Will an oil spike have a negative impact in 2017?

Mr Mangion is a senior partner of PKF an audit and consultancy firm, and has over 30 years experience in accounting, taxation, financial and consultancy services. He can be contacted at gmm@pkfmalta.com or on +356 21493041.

Next year Malta plans to buy less crude oil to generate electricity, provided it succeeds in its objective to change completely to LNG. However, the price of oil will still affect fuel prices at the pump and consequently the production costs for both domestic production and exports. Since the sudden drop in the international price of crude to below $30 dollars a barrel in mid-2014 (refer to attached graph), the oil producing cartel OPEC has made several attempts to regulate the price by controlling output. On 28th September, it held a summit for its members in Algiers in an unsuccessful attempt to resolve a stalemate to reduce production levels in order to improve the price of crude since at its present low level there has been a number of producing countries which are facing severe internal budget deficits. These factors and others mentioned later on in this article will be instrumental to dictate the future price of oil next year.

The views of President-elect Donald Trump, who is expected to appoint an energy minister from the ranks of an oil fracking tycoon, speaks volumes on the US policy of maintaining control over the future price of this valuable commodity. To make matters worse, uncertainty is leading to further price volatility as Europe is going to face a restless year: a constitutional referendum is to take place in Italy today and there is a good chance that the Eurosceptic candidate, Mr Hofer, to prevail over the Greens’ opponent, Mr Van der Bellen. Again, in 2017 there will be elections in the core of Europe: The Netherlands (March), France (April and May), Germany (late summer/autumn).

Geert Wilders and Marine Le Pen, nationalist and populist competitors respectively in The Netherlands and France, have seen their consensus boosted week after week; in Germany Angela Merkel will compete for her fourth mandate, but she will be hardly able to form a government without the support of SPD’s social democrats, foreshadowing another “Große Koalition” that could help the significant entry of the rightwing AfD party into Parliament.

At this juncture, it is opportune to comment on the agreement OPEC reached this week to reduce the level of production, across the board, and the resultant surge in the price of oil will benefit a number of oil producers including Venezuela, Nigeria, and Libya among others which are suffering the consequences of price stagnation. Global oil prices have surged 15 per cent since the announcement, with Brent crude rising from $46 per barrel up to $54.31 per barrel by last Thursday. The question as to whether the price will shoot up at a high rate next year depends on a number of economic and political factors. However, in the past, it has followed a steady growth trend for all the 2000s, mainly due to the outbreak of wars and to the general instability of the Middle East area. In July 2008, the Brent index reached its peak of $140 per barrel.

At the beginning of 2014, after the Crimea crisis, the price fell again due to new geopolitical upheavals that are still being felt. Originally thought as a way to weaken the Russian economy and force Vladimir Putin to take a step back from the Ukrainian scenario, lowering the price of oil has become a powerful tool that is centric to various political and strategic interests. The situation in the Middle-East region is highly unstable, with the presence of large-scale armed conflicts in Yemen, Syria and Iraq. The future stability of the area, from which the majority of the world’s oil is extracted, will affect both oil price and prices of substitute products, such as gas and other derivatives. Companies will only have the necessary funds to invest in research and development of new exploitation and production technologies if the price rises to a level which would ensure sustained economic returns. Just reflect that with the election of Trump, the historical alliance between the US and Saudi Arabia is weakening and Iran appears to be strengthening its power under the Russian influence; in the current scenario, Saudi Arabia (Iran’s historic rival) is the most influential oil producer country; but others have to lose from this Russia-Iran axis policy of low prices as well. After the advent of Brexit and election of Donald Trump, the troubled waters in Europe probably will reshape the political and strategic alliances, and this will influence heavily the choices of action in maintaining stability in the major oil producing fields of the Middle East. It is therefore likely that oil prices will not stabilize in the next months and that indeed it will be subject to high volatility, as the shocks will mirror the world political arena. The effect of an eventual rise in oil price on the Maltese public and foreign accounts should not be that pessimistic anyway since our dependence on oil imports will decline once we switch to gas. Precisely the unexpected election of Donald Trump may inspire a protectionist policy to make fuller use of domestic shale oil deposits and this may have a contra effect to suppress the price of oil. Not surprisingly, the complex formula to predict the price of oil in 2017 is beyond the grasp of the author and one hopes that Malta will act in a prudent way next year as the chances of a price hike are not negligible and the quicker Electrogas manages to start using a cheaper and more efficient hydrocarbon such as LNG the better our chances to reduce emissions.

As an island having to import most raw materials an oil price increase would be reflected in a general increase in the price of all goods, especially those imported. This intuitively would involve an improvement in the trade balance because imports would theoretically reduce (depending on elasticity), but this only takes place if the majority of imported goods are substitutable with domestic goods. Many goods are not, however, produced locally and the oil price increase would result in an induced inflation beyond the two per cent. This is in effect proportionally higher than the anticipated reduction of quantities imported. The effect on the trade balance is hence undesirable. If the volume of imports should reduce (in percentage terms) less than the increase in the price of goods, this would cause a worsening of the trade balance instead: funding this imbalance would require an increase in public savings, namely more restrictive fiscal policies. In conclusion, the effects of a probable rise in oil prices would negatively affect the Maltese accounts from two perspectives: the trade balance and the public accounts.