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The Falling Oil Prices: What We Should Know

January 28, 2015 By: Alhaji Abu Komeh

In the year 2014 when the Mano River Union countries were hard hit by the deadly Ebola Virus Disease (EVD), the world witnessed a major decline in oil prices between June and December, bringing an end to a 4-year period of relative price stability. Just as this event, there have been various episodes of price declines of more than 30% occurring in a 6-month period during the past three decades. Between 2010 and 2014, prices remained stable around $110 per barrel but a dramatic fall to $48 has been received with mixed global outcomes.

Against this backdrop, many citizens have raised concerns as to why these declining prices of oil have not been reflected in every sector of the economy to help stimulate and spread economic activity. In fact, the average Sierra Leonean is more concerned about how the global price reduction will make petroleum products cheaper, such that it helps to reduce the price of other basic goods and services via the pass-through effect.

Causes of the Sharp Drop

Energy economists have identified four major factors responsible for the acute decline in oil prices. Firstly, trends in demand and supply over recent years have played an important role in the ultimate fall in oil prices. By 2014, oil supply was much higher than demand. Recent developments in global oil markets indicate that shale oil production in the United States has seen a surprising upward trend since 2011. As of 2008, the U.S. was the third largest producer of oil behind Saudi Arabia and Russia, but has now leapfrogged both countries producing 9.1 million barrels per day during the week ending 9th January, 2015. The U.S. Energy Information Administration says crude oil production will average 9.3 million barrels per day in 2015. Since the U.S. does not export oil, and imports much less, a lot of spare supply has been created thus suppressing prices downwards.

Secondly, the Oil Producing Exporting Countries (OPEC) at its meeting in late November 2014 failed to agree on cutting down production to prop up prices. Even though countries like Saudi Arabia and Iran need high prices to operate and balance their budgets, they supported the idea of maintaining OPEC production levels of 30 million barrels per day. Actually, Saudi Arabia wanted to consolidate its market share, hoping that lower prices would help strangle the U.S. oil boom.

Also, global oil markets saw an unexpected rise in the supply of oil from countries experiencing geopolitical conflicts. When turmoil heightened in Libya and Iraq, 3 million barrels per day were taken off the market, but this situation changed by mid-2014, with Libya witnessing an unexpected rise in its exports, and Iraq seeing a boom in its production levels.

Finally, economic slowdowns in some parts of Asia and Europe – specifically China and Germany – gave rise to weakened demand for oil. Generally, oil demand had been declining in many parts of the world. Weak global economic activity and the growing switch away from oil to other sources of energy have lowered demand significantly.

Implication for Economies

While the recent sharp drop in oil prices is very welcome news for many non-oil producing, oil importing countries and developing economies including Sierra Leone, many energy-exporting nations are bound to witness significant revenue shortfalls with replicating economic effects.

Russia, which is one of the world’s largest oil producers, has been hard hit, and the World Bank has cautioned that the country’s economy would contract by at least 0.7% in 2015 if oil prices do not pick up. Venezuela, which is among the world’s largest oil exporters, has recorded an inflation rate of about 60%, and the economy is shaking on the verge of a recession, with sinking foreign reserves. Economists at Bank of America Corp suggest that the drop in crude prices will reduce government revenue by about $10bn a year.

Although the IMF suggests that Saudi Arabia needs oil prices to be around $104 to balance its budget, it safely sits on a reserve of $700bn which makes it able to withstand lower prices for a long period. Other producers such as Kuwait and the United Arab Emirates have similarly stockpiled substantial foreign currency reserves which puts them in a safe position to run deficits for several years if need be.

However, countries like Iraq, Iran, Nigeria, Angola and other countries in Africa face severe economic constrains as revenue shortfalls resulting from the falling oil prices will make it difficult for these countries to fund their budgets. Alongside Nigeria and Angola, Equatorial Guinea, Gabon, Sudan, Algeria, Egypt and Libya are the countries in Africa that are faced with serious threats that will potentially undermine their economies.

In fact, Nigeria will receive the heaviest impact of the falling prices. Revenues from oil exports account for about 80 percent of its total revenues, but this situation has already given rise to a currency depreciation of 15%. In the short run, the poor and disadvantaged communities may suffer from increasing prices in food and agricultural products if the government reduces subsidies.

Take Trinidad and Tobago for example which is not a member of OPEC but is the largest oil producer in the Caribbean. The country’s budget is based on oil prices at US$80 per barrel but will not be able to fix its oil price at a level higher than OPEC members, as a result of its inability to effectively compete and maintain its market share. As such, the government stands to lose significant revenues.

In oil-importing countries like Sierra Leone, lower prices should contribute to strong growth, reduce inflationary, fiscal and external pressures. For developing countries in particularly, the current drop in oil prices presents a window of opportunity for them to formulate policies and undertake structural reforms which will alleviate poverty and promote sustainable livelihoods.

What should happen now in Sierra Leone?

At the time of writing this article, the Oil Marketing Companies and the Government of Sierra Leone (GoSL) had announced a reduction of 16.7% (from Le4,500 to Le3,750) for all major petroleum products consumed in the country. This reduction is certainly a welcome development to the people of Sierra Leone as fuel is an extraordinary commodity which can either distress or stabilise the economy. Ghana and Nigeria have similarly announced reductions of 10% and 10.3% respectively.

Based on economic theory and evidence, it is expected that lower oil prices should reduce energy costs generally, as electrical power generated by oil should be cheaper to produce. The transportation, manufacturing, agricultural, banking, entrepreneurial and several other sectors should see a reduction in the cost of energy consumed. Therefore, commuters should pay less transport fares; businesses will make some savings by paying less energy costs; farmers should be able to transport their produce at a lesser cost which should influence a reduction in agricultural products.

In summary, if the Sierra Leone economy is price sensitive, the reduction in oil price should boost general economic activity as real income shifts from oil sellers will leave consumers with a higher propensity to spend, thus increasing aggregate demand at least in the short run.

With all these developments, the onus is now on Government and people of Sierra Leone to ensure that the welfare benefits of the global oil price slump is reflected in general economic activity. In a country where dishonesty and lack of patriotism are common, the Government must ensure that businesses comply with the realities of the price drop and exercise due diligence when dealing with their customers.

Firstly, irrespective of the pricing formula used by the Ministry of Transport and Aviation and the Motor Drivers Union in fixing transport fares, it is my expectation that one-way taxi and ‘poda-poda’ fares should be at least Le800. Transport fares to provincial towns and cities must be reduced and picture the reduction in pump price.

Most importantly, when these transport fares reduce, the Government must ensure that fuel dealers and commercial drivers don’t have a field day and do ‘business as usual’ by ripping off customers. Should one-way transport fare be brought to say Le800, commuters must be respected accordingly and provided their Le200 remainder. It is common knowledge in Sierra Leone that before, if you issue a Le5,000 note to a fuel salesman for a litre of petrol costing Le4,500, the Le500 difference which must be duly given to you rarely or hardly comes back.

In the UK for example, everyone knows that if you buy a commodity for £4.99 and handed a £5 note to the vendor, you are assured of your getting your 1p change. In Sierra Leone, this is somewhat a business abomination because a good number of service providers simply feel that they do a favour to their customers and therefore don’t mind to carry out treachery.

On a number of occasions when I pumped petrol in my car, I have not been able to bear the degree of business dishonesty exhibited by fuel dealers who always give flimsy excuses about the unavailability of Le500 coins. Well, the Bank of Sierra Leone and commercial banks must issue coins to guarantee that consumers who work for their hard-earned incomes are not ripped off by fraudulent folks.

Besides, ‘okada riders’ who continue to benefit from and exploit commuters by charging high transport fares must be made to comply with the demands of the current situation and reduce their charges. As a matter of fact, many business people in Sierra Leone, including ‘okada riders’ and taxi drivers, arbitrarily fix prices with no consideration to prevailing economic circumstances all in pursuit of achieving abnormal profits. To say the least, many residents in the East of Freetown are made to suffer in the hands of unscrupulous taxi drivers who would dare to charge a 4-way fare just from Calaba Town to Up-Gun.

With all these, the Government – through its responsible institutions – must introduce a ‘price control mechanism’ across all sectors to enhance consumer welfare protection. Sierra Leoneans are left at the mercy of wicked service providers and traders simply because there is no price control machinery; a situation that renders our people worse off.

Secondly, it is expected that the current price drop should exert a positive impact in reducing inflation. According to Blanchard and Gali in their work, “The Macroeconomic Effects of Oil Price Shocks”, a decrease in the cost of energy-intensive goods may benefit consumers by its indirect impact on reducing inflation. The current situation is likely to reduce general inflation expectations, with people willing to spend more as a result of their increased purchasing power.

The World Bank currently suggests that oil prices will average $53 per barrel in 2015 and it is expected that prices will recover in 2016 but at a very slow pace. This means, Sierra Leoneans should expect stable pump prices during the year although a change in OPEC policy to reduce production levels and increased global demand for oil are the likely factors that may cause an increase in oil price.