Low Oil, High Risk

Oil prices have reached their lowest since the 1990s with prices per barrel going as low as 27 dollars per barrel, from a high of 120 dollars in early 2014. It was assumed at the beginning of the oil glut that it would not affect western developed economies which are mainly importers and not directly affected by declining demand from China.

However, this year, a number of major US and European producers have had to announce job cuts and close some of their rigs.  Surprisingly, or   maybe not, some African oil producing countries have increased their capacity in the past two years.

High oil prices, generally, are said to have a negative impact on global economic growth. Low oil prices would mean greater economic activity as overall inflation and prices will be lower. But, things are not as simple as that.

Many Western rigs are being closed. Given this, why are African countries increasing their production instead of cutting it down like Europe and the US so that prices go up?

The last time there was such a plunge it took 20 years for oil prices to recover. There will be variances in impact for different economies. This means the increased production by some African countries may still work in their favour depending on other economic activities and factors in a nation.

In many oil producing countries, government is the biggest investor in the industry. If government investments are not well diversified, it would mean that lower oil prices would result in less income.

Government is also the largest spender in most economies. If it does not spend, it means there is less money in circulation resulting in high inflation. This is the position of Nigeria right now which is experiencing the highest inflation rates (10pc), it has had in recent years. However, its government is diversifying into other sectors like infrastructure.

Storing oil is expensive. This means when prices go down as they have right now, some countries will stop producing with the intention of cutting costs and driving the price back up. However the Organisation of Petroleum Producing Countries (OPEC) in which most African oil producing countries are members, has no intention of reducing production, so prices continue to be low. This means they continue to maintain their market share and probably may grow market share if other rigs close.

Infrastructural investment is at its highest in the continent. This increases demand for oil and this should continue – at least in the short to medium terms. Most African oil producing countries cannot meet their own need, let alone that of the continent.

The growing demand is also facilitated with improved trade agreements within the continent. Increased production means that the growing demand is met – albeit at lower prices and with lower income for governments.

The best time to invest in an industry is during a down-trending bear market as opposed to an upward trending bullish market. In a bear market, costs of investment in infrastructure are at their lowest point and when the market peaks, one is likely to make the highest return on investment.

While it may not make sense to buy crude oil futures at the moment, the opposite is true for infrastructural investments and some stocks. It may be difficult to tell whether current prices are at their lowest, however, chances are that they are close to their lowest point.

Even for OPEC countries, there will soon be a need to sustain barrel prices at rates that will ensure they can sustain production. This may not be at a price that is affordable to western producers where operational costs are high, but is sustainable in African and Arabic markets with lower operational costs.

These are just a few of the reasons it makes sense that some African countries would be increasing their production capacity now. Investments made in the industry before 2011 would be quite expensive and prices would have to rise significantly to justify investments. However, even with the lower prices, as long as there is increasing demand, it may just be possible for these nations to make good on their investments.

At the same time exploration in the East African countries is going on with no one talking about the glut. Investments in infrastructure and negotiations on how different countries will get their oil to market are on going. In Europe and Asia, there has been reduced activity or investment highlights of energy saving technology especially in private vehicles.

After all, if fossil energy stays low in cost there will be little need for cheaper energy. Most people are generally more concerned about their personal comfort (which most energy saving vehicles do not provide), than about cleaner environments. Probably the next big inventions will be around cleaning the environment, rather than around reducing the use of fossil energy.

By Annabel Onyando
is a business coach. She can be reached at annabelonyando@yahoo.com.

Published on Mar 14,2016 [ Vol 16 ,No 828]



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