Middle East and as a way to impede further development of the US shale oil resources, then investors should expect the present state of affairs to continue for some time.

Improved spending power

“We are likely to see this trend going on for about one or two years,” said Dr Odhiambo. “As an economy, however, we expect a reduction in the cost of products and companies selling more to make more profit. As a result, companies will undertake more investments and create more employment opportunities for the people. This will in return boost consumers’ spending power.”

According to a cross-section of economists, the cost of production, transport and electricity is expected to drop in tandem with the fall in the crude price.

“In Kenya, the main drivers of inflation are the cost of food and energy. With a fall in crude price, we expect a lower rate of inflation,” said Kwame Owino, chief executive of Institute of the Economic Affairs (IEA), a public policy think tank that seeks to promote pluralism of ideas through public debates.

“Definitely it will lead to a fall in prices but the key concern is that the shilling is under pressure. A further drop in prices is also dependent on the shilling’s exchange rate.”

Kenya Power’s chief executive Ben Chumo, however, ruled out the possibility of a reduction in electricity prices in the short term, citing long term power purchase agreements with suppliers.

“We don’t expect power costs to come down immediately as a result of the fall in crude prices, because we have long term fuel supply agreements,” said Dr Chumo.

Kenya’s inflation for the month of December 2014 fell to 6.02 per cent from the previous month’s 6.09 per cent driven by a reduction in the cost of housing, water, electricity, gas and other fuels, according to data from Kenya National Bureau of Statistics (KNBS).

Contributing to the lower cost of electricity was the fuel cost adjustment which decreased from Ksh 3.47 ($0.04) per KWh in November to Ksh 2.87 ($0.03) per KWh in December.

Despite notable reductions in the pump prices of petrol and diesel, an upsurge in transport inflation was recorded mainly due to higher fares charged by taxis and other public service vehicles over the Christmas holiday.

Kenya’s Energy Regulatory Commission (ERC) last week promised to effect a further reduction in pump prices to reflect the drop in crude prices.

“Yes we expect to see a further reduction in pump prices,” Linus Gitonga, the director of petroleum at ERC, said, adding that the downward trend in crude prices was as a result of international forces, and there was no way of telling how long it would continue.

According to Polycarp Igathe, the chairman of the Petroleum Institute of East (PIEA), oil importing countries such as Kenya stand to benefit immensely from the cut in fuel prices.

“A cut in fuel prices means extra disposable income for the average citizen. So let us enjoy while it lasts,” said Mr Igathe. “It is hard to tell how long the drop of crude will last. but Saudi Arabia has the last word on it. They have the lowest cost of production in crude at $6 a barrel. The rest of the world produces at $20 a barrel.”

He, however, added that if crude oil sells at a price lower than $80 a barrel, it will become unsustainable.

“The lowest price that oil exporting countries budget for is $70 a barrel,” said Mr Igathe.

Lower pump prices

In Kenya, the cost per litre of petrol has dropped 13 per cent from Ksh117 ($1.3) in August to Ksh102 ($1.13) in December.

“We are now in a much reduced price environment for fuel, and the only question remaining is who wins and who loses,” said Jeffrey Cavanaugh from the University of Illinois at Urbana-Champaign.

“In Africa, the obvious beneficiaries are non-oil producing countries, meaning that out of the continent’s big three regions it is Southern Africa and East Africa that are most poised to benefit,” said Dr Cavanaugh.

He added that the emerging oil boom in East Africa that is developing both offshore and onshore will be slowed down significantly, if not scuttled altogether.

“The recent announcement by African player Tullow Oil that it will be dramatically cutting its exploration budget in 2015 should serve as warning that many big oil exploration companies will now be more sceptical about expensive African oil and gas projects, especially offshore,” he said.

Onshore, especially in Kenya’s Lokichar Basin, prospects are brighter as costs are lower, so that the nascent oil boom may continue. Lower oil prices will bolster Kenya’s vital shipping industry and help particularly with international air freight and travel.

“Agriculture too, should also see important benefits as costs for inputs such as fuel and fertiliser decline, and shipping costs make it cheaper to transport goods to markets in the Middle East, India and Europe,” said Dr Cavanaugh.

“Kenya, therefore, should possibly see the most benefit from lower oil prices. East African currencies will rise in the future as their economies grow stronger.”

But the price fall will hurt Africa’s oil producers such as Nigeria, Angola, Equatorial Guinea, Gabon and, Algeria which are all likely to head into recession if they are not there already.

According to Andre Haughton, a lecturer in the department of Economics on the Mona Campus of the University of West Indies in Jamaica, lower oil prices are good for countries that import oil and bad for countries that export. It is expected that the fall in oil prices will result in a decline in overall prices for developing/emerging market oil-importing economies.

“Lower crude oil prices suggest a fall in import prices and a decline in the price of energy, which is a necessary input in most production processes. The fall will also be reflected in falling gas and electricity prices,” said Dr Haughton.

Lower crude oil prices mean a lower cost of production, and lower prices for goods and services that depend on oil in the production process.

“Lower prices mean households should have more of their disposable incomes to spend on other products. A higher disposable income means a rise in aggregate demand, which should be offset by an increase in production, thereby increasing gross domestic product (GDP),” said Dr Haughton, adding that the stocks for oil companies stocks are expected to fall while banks will register a fall in oil-based asset prices.

According to Fitch Ratings, the drop in oil prices this year could bolster growth in sub-Saharan Africa to five per cent this year from 4.5 per cent in 2014.

Countries such as Kenya, Cote d’Ivoire, Seychelles and Ethiopia spend more than 20 per cent of their import bill on buying oil. Lower oil prices represent a fall in the overall import bill, which is a significant positive for Kenya, given the current long- term development goal of Vision 2030 the country aspires to achieve.

Although oil-importing countries such as Kenya and Uganda are profiting from the existing drop in oil prices, they are set to become oil-exporting countries, possibly as early as 2017. Consequently, falling oil prices may reduce the expected profitability of their investments in the oil sector.

Kenya’s economy is estimated to have grown by 5.5 per cent in the third quarter of 2014 compared with a revised growth of 6.2 per cent in the same period of 2013. This is due to a slump in the tourism industry occasioned by security concerns, according to data from the KNBS.

Global trends

A review of the global trend in crude prices shows that average crude prices fluctuated between $10 and $20 a barrel between 1947 and 1972 followed by a jump from $15 to $42 a barrel in 1973-74, after the oil exporters’ cartel, Organisation of Petroleum Exporting Countries (Opec), enforced an embargo on the US, UK, Japan, Netherlands and Canada for supporting Israel.

Crude prices declined 40 per cent to less than $12 a barrel in 1998-99, when Opec announced a 10 per cent quota increase amid slowing growth in Asian economies. In 2004-08, crude oil jumped from $27 a barrel to over $98, due to a number of factors including the Iraq war, growth of Asian economies and a weaker US dollar. In late 2007 and early 2008, a barrel of oil was trading as high as $165.

But the crude price fell sharply from $98 a barrel to $50 a barrel during the financial crisis of 2008-09, At the moment, one of the key drivers of lower oil prices is the American shale boom.

Over the past few years, the abundant supply of domestic oil has helped keep oil prices low but the US has gone from being 40 per cent energy dependent, to 75 per cent energy independent.

The shale oil boom in the US has increased global supply and since oil is a relatively price-insensitive commodity, a small increase in supply can have a large impact on price.

The fall accelerated after Saudi Arabia persuaded Opec not to stand in the way of the fall in price by cutting production.
Other explanations include a slowing world economy and weak demand from energy-intensive industrialising economies such as China.

The East African