The Impact of the 2014 Oil Shock on Arab Economies
Mohamed Hedi Bchir Jose Antonio Pedrosa-Garcia1
Abstract This study uses a multi-country, multi-sector, recursive dynamic, global CGE model to assess the implication of a drop in oil prices for Arab economies. Overall the results are as expected: oil-importing countries benefit (particularly Morocco, but also Tunisia and Jordan). In turn oil-exporter lose, especially Saudi Arabia but also Oman. However, importers’ gain is smaller than exporters’ loss. The simulations show that the larger the shock, the more important are the consequences on GDP growth, total investment, skilled and unskilled unemployment rates. The sectoral implications are also clear: sectors intensive in oil (e.g. metal) are positively affected and vice versa. Larger shocks are associated with higher benefits from flexibility in the allocation of resources in the long run. Oil price shocks can also induce higher unemployment which can stick in the long run. Indeed as oil exporters are intensive in capital and capital is associated with knowledge, when the oil sector is shocked skilled labor fares worse than unskilled one (in oil importing countries the effect is opposite). Given the fiscal policy of high subsidies and handouts in oil-exporting countries, its consequences could potentially turn sociopolitical were those fiscal policies to be terminated. To address such threat countries may turn to their SWFs, but only Saudi Arabia has a large-enough buffer. Another option is debt, which is particularly appealing given the current context of ultra-low interest rates. Yet, the current slump in oil prices presents a unique opportunity to undertake subsidies’ reforms which may arguably be the soundest option in the long run. Some oil- importing countries that have moved in this direction are Tunisia, Egypt and Morocco. However, such oil exporters as Bahrain and Kuwait have also started to implement subsidy reforms. The great unknown is what will be the reach of those reforms...
1 This paper has been published as Chapter 3 in ESCWA’s Survey of Economic and Social Developments in the Arab Region 2014-2015. The views and interpretations do not necessarily reflect those of the United Nations or its member countries.
Both authors work at the Economic and Social Commission for Western Asia (ESCWA). Email for correspondence: [email protected]
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1. INTRODUCTION
Despite considerable increase in the use of alternative sources of energy and efficiency improvements, oil remains one of the most strategic commodities in modern economy. The twentieth century has been called the ‘hydrocarbon century’: at the beginning of the century global oil output was about 150 million barrels per year, while at present this amount is extracted in just a few days. Oil prices are one of the most significant explanatory variables of global growth and more than any other commodity, and their fluctuations can be intense and hardly predictable. Explaining oil prices fluctuations and assessing their macroeconomic consequences at country and global level has become one of the most and recurrent topics in economic literature. Over the past forty years, researchers have explored the relation between oil price shocks and macroeconomic performance. The 1973 oil crisis was a particular turning point and substantial empirical literature on the macroeconomic impact of oil supply appeared thereafter. Some early studies noted that higher prices of energy resources, relative to the prices of labor and capital, resulted in a loss of economic capacity and higher output prices.2 In 1980, it was estimated that the shocks depressed real output by two percent in 1974 and by five percent in 1975 (prices rose by four percent in 1974 and by another two percent in 1975).3 In 1983, James Hamilton published a seminal study on oil shocks. Hamilton looked at how oil prices affected the U.S. economy with a Vector Auto Regressive (VAR) system using quarterly data of Gross National Product and other macroeconomic variables. The results were clear: all but one of the post-World War II recessions in the USA were preceded, typically with a lag of 9 months, by a dramatic increase of oil prices.4 Several other studies corroborated Hamilton’s findings, and other documented similar relations for countries other than the US.5 Hamilton’s 1983 study belonged in a period in which all the large oil price movements were upward, and therefore did not explore what happens in periods of price declines. Knut Mork (1989) showed that if Hamilton’s sample is extended to 1988 (prices dropped drastically in the mid-1980s), the results “persist in the longer sample and are strengthened by the correction for price controls. On the other hand, an asymmetry in the responses is quite apparent in that the correlation with price decreases is significantly different and perhaps zero”.6 Other research showed evidence that “oil prices no longer Granger cause many U.S. macroeconomic indicator variables in data after 1973”.7 A number of studies suggested that this breakdown of the oil price - economy relation was a result of misspecification of the oil price rather than a weakened effect. Then, the literature refined positions about oil price measurement and specifications. 8 For instance, some economists incorporate different
2 Rasche, Tatom 1977 3 Mork, Hall 1979 4 Hamilton 1983 5 See e.g. Burbidge and Harrison 1984 6 Mork, 1989 7 Hooker 1996 8 Hamilton 1996 2 transformations of oil price data to account for possible non-linear relationships.9 It has also been argued that what matters are different measures of oil price volatility10, which suggests the role of expectations: the most important aspect is how surprising an oil price increase was relative to the observed recent evolution of prices. In this vein, it has been claimed that only price changes which establish new annual highs should be considered.11 Rises in oil prices deteriorate the terms of trade, implying a wealth transfer from net oil- importing countries to net oil-exporting ones.12 In today’s context, it has been estimated that the slump in oil prices since mid-2014 represents a value transfer of 1.6 trillion USD from oil-producing to oil-importing countries.13 In the literature the transfer of wealth has been qualified by a number of authors, however, as higher oil price shocks can affect the economy both directly and indirectly.14 The indirect effect is transmitted through trade: oil-importing countries import less from oil-exporting countries. As a result of the indirect effect, even net oil exporters cannot escape the negative effect of high oil price shocks. For example, Malaysia and Indonesia are net oil-exporters and major trading partners of Singapore, an oil- importer. While higher oil prices impact negatively on Singapore’s GDP growth, Malaysia and Indonesia reap the benefits in terms of higher export revenues. This in turn increases their imports from Singapore. The net effect of oil prices on the latter, therefore, depends on the magnitude of these direct and indirect effects. In turn, this depends on how trade-dependent countries are, and how net oil-exporting countries use their extra windfall purchasing power. Higher oil prices make the oil sector more attractive to invest in. However, they also diminish the profitability of sectors for which oil is vital (e.g. transportation). This explains the large investment in renewable energies when oil prices are very high. On the other hand, when oil is cheap investments in clean energies have to be heavily subsidized if they are to be undertaken. Similarly, it is worth noting that if oil prices were to remain low, the use of oil would be favored relative to other more polluting fuels such as coal, especially in China where it is widely used. An additional effect is on exchange rates. Research has shown that oil prices significantly explain movements in the value of the U.S. dollar (USD) against major currencies from the 1970s to 2008. 15 As oil is denominated in USD, higher prices are associated with an appreciation of the USD (countries demand more USD to buy oil). However, to the extent that importing countries sell those USD revenues and convert them into their national currencies, the effect may fade away. As with any other export commodity, increases in the real price of that commodity lead to an appreciation of the exporting country’s currency. This rationale is consistent with recent evidence. In the case of the current slump of oil prices, Russia and Nigeria have seen large depreciations of their currencies. As countries import in USD and may have debt denominated in USD, weaker currencies trigger fiscal tightening efforts. If Sovereign Wealth Funds (SWF) are available, it may be tempting to draw from them because the relative value of net foreign asset holdings has
9 Cuñado and De Gracia (2003) 10 See e.g. Lee, Ni and Ratti (1995) and Ferderer (1996) 11 Hamilton (1996) 12 Dohner 1981 13 By Barclays, as reported at ValueWalk 2015 14 Abeysinghe 2001 15 Lizardo, Mollick 2010 3 increased -especially in the current context of quantitative easing (QE) in some of the most important world economies. Indeed, it has recently been noted that the asset structure of SWFs is starting to change (especially of those fueled by oil revenues): SWFs are becoming more liquid, as their share of investments in money market funds has grown, and the balance of SWFs has remained stable or declined for some countries, but not increased.16 To assess the relation between oil prices and the economy methodological issues have also been raised over time. For instance, it has been argued that in most of the research relating oil price shocks, the reasons underlying those shocks are ignored, which is a mistake because not all oil shocks are alike.17 To address this it is necessary to account for the endogeneity of energy prices, and differentiate between the effects of demand and supply shocks in energy markets.18 For Arab economies the influence of oil prices is very important, as the region is a major actor of the global oil market. While no individual country can influence the price by itself, Arab countries’ combined role in the Organization of Petroleum Exporting Countries (OPEC) and their low production cost allows them to control a large part of the global supply, and therefore to affect the world’s oil price. Oil has played an essential role in the Arab world’s socio-economic development, shaping decisively the Arab world and its modern-day development trajectory. Nonetheless, few studies have focused on the economic implications of oil prices on the economies in the region. Thus, the recent slump in oil prices is an occasion to contribute towards filling this gap.
2. THE IMPORTANCE OF OIL IN THE REGION
Arab countries hold approximately 71 per cent of the world’s total proven reserves (Annex Figure 16). In 2011, they produced 22 million barrels per day which represent nearly a third of global oil supply, making the region the world’s most important supplier of crude oil.19 However, there is great variability in oil production. Figure 1 shows that growth has been more volatile than oil prices, but the mismatch has declined over time. Broadly, economic performance and oil prices are loosely correlated but this includes different price periods and all countries.
16 Financial Times 2015a 17 Kilian 2009 18 Kilian 2008 19 Fattouh and El-Katir, 2012 4
Figure 1. Relation between Arab growth rate and oil prices
Natural log of (Brent price) Growth
14
12
10
8
6
4
2
0
-2
-4
-6 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Source: Authors’ own elaboration based on data from the World Bank 2015a
To assess country specific patterns over time table 1 shows correlation coefficients for the entire period (column 1), the first half (column 2) and the second half (column 3). The time break up is relevant. It has often been noted that during the first boom (1970s) Arab oil exporters did not follow prudent macroeconomic policies, although they have done so in the last 15-20 years, especially through the accumulation of reserves.20 The coefficients in table 1 show that not only oil is important for Arab growth; overall it has become more important over time (the coefficients increased from 0.0237 to 0.2726). The move has been driven by such countries as Djibouti, Saudi Arabia, Sudan and Yemen. Conversely, the relation (either positive or negative) between growth and oil prices has faded way for such countries as Algeria, Egypt, Kuwait and Oman. This would be explained by economic diversification in those countries - although not necessarily out of hydrocarbons: e.g. if the gas sector is highly promoted dependence from oil is reduced.
TABLE 1. CORRELATION COEFFICIENTS BETWEEN GROWTH AND OIL PRICES BY COUNTRY
1979-2013 1979-1994 1995-2013 (1) (2) (3) Algeria 0.2968* 0.7368* -0.2833 Comoros 0.1517 0.4389 -0.0668 Djibouti 0.8082* 0.0892 0.8183* Egypt 0.1766 0.6818* -0.1016 Iraq -0.0574 0.006 -0.1577 Jordan 0.2104 0.3547 0.1609 Kuwait -0.1947 -0.5264* 0.1713 Lebanon 0.0358 0.3034 0.2447
20 Beattie 2014 5
Morocco 0.0042 -0.1461 0.1325 Oman 0.2048 0.5480* 0.2833 Qatar 0.2301 . 0.2301 Kingdom of Saudi Arabia 0.2113 -0.2508 0.6336* Somalia -0.0763 -0.0763 . Sudan -0.3439* -0.3342 -0.4716* Syria 0.0657 -0.009 0.273 Tunisia 0.0296 0.3697 -0.3019 United Arab Emirates (UAE) 0.1017 0.2452 -0.0804 Palestine -0.3961* . -0.3961* Yemen -0.4757* 0.4375 -0.4228* Total Arab 0.1856 0.0237 0.2726 * Significant at 10 percent level, ** significant at 5 percent level; *** significant at 1 percent level Source: Authors’ own calculation
Oil-exporting countries rely heavily on oil revenues to fund their budgets. For instance, in 2013 oil rents amount to 53.8 percent of GDP in Kuwait.21 In Saudi Arabia, oil and gas revenues in 2010 were equivalent to 90 percent of government income and 88 percent of exports.22 Fiscal breakeven oil prices per barrel have been estimated as follows: Kuwait (52 USD), Qatar (59.4 USD), UAE (81.3 USD), Saudi Arabia (84.3 USD), Oman (89.4 USD), Algeria (106.7 USD), Bahrain (126.9 USD).23 Based on these estimates, Oman and Bahrain would be the most affected by the current drop in prices because they have a high fiscal breakeven and low reserve buffers: their SWF are estimated at 13 and 10.5 billion USD, respectively, while Algeria’s is estimated at 50 billion USD.24 At the other extreme, Kuwait, Qatar, the UAE and Saudi Arabia have a similar shock absorption capacity, although in 2013 Saudi Arabia has reserves estimated at 718 billion USD (Table 2). Saudi Arabia’s huge reserves have been accumulated thanks to the fact that it’s got the lowest cost of production per barrel in the world, estimated at 10 USD. A second vital link between oil and countries’ economy is subsidies, which apply to both net oil exporters and importers. Globally, 2 percent of global government revenue is spent on subsidies each year, but this situation is much more pronounced in the Arab region, which spends 8.6 percent of its GDP (approximately 250 billion USD) in subsidies.25 Table 2 below shows that very significant shares of government spending go to subsidies and other transfers.
21 World Bank 2015 22 Natural Resource Governance Institute 2015 23 IMF 2014 24 Sovereign Wealth Fund Institute, 2015 25 Sdralevich et al. 2014 6
TABLE 2. KEY INDICATORS OF THE IMPORTANCE OF OIL FOR EXPORTING COUNTRIES, IN 2013 OR CLOSEST YEAR Oil price at fiscal Gross official reserves Subsidies and other transfers
breakeven26 (billion USD) 27 ( percent of expenses) 28 Algeria 106.7 194 44.9 Bahrain 126.9 4.7 38.6 Kuwait 52 27.5 29.0 Libya 106.2 122.5 - Oman 89.4 16.6 17.4 Qatar 59.4 42.1 15.8 Saudi Arabia 84.3 718.4 - UAE 81.3 71.8 25.6
The main uses of subsidies are petroleum and food products but the subsidization rate is usually higher in oil exporting countries: the average subsidization rate is 77.5 percent of the total fuel cost in Algeria, 78.4 percent in Kuwait, 77.3 percent in Saudi Arabia, and 65 percent in the UAE; Egypt is the first net-importer at 61.2 percent.29 The current drop in oil prices offers a unique opportunity to smoothly reform subsidies. Indeed, several countries have made efforts to implement reforms and reduce or eliminate subsidies since 2014: Tunisia (April), Egypt (July), Kuwait (September), and Morocco (February 2015).30
3. WHY THE SHARP DROP IN OIL PRICES?
Historically, the oil market has experienced many shocks between 1960 and 2014 (Figure 2 below). First, the oil supply shock of 1973-74 was a boldly visible event followed by considerable turmoil. The 1979 oil crisis occurred in the wake of the Iranian revolution. The protests shattered the Iranian oil sector. OPEC nations increased production to offset the decline, and the total loss in production was about 4 percent. A widespread panic resulted, however, driving the oil price to double its previous level.
By the early-to-mid-1980s, continuing increase of North Sea, Mexican and Angolan oil output led to OPEC experiencing falls in its market share. At the same time, Saudi Arabia increased oil production despite the context of slow world oil demand growth, which led to the oil price collapse of 1985-86.
26 IMF 2014 27 IMF 2014 28 IMF Government Finance Statistics Yearbook, as available at the World Bank’s World Development Indicators (2015) 29 International Energy Agency (2013) 30 Financial Times 2015c 7
Figure 2. Average price of crude oil in current US$ since 1960 120 Global crisis Present
100 Strong demand, stagnant supply
80 Iran-Iraq war
60 Iranian revolution Asian crisis Arab Spring & Gulf War I Japanese tsunami 40 OPEC Embargo Gulf War II 20
September 11
0
Source: Oil price series were extracted from International Financial Statistics
The 1990 energy crisis was milder and briefer than the two previous oil crises (1973 and 1979). The Iraqi invasion of Kuwait in 1990 effectively removed some 9 percent of world oil production from the market and caused considerable uncertainty in the oil market. Oil went from US$ 17 to US$ 25 per barrel during the crisis. A second, minor decline in oil prices took place in the beginning of 1996 when Iraq began exporting oil under the oil-for-food deal.31 Prices would go down again as the Asia crisis hit and world demand slowed down, but they would go back up shortly after. In the beginning of 1999, the threat of a new oil shock appeared especially following California's energy crisis32 and the tensions in the Middle East (with the beginning of the second intifada). These factors were compounded with the emergence of new industrial superpowers: China, India, Brazil, Turkey and Iran (with a combined population close to 2.8 billion). In the next years oil prices went up not so much due to a shortfall of supply, but to a steady growth in demand. After the September 11th terrorist attacks in 2001, the US war in Iraq and ensuing instability in the region led to a significant hike in prices. Oil prices rose to unprecedented levels, but in 2007 when the financial crisis hit, oil prices declined drastically due to a weak global demand.
31 Although established in April 1995, the implementation of the oil-for-food program started only in December 1996, after the signing of the Memorandum of Understanding (MOU) between the United Nations and the Government of Iraq on 20 May 1996. 32 The California electricity crisis of 2000 followed a failed partial-deregulation, in 1996, of the electricity market in the state. The energy crisis was characterized by a combination of extremely high prices and rolling blackouts. Price instability and spikes lasted from May 2000 to September 2001. Rolling blackouts began in June 2000 and recurred several times in the following 12 months. 8
Uncertainties over the supply of oil linked to the 2010 events known as the Arab Spring helped oil prices to regain previous levels. Since then prices stayed relatively stable, hovering around 110 USD for around 3 years and reaching a peak at 115USD in mid 2014 (Figure 3 below). Then, around mid 2014 prices started to fall; between July 2014 and January 2015, prices in the world market for crude oil (using Brent as benchmark) decreased by 58 percent. The plunge constitutes the second largest fall over a twelve-month period in the last 50 years.
Figure 3. Evolution of oil prices between January 2014 and April 2015.
140
120
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40
20
0 J-14 F-14 M-14 A-14 M-14 J-14 J-14 A-14 S-14 O-14 N-14 D-14 J-15 F-15 M-15 A-15
WTI Brent OPEC
Source: EIA for WTI and Brent; OPEC for OPEC Basket
The reasons behind the recent and marked drop in oil prices are multiple. Although the USA has a ban on oil export since the 1970s, the rapid expansion of North American crude thanks to new technologies in shale oil extraction, horizontal drilling, and exploration in deep offshore (more than 2,000 m deep) has constituted a significant expansion of supply, while such traditional suppliers as Saudi Arabia have remained quite stable (Figure 4 below). Indeed, it has been shown that three-fifths of the oil price drop in the second half of 2014 was caused by growth in supply, which would raise global economic activity between 0.3 and 0.7 percent in 2015.33
33 Arezki and Blanchard (2014) 9
Figure 4: Crude oil production Figure 5: Crude oil production The United States (thousand barrel per day) Saudi Arabia (thousand barrel per day)
12000 12000
10000 10000
8000 8000
6000 6000
4000 4000
2000 2000
0 0
Jan2008 Jan2009 Jan2010 Jan2011 Jan2012 Jan2013 Jan2014 Jan2008 Jan2009 Jan2010 Jan2011 Jan2012 Jan2013 Jan2014
Sep2008 Sep2009 Sep2010 Sep2011 Sep2012 Sep2013 Sep2014 Sep2008 Sep2009 Sep2010 Sep2011 Sep2012 Sep2013 Sep2014
May2008 May2009 May2010 May2011 May2012 May2013 May2014 May2008 May2009 May2010 May2011 May2012 May2013 May2014
Source: EIA Source: JODI
But the demand side has also contributed to this evolution. International organizations, including the United Nations (2015) and the World Bank (2015) has forecasted that global growth in 2015 is expected to remain much weaker than it was during the 2003-08 period (when oil prices rose substantially). In the same vein, growth projections in the Euro area, China, Japan, and Russia are slower than initially projected. The International Energy Agency (IEA) expectations of global demand for oil have been revised downwards on several occasions during the last year. Between July and December 2014 alone, the projected oil demand for 2015 has been revised downwards by 0.8 millions of barrels per day.34 Technology improvements have contributed to reducing the demand for oil. 35 Improvements in energy efficiency allowed the oil-intensity of global GDP to be halved since the 1970s. In the region, the surge in investments in renewable energies -estimated at $250 billion in 2013-36 has led to an increase in production capacity with renewable energies of 25 percent. Faced with this situation, in November 2014 OPEC producers’ decided to maintain the same level of production to keep their market share.37 The move was controversial because producers with the highest-breakeven prices (e.g. Venezuela) wanted to cut production to see oil prices rebound. The Saudi Arabia led the position of the cartel, however, arguing that it is not OPEC that increased supply. If there are cuts to be made it should be by all producers, not only by OPEC, a strategy that seems to have yielded results.38
34 IEA, 2014a and 2014b 35 Technological advancement affected both supply and demand side. Improvements in RE and EE technologies lowers the demand for energy consumption; while innovations in drilling technologies decrease the cost of the extraction of offshore hydrocarbon resources (As observed in Brazil, and Mexico) and allow exploration and extraction in ultra-deep offshore areas. 36 ESCWA (2015) 37 Financial Times 2014 38 Financial Times, 2015c 10
Other explanations of Saudi Arabia’s reaction not to cut production and let prices surge have emphasized geopolitical reasons as well. According to some of those, not only the Saudi Arabia would keep its market share and put financial pressure on shale oil producers to drive them out of the market; low prices put pressure on Iran’s endeavors for the supremacy in the region (in the context Sunni vs Shi’a), and on Russia (a move that would be very well seen in the USA and Europe, who have imposed sanctions on Russia in response to its actions in Ukraine). This study remains agnostic about the political underpinnings, although it must be noted that as of May 2015, shale oil producers have started to face financial strains: they have increased their debt levels and some of them have already filed bankruptcy. Saudi Arabia has also retained its market share.
4. RESULTS
The use of CGE to analyze the macroeconomic impact of an oil price shock is relatively new. The idea is to measure the structural (not cyclical) impact of a singled-out shock on oil prices. For instance, using a dynamic CGE model it has been shown that the oil price rise during the 2002-2008 period would have caused a decrease of 2 percent to 3 percent of GDP annually in six oil importing countries (Bangladesh, El Salvador, Kenya, Nicaragua, Tanzania and Thailand).39 It has also been estimated that in 10 years, a doubling of oil prices could cause a 14 percent loss of economic output in Turkey.40 Using a Global CGE model to assess the effect of an increase in oil prices, it has been demonstrated that a 50 percent increase in oil prices could reduce global GDP by 1.5 percent by 2020; GDP reductions would be smaller than 1 percent in most developed countries or regions. However, the losses would be much higher in emerging developing economies such as China, India, Thailand, Indonesia, Malaysia, and economies in transition.41 Under the same methodological approach, this analysis uses a modified version of MIRAGE, a multi-country, multi-sector, recursive dynamic, global CGE model to assess the economic implication of a drop in oil prices for Arab economies. The tool also gives the possibility of discerning the mechanisms through which the shock is transmitted, including the reallocation of resources within the economy’s productive structure. Moreover, it captures the effects on unemployment and fiscal policy.
1. Short-term implications of a 10 percent decline in oil prices
The initial simulation consists of a shock in oil prices, driven by an increase of the US supply of oil (all the other producers maintain their supply at the 2014 level). The shock is supposed to take place early in 2015 and be maintained until 2020. The results show that as a whole, the Arab region would lose 1.5 percentage points in the year following the shock (Figure 6). The impact of lower oil prices on individual countries depends on their situation in the oil market (net exporters or net importers). Oil exporting
39 Sanchez (2011) 40 Aydın and Acar (2011) 41 Timilsina (2013) 11 countries would lose 1.88 percentage points of growth, while the rest of Middle East countries would lose 2.73 percentage points of growth. Saudi Arabia’s loss is estimated at 2.58 percentage points of growth, while Kuwait’s is 2.28 percentage points. Oil importing countries do benefit, but the gain is lower than the loss registered by oil exporters. The average gain is 0.5 percentage points of additional growth. Morocco is the greatest winner, with 1.35 percentage points of extra growth, followed by Jordan (0.25) and Tunisia (0.22). The impact on Egypt, Bahrain and Emirates is negligible, as these countries face a combination of positive and negative effects that offset each other.
Figure 6. Short-term implications of 10 percent decline in oil price: Difference in growth in the first year after the shock
1.35 Morocco
0.5 Non exporting Arab Countries
0.29 Jordan
0.22 Tunisia
0.07 Egypt
-0.27 Bahrain
-0.35 Union of Arab Emirates
-0.97 Qatar
-1.28 Oman
-1.5 Total Arab Countries
-1.88 Arab Oil Exporting countries
-2.18 Rest of North Africa
-2.28 Kuwait
-2.58 Saudi Arabia
-2.73 Rest of Middle east countries
Source: Authors’ simulation
As expected, the nature of the effects also varies across sectors. Oil production and construction are negatively impacted by the shock, while oil-intensive sectors such as chemical products, metal, transport and oil refinery see their production increasing (Table 4 in the Annex). These results are in line with previous research noting that output in oil-exporting countries could contract by 0.8 to 2.5 percentage points in the year following the shock.42 Similarly, previous works have pointed out that a 10 percent decrease in oil prices would raise growth in oil-importing economies by 0.1 to 0.5 percentage points, depending on those countries’ share of oil imports to GDP.43 Furthermore, the estimates are in line with previous results that find a significant and positive effect of oil prices on the output of Algeria, Iran, Iraq, Kuwait, Libya, Oman, Qatar, Syria, and the UAE; but a non-significant effect on the output of Bahrain, Djibouti, Egypt, Jordan, Morocco, and Tunisia.
42 World Bank 2013; Berument et al. 2010; Feldkirchner and Korhonen 2012 43 World Bank, 2013; Rasmussen and Roitman, 2011 12
2. Medium-term implications
The medium term effect is simulated by a permanent 10 percent price reduction during the period 2015 to 2020. In this timeframe, the reallocation of resources among sectors would be expected to assuage the growth implications of the shock. On average, the net result for the region is a growth loss of 0.15 percentage points. Oil exporting countries would lose annually 0.06 growth points while oil importing countries would win 0.15 percentage points of growth (Figure 7).
Figure 7. Medium term implications of 10 percent decline in oil price: Difference in growth in the first year after the shock
0.17 Morocco 0.06 Non exporting Arab Countries 0.03 Jordan 0.02 Tunisia 0.01 Egypt -0.03 Bahrain -0.03 Union of Arab Emirates -0.09 Qatar -0.12 Oman -0.15 Total Arab Countries -0.19 Arab Oil Exporting countries -0.22 Kuwait -0.25 Rest of North Africa -0.25 Saudi Arabia -0.27 Rest of Middle east countries
Source: Authors’ simulation
For Arab oil exporters the shock affects the profitability of investments, especially in the oil and construction sectors (Table 5 in the Annex). According to the simulations and despite maintaining the level of public investment unchanged44, total investment could be reduced by 4.4 percent in 2015 and by 3.6 percent cumulatively between 2015 and 2020 compared to the reference scenario (Figure 8). This effect is more visible in oil-exporting countries, especially in Saudi Arabia where total investment could be reduced by 8.7 percent in 2015 and by 7 percent between 2015 and 2020. In Kuwait, the reduction would be of 9.8 percent and 7 percent, respectively. For the rest of North Africa the loss is estimated at 6.9 percent and 5.8 percent, respectively, and for the rest of the Middle East at 3.4 percent and 2.7 percent. In oil importing countries the shock affects positively the profitability of oil-consuming sectors (especially chemical products, oil refinery and metal sectors). This leads to an
44 This hypothesis was adopted after the declaration of most of GCC’s economic authorities that the decline of oil prices will not affect their public investment plans and that they will use their strategic reserves to finance their public deficit.
13 increase in total investment of 0.5 percent, which reaches 1.5 percent in Morocco and 1.1 percent in Jordan in 2015 (Figure 8).
Figure 8. Variation of total investment compared to the reference scenario after a 10 percent reduction in international oil prices
2015-2020 2015
1.0 1.1 Jordan -0.2 -0.2 Tunisia 1.3 1.5 Morocco -0.2 -0.2 Egypt 0.5 0.6 Non exporting Arab Countries -7.6 -9.8 Kuwait -2.7 -3.4 Rest of Middle east countries -5.8 -6.9 Rest of North Africa -1.5 -1.8 Bahrain -3.1 -3.9 Oman -2.2 -2.8 Qatar -0.8 -1.0 Union of Arab Emirates -7.0 -8.7 Saudi Arabia -4.4 -5.4 Arab Oil Exporting countries -3.6 -4.4 Total Arab Countries
Source: Authors’ simulation
The variation of investment is also linked to trade (Figure 9): as Arab oil exporters receive less foreign exchange (because they export less), their currencies lose strength and their imports decline. This decline is approximately 6 percent depending on the scenario: -5.5 in 2015 and -6.8 percent in the medium run (as economic structures are more flexible and adapt). Countries that suffer this phenomenon most are those most reliant on oil (e.g. Saudi Arabia and Kuwait). Conversely, Morocco, Jordan and Tunisia import more: as now they spend less of their resources on oil, they can use those more funds to import. With regards to exports, the pattern is not inverse to that of imports (Figure 10). The reason is that by having weaker currencies, countries can export more. This offsets the shock- induced loss of export revenues but exports from oil-exporting countries still decline slightly (-0.1 percent). Other countries such as Tunisia and Morocco export considerably more because they have small economies that are very export-oriented; ceteris paribus, paying less for their energy costs can boost their productivity and hence their exports.
14
Figure 9. Variation of total Imports compared to Figure 10. Variation of total Exports compared to the reference scenario after a 10 percent reduction the reference scenario after a 10 percent reduction in oil prices in oil prices
2015-2020 2015 2015-2020 2015
1.1 Jordan 0.6 Tunisia 1.3 0.8 0.3 Tunisia 1.1 Morocco 0.3 1.2 1.6 1.9 Morocco -0.1 Egypt -0.1 -0.1 Egypt -0.1 0.3 Non exporting Arab Countries 0.3 0.6 Non exporting Arab Countries 0.7 0.6 Kuwait 0.7 -8.6 -10.8 Kuwait -1.5 Rest of Middle east countries -1.8 -5.4 -6.6 Rest of Middle east countries 0.8 Rest of North Africa 0.9 -8.6 -10.3 Rest of North Africa 1.1 Bahrain 0.5 1.3 0.6 Bahrain -0.2 Oman -4.5 -0.4 -5.7 Oman 0.3 Qatar -2.7 0.2 -3.6 Qatar -0.1 Union of Arab Emirates -1.4 -0.2 -1.9 Union of Arab Emirates -0.1 -9.1 Saudi Arabia -11.2 Saudi Arabia -0.2 -5.5 0.0 Arab Oil Exporting countries -6.8 Arab Oil Exporting countries -0.1
-4.2 0.0 Total Arab Countries -5.2 Total Arab Countries 0.0
Source: Authors’ simulation
On the given 6-year timeframe, the simulated shock induces structural changes in countries’ economies. This includes the use of factors of production such as labor, which is of particular importance given the high unemployment rates in the region. Keeping the supply of labor constant, firms demand less labor because they have lower activity levels (as they export less). The overall effect is the same for both skilled and unskilled labor. For the entire region, unemployment increases by 2 percent in 2015, which is reduced to 1.4 percent in the larger timeframe (2015-2020) as factors of production are more flexible (Figure 11 and Figure 12).
15
Figure 11. Variation of skilled unemployment Figure 12. Variation of unskilled unemployment
2020 2015 2020 2015
-0.2 Jordan -1.1 -0.3 -1.6 Morocco -0.2 -0.3 Tunisia -0.1 -0.2 Egypt -1.0 -1.4 Morocco -0.4 Non exporting Arab -0.6 -0.1 Countries -0.2 Egypt 3.5 Kuwait -0.4 Non exporting Arab 5.8 -0.5 Countries 2.4 3.1 3.4 Rest of Middle east countries 5.2 Kuwait 2.3 2.6 Rest of North Africa 3.4 Rest of Middle east countries 3.9 2.8 0.2 4.1 Rest of North Africa 0.3 Bahrain 0.4 Bahrain 1.7 0.7 2.8 Oman 1.4 2.3 Oman 1.1 1.9 Qatar 1.0 1.7 Qatar 0.7 Union of Arab Emirates 0.4 1.2 0.7 Union of Arab Emirates 2.9 Saudi Arabia 2.7 4.9 4.5 Saudi Arabia 2.4 2.3 Arab Oil Exporting countries 3.6 Arab Oil Exporting countries 3.7 1.4 1.4 Total Arab Countries 2.0 Total Arab Countries 2.0
Source: Authors’ simulation
The simulated 10 percent negative shock in oil prices is lower than the actual shock experienced between July 2014 and January 2015. Thus, it is important to explore sensitivity of the results presented so far with regards to the magnitude of the shock. To do so, the results of five types of shock are described: from 10 percent incrementally to 50 percent. As the difference between oil exporters and oil importers is vital, the simulation results are presented in 3 categories: for the entire sample of Arab countries (Figure 12), for oil- exporting only (Figure 13), and for oil-importing only (Figure 14). Overall, the simulations show that the larger the shock, the more important are the macroeconomic consequences with regards to GDP growth, total investment, skilled and unskilled unemployment rates. This result is robust to all scenarios. Larger shocks exhibit higher slopes over time, however, which implies that the harder are oil prices shocked, the more flexibility in the allocation of resources pays off in the long run (Figure 12). The elasticity of different dimensions varies within a specific shock magnitude. GDP and investment have slightly positively-sloped curves, while unemployment rates show much higher negative elasticities, especially in high-magnitude shocks. The unemployment patterns show that shocks can have a lock-out effect, whereby people who are unemployed stay there - regardless of their skill level (Figure 12). The key threshold is 2 years, which corresponds to the often-accepted definition of long-term unemployment.
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Although the reasons for that threshold go beyond the scope of this study, this would be consistent with a common view that beyond that threshold, workers’ skills are likely to be considered obsolete by employers, while job-seekers are likely to lose hope and put less effort trying to find a job. The interpretation is similar when only oil-exporting countries are considered (Figure 14). However, skilled unemployment is slightly more vulnerable than unskilled, which is not surprising because skilled workers are more closely connected with the oil sector. As the scale of the y-axis is the same in all charts for an easy comparison, the graphs show that the overall result in the region (Figure 13) is driven mainly by oil exporters (Figure 14). Indeed considering oil-importers only (Figure 15), the results are broadly symmetric: countries benefit from negative oil shocks in all four dimensions, the elasticity of the macroeconomic effects is higher as the intensity of the shock rises, and the differences between skilled and unskilled labor are largely negligible. However, in oil-importing countries unskilled workers would benefit much more than skilled ones. This can be interpreted under a trade perspective: oil importers benefit from lower oil prices, they export more and in so doing, they absorb more unskilled workers - relative to skilled ones, who would not have much difficulty in finding jobs anyway.
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Figure 13. For entire region: difference between reference projection and projection after permanent oil decline of: GDP Total Investment 0 0 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020 10% 10% -2 -5
20% 20% -10 -4 30% -15 30% -6 40% -20 40% -8 -25 50% 50% -10 -30
-12 -35
-14 -40
Skilled Unemployment rate Unskilled unemployment rate 200 200
180 180
160 160
140 140
120 120
100 50% 100 50% 80 40% 80 40% 60 30% 60 30% 40 20% 40 20% 20 10% 20 10%
0 0 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020
Source: Authors’ simulation
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Figure 14. For oil exporters: difference between reference GDP projection and projected GDP after permanent oil decline of: GDP Total Investment 0 0 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020
-2 10% -5 10%
-10 -4 20% 20%
-15 -6 30% 30% -20 -8 40% -25 40%
-10 -30 50% 50% -12 -35
-14 -40
Skilled Unemployment rate Unskilled unemployment rate 200 200 50% 180 180 50%
160 160 40% 140 140 40%
120 120
100 30% 100 30%
80 80 20% 20% 60 60
40 40 10% 10% 20 20
0 0 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020
Source: Authors’ simulation
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Figure 15. For oil importers: difference between GDP projection and projected GDP after permanent oil decline of: GDP Total Investment 14 40
12 35
30 10 25 8 20 6 15
4 50% 10 40% 2 30% 5 50% 20% 40% 30% 10% 20% 0 0 10% 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020
Skilled Unemployment rate Unskilled unemployment rate 0 0 10% 10% 20% 20% -20 30% -20 40% 30% 40% -40 50% -40 50% -60 -60
-80 -80
-100 -100
-120 -120
-140 -140
-160 -160
-180 -180
-200 -200 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020
Source: Authors’ simulation
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5. CONCLUSION
Overall, the results of a negative shock in oil prices are as expected: oil-importing countries benefit from a shock in oil prices (particularly Morocco, but also Tunisia and Jordan). In turn, oil-exporting lose, especially Saudi Arabia but also Oman. However, importers’ gain is smaller than exporters’ loss. The simulations show that the larger the shock, the more important are the consequences on GDP growth, total investment, skilled and unskilled unemployment rates. The sectoral implications are also clear. Sectors that are intensive in oil (e.g. metal) are positively affected and vice versa. Larger shocks are associated with higher benefits from flexibility in the allocation of resources in the long run. As a particularly relevant result, oil price shocks can induce higher unemployment which can stick in the long run, particularly beyond a 2-year timeframe. Indeed as oil exporters are intensive in capital and capital is associated with knowledge, when the oil sector is shocked skilled labor fares worse than unskilled one. (And in oil importing countries the effect works in the opposite direction). Given the fiscal policy of high subsidies and handouts in oil- exporting countries, its consequences could potentially turn sociopolitical were those fiscal policies to be terminated. To address such potential threat countries might turn to their SWFs, but only Saudi Arabia has a large-enough buffer. Another option is debt, which is particularly appealing given the current context of ultra-low interest rates. Yet, the current slump in oil prices presents a unique opportunity to undertake subsidies’ reforms (especially for oil importers), which may be the most sound option in the long run. Indeed, some countries that have moved in this direction are Tunisia, Egypt and Morocco. However, Kuwait also started to implement subsidy reforms. Will more oil-exporters follow?
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6. ANNEXES
Figure 16. Crude oil reserves by the end of 201345
Iran Iraq 10% 10%
Kuwait 7%
Non-OPEC OPEC Saudi Arabia UAE 19% 81% 18% 6%
Libya 3% 0% Nigeria 2% Qatar Venezuela 2% Algeria 20% Angola 1% Ecuador 1% 1%
45 Source: OPEC 2014 22
TABLE 3. PRODUCTION BY SECTOR COMPARED TO THE REFERENCE SCENARIO AFTER A 10 PERCENT REDUCTION IN INTERNATIONAL OIL PRICES Rest Rest of United Saudi of Middle Qatar Arab Kuwait Bahrain Oman Morocco Egypt Jordan Tunisia Arabia North east Emirates Africa countries Agriculture -4.0 0.0 -0.7 -5.9 0.0 -2.4 0.3 0.0 -1.8 -0.2 -4.2 -1.2 Food Products -2.6 -1.2 -0.6 -3.9 -2.4 -1.1 0.0 -0.3 -1.1 -0.4 -2.8 -1.7 Textile 2.2 0.0 1.1 0.0 0.9 0.0 -0.4 0.4 0.4 0.9 -3.0 3.9 oil -0.9 -2.4 -3.0 0.3 -2.3 -1.5 0.0 -2.1 0.0 -3.4 0.1 -3.4 Gas and mining 3.3 2.2 1.8 3.6 -0.2 4.4 -0.4 0.5 0.5 0.0 4.4 4.9 Chemicals Products 9.0 2.9 0.6 6.5 -0.4 5.0 -1.2 0.0 -1.7 -0.2 2.0 5.6 Oil Production 2.8 -1.5 -4.1 3.4 0.8 2.2 4.6 -0.2 1.8 -0.5 1.7 2.4 Metal 4.4 0.8 2.8 4.3 0.2 4.5 0.0 0.6 0.0 0.6 3.8 7.6 Electronic equipments 2.6 1.5 3.1 4.3 0.0 1.8 0.6 1.1 1.3 0.8 0.0 5.3 Machinery 6.6 1.3 1.6 5.4 0.0 4.6 0.3 0.0 0.0 2.5 4.1 5.9 Other transport equipments 3.0 0.6 1.6 2.8 0.0 0.0 0.0 -0.8 0.0 0.6 0.0 3.6 Other Manufacture Products 0.6 0.0 1.5 0.4 -0.7 1.1 0.0 0.2 -0.2 0.6 0.0 2.6 Construction -5.4 -1.5 -0.6 -7.6 -1.6 -2.7 0.2 -0.1 0.0 -0.4 -4.1 -0.3 Transport 0.6 0.3 0.2 0.2 5.5 0.5 -0.2 0.0 0.6 0.2 0.4 5.6 Other Services 0.4 0.5 0.3 -0.8 0.2 0.1 -0.1 0.3 0.2 0.0 -0.1 0.6 Source: Authors’ simulation
TABLE 4. INVESTMENT BY SECTOR COMPARED TO THE REFERENCE SCENARIO AFTER A 10 PERCENT REDUCTION IN INTERNATIONAL OIL PRICES Rest Rest of United Saudi of Middle Qatar Arab Kuwait Bahrain Oman Morocco Egypt Jordan Tunisia Arabia North east Emirate Africa countries Agriculture -24.1 -6.3 -1.3 -31.3 -5.0 -10.0 2.4 3.7 -12.8 3.0 -41.1 -11.5 Food Products -16.6 -6.5 0.0 -20.0 -6.3 0.0 0.5 0.0 -8.3 1.1 -31.5 -12.5 Textile 21.9 0.0 14.8 0.0 12.4 14.3 -2.3 5.7 2.7 11.5 -30.1 50.0 oil -28.8 -34.9 -47.7 -7.7 -32.2 -19.2 -100.0 -33.2 -100.0 -40.4 -29.3 -66.8 Gas and mining 31.4 15.8 15.0 26.7 3.5 44.5 -1.0 10.1 1.9 5.9 62.5 80.0 Chemicals Products 81.5 13.8 4.7 46.7 0.6 36.2 -4.6 4.7 -13.0 3.3 26.0 78.8 Oil Production 23.2 -11.0 -35.3 31.6 12.8 18.8 33.8 -1.6 14.0 1.9 7.9 25.0 Metal 34.8 2.9 20.0 34.9 6.4 32.4 0.0 12.1 2.9 9.5 43.4 120.8 Electronic equipments 21.2 5.5 25.4 40.7 10.6 22.7 2.2 12.0 10.8 14.5 10.5 77.8 Machinery 53.5 6.5 13.9 51.3 11.0 45.1 2.0 8.1 1.0 19.0 33.3 88.2 Other transport equipments 25.8 3.4 13.5 25.9 7.8 3.4 0.0 1.7 6.9 7.6 -2.3 35.7 Other Manufacture Products 5.4 -0.9 14.2 8.7 -2.9 14.9 0.4 4.3 -2.2 9.1 -2.1 37.2 Construction -41.5 -6.5 -0.7 -42.3 -7.8 -7.8 0.5 1.3 0.7 1.3 -32.3 -10.4 Transport 50.0 0.4 3.8 8.9 59.1 11.4 -0.9 2.3 4.1 5.9 4.7 68.6 Other Services 8.2 3.1 4.5 0.1 7.0 9.4 -0.8 6.8 2.1 4.5 4.4 9.9 Source: Authors’ simulation
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