How to Get a Breakthrough in Ukraine
The Case Against Incrementalism
In normal times, the global economy hums on oil. But as more and more countries issue shelter-in-place orders in response to the novel coronavirus, the demand for oil is plummeting and with it, the hope that prices will rebound anytime soon. At first, OPEC and other major petroleum producers sought to put a floor under falling prices by slashing production, but they failed to reach an agreement. To the contrary, Russia and Saudi Arabia have been waging a price war since early March, each seeking to expand its market share at the expense of countries with higher production costs. By March 30, the price of Brent crude—the international benchmark product—had fallen to an 18-year low of less than $23 a barrel.
U.S. President Donald Trump has called the oil price war “crazy,” and his administration has sought to convince Russia and Saudi Arabia—through bilateral diplomacy, as well as discussions within the G-20 forum—to stabilize energy markets. These efforts appear to be gaining traction: Russian officials have indicated publicly that they are open to a potential deal—possibly because Russia’s oil industry could soon run out of storage for barrels that can’t be sold to Europe during a virus-related shutdown—and today, Saudi Arabia publicly stated its willingness to work toward an agreement to end the price war.
But even if Russia and Saudi Arabia agree to cooperate, any short-term recovery in oil prices could be tenuous, depending on the pandemic’s continuing severity. And if prices stay low for much longer, leaders of the G-20 and the international financial institutions will have yet another problem to worry about: sovereign debt risk emanating from nations whose economies are overly dependent on oil. Both Russia and Saudi Arabia have enormous foreign exchange reserves that will enable them to ride out the storm, but other oil-producing states aren’t so lucky. Eurasia and the Middle East alone have an estimated $35 billion in maturing external sovereign debt in 2020, and many of the countries in these regions budgeted for an oil price of $50 per barrel or more. Rising insolvency in oil states would exacerbate an incipient meltdown in emerging markets, where the International Monetary Fund had been warning about widespread debt distress even before the coronavirus pandemic.
The first hints that extremely low oil prices could plunge many petrostates into crisis came at the beginning of March, when the price of Ecuador’s sovereign bonds fell to record lows. Oil accounts for about a third of Ecuador’s export earnings and a similar portion of its public-sector revenue. Last year, Ecuador secured a $4.2 billion loan from the IMF, but the deal called for economic reforms that the state failed to implement. Investors worried that the IMF would hold up disbursement of the promised funds, leaving Ecuador unable to make interest payments on its bonds. An immediate crisis was averted last week, when Ecuador said it would use a 30-day grace period for interest payments on its bonds, during which it expects to receive $500 million in bridge financing from the IMF as part of a separate deal. But the country is by no means out of the woods. It planned its national budget assuming an oil price of $51 a barrel. The price is now nearly half that, and Ecuador will have to make up the difference in austerity policies.
Concerns are also mounting in Iraq, which expected to run a budget deficit of $40 billion even before oil prices collapsed. The country was already in existential turmoil—unable to form a government, wracked with political unrest, and short on basic goods and services. Now, the spread of the coronavirus, with the attendant collapse in oil prices, has compounded all of these problems. Iraq still has $62 billion in foreign exchange reserves, but it had planned to use oil revenues to cover almost 95 percent of its $100 billion-plus national budget. Having assumed an oil price of $56 per barrel, Baghdad could end up needing an IMF bailout, as well.
The problem is just as pronounced in Nigeria—another cash-starved, indebted petrostate. Nigeria’s $28 billion national budget for 2020 was based on an oil price of $57 per barrel. The state has announced deep budget cuts but will still need to come up with $7 billion to service its debts this year. Mexico is likewise on the hook for the debts of its national oil company, Pemex. The company owes more than $6 billion in bond payments in 2020 and will owe a total of $30 billion by 2024. Pemex suffered $18.3 billion in losses last year. It used derivative markets to lock in prices above the current market for some of its exports this year, but it will nonetheless likely record even heavier losses in 2020.
Saudi Arabia might take this opportunity to cripple competitors with high production costs in order to secure a threatened market for its own resources.
Pemex’s predicament raises important questions about the long-term health of many national oil companies. According to the IMF, the average debt of national oil companies around the world has doubled over the last 15 years as profitability has declined precipitously. Increasingly, these debts are weighing on the national governments that guaranteed them. In one telling example, Brazil’s national oil company, Petrobras, sits atop a staggering $78.9 billion debt load—more than double its historical pretax earnings, which will be much lower this year. The national oil firm has already cut back expensive offshore oil production by 200,000 barrels per day. Even in the wealthier Middle East and North Africa, total net government debt of oil-exporting countries rose from an average of 3.0 percent of GDP in 2016 to 12.7 percent in 2018. That figure was projected to jump to 22.0 percent this year even before oil prices collapsed. Now it will be far higher.
The greater the debt burden of national oil companies, the greater the stress on the governments that support them. Some of these governments could be forced to slash the budgets of their national oil companies, mortgaging future oil revenue to meet current fiscal needs. The Princeton scholar Bernard Haykel has suggested that Saudi Arabia might take this opportunity to cripple competitors with high production costs in order to secure a threatened market for its own resources. The kingdom has more than 50 years of resources left to exploit, but many countries are already transitioning away from fossil fuels because of climate change. If the demand for oil declines in the future, a portion of Saudi Arabia’s reserves could end up as “stranded assets.” Even if Riyadh doesn’t prolong its price war with Moscow, persistently low prices could drive some of the national oil companies with the highest production costs out of business.
Oil-linked debt troubles could explode across the Middle East, Latin America, and Africa in 2020, setting off financial crises and potentially even defaults that would be felt around the world. The Middle East, in particular, is deeply intertwined with Western financial markets: between $100 billion and $200 billion in portfolio investments has flowed into the region in the form of global bonds and equity indices since 2016. These inflows could stop or reverse in response to the dual shocks of the pandemic and a collapse in oil prices. This week, the Abu Dhabi Securities Exchange reported a first-quarter decline of 26 percent, its worst performance since 2008. A decline in investor confidence in Middle Eastern exchanges would be bad news for the global financial system even if it didn’t lead to widespread defaults outside of the weakest petrostates, such as Iraq. That is because the wealthiest Middle Eastern oil producers could find themselves suddenly pinched and certainly in no position to bail out other slumping economies, as they did during the global financial crisis in 2008 and 2009.
Tiny Qatar injected billions of dollars into Barclays during that crisis and helped secure emergency support to UBS and Credit Suisse. The Abu Dhabi Investment Authority simultaneously invested $7.5 billion in bonds issued by Citigroup to shore up that bank, while the United Arab Emirates injected $19.0 billion into its own banks to keep them afloat. Where bailout funds might come from this time around if a sovereign debt crisis were to hobble Middle Eastern oil producers is an open question.
The United States was the first to sound an alarm, but China should fear the looming sovereign debt crisis among oil producers just as much. Beijing will be left holding the bag on sovereign debt in troubled oil and mineral producers, such as Iran and Venezuela, as well as numerous smaller oil producers in Latin America and sub-Saharan Africa. Countries in these regions have taken out an estimated $152 billion in Chinese loans linked to oil, minerals, and rare metals—much of which could soon be distressed.
Amid the twin crises of a pandemic and a collapse in oil prices, it is unlikely that anyone will be in a position to inject desperately needed liquidity into the depleted coffers of indebted petrostates. Even China, which under normal circumstances could have been expected to forgive indebted oil producers in exchange for barrels of crude to stash in its strategic stockpile, has to worry about the toxic levels of distressed debt sitting on the balance sheets of its own banking sector. With the largest oil producers now struggling to find storage tanks to house their burgeoning supplies, a crisis of epic proportions is slowly taking shape in emerging markets. And with China and the West mired in crises of their own, no one will have the funds to ease the tragedy about to ensue in the developing world.
UPDATE APPENDED (April 2, 2020)
This article has been updated to reflect news of a possible deal to end the price war between Saudi Arabia and Russia.