When “NO” Shakes the World

The article was written in early December 2014, immediately after OPEC decision Not to cut output on Thanksgiving day in 2014

All it took to shake the world is a “NO” from Saudi Arabia, to the idea of production cuts to prop up oil prices. While this “no” is generating more economic stimulus to consumers around the world than what governments and central banks could provide, it has wreaked havoc on the oil and gas industry, on the global financial system, and on stock markets across the globe, including those of Saudi Arabia and other Gulf states. Some people are now terrified, as the memories of 1998-1999 are still vivid in their mind. (Editor’s note: And, we might add, the memories of 1986 are still vivid in many of our minds, too.)

“This decline in oil prices influenced many economic, social, political and environmental aspects in the lives of millions of people around the world. In fact, it led to profound changes, especially in the oil-producing countries, where governments were not able to spend on essential services, such as health and education.”

The preceding quote is from the introduction to a survey article that I conducted about the aftermath of the 1998-1999 collapse in oil prices, and which was published in OPEC Review during 2001. The article title summed it up: “What have we learned from the experience of low oil prices?” It was intended to be a timeless article that can help various industry stakeholders and policymakers realize what might happen when oil prices decline.

Let us go down memory lane. Here are more excerpts:

“Venezuela cut its budget three times in 1998. It already had slashed $4 billion from its budget, when it cut an additional $1.37 billion in 1999. Education suffered a $245-million cut, and subsidies to various institutions were cut by $2.5 billion. Saudi Arabia’s 1999 budget slashed spending by 15.8%, the largest budget cut in its history. In 1998, Mexico cut its budget twice, by $1.8 billion and $1.1 billion, respectively. Iran closed several embassies throughout the world, citing budget cuts. Abu Dhabi saw 35% of its building contracts cut back.

“After the decline in oil prices in 1986, Ecuador, unable to pay interest on its debt, sought debt-refinancing and halted interest payments. The same story was repeated in 1998, when Ecuador asked the International Monetary Fund (IMF) to help restructure its debt, while many voices in the country called on the government to simply default. To cover its shortfall, Iran negotiated with creditors for $3 billion in loans, and Kuwait wanted to borrow $50 billion from abroad. Even the richest countries borrowed money. Saudi Arabia borrowed $3 billion from domestic banks in May 1998. It also reportedly sought loans from Abu Dhabi, estimated at $5 billion.

“When the oil market collapsed in 1986, six OPEC members experienced negative economic growth—Algeria, Gabon, Iran, Libya, Nigeria, and the United Arab Emirates. In 1998, most oil-producing countries suffered declining economic growth—Iran, Iraq, Kuwait, Saudi Arabia, Qatar, Venezuela, Indonesia, Oman, Yemen, Syria, Norway—while Libya and the UAE experienced negative economic growth.

“In 1998, the Saudi Arabian Monetary Agency (SAMA) spent an estimated $1 billion to defend its currency. Ecuador devalued its currency twice in 1998, and created another devaluation by floating its currency in early 1999. Under the direction of the IMF, a tight monetary policy reduced pressure on the Nigerian naira, preventing devaluation. Russia devalued its currency, and there was a possibility that it might devalue the ruble again, because of lower oil prices.”

Impact on the oil companies. In fourth-quarter 1998, 21 companies among the top 40 oil and service companies reported losses, with the rest reporting major declines in net income. Most of these companies reported spending cuts. For example, Chevron cut spending 23%, Shell by 33%, Philips by 31%, Conoco by 21%, BP Amoco by 33% and Texaco by 20%.

You might have noticed that the names of some of these companies do not exist anymore. The decline in oil prices in 1998-1999 led to a major wave of mergers and acquisitions that created new companies, such as Exxon Mobil and BP Amoco. There were nearly 20 major mergers and acquisitions in 1998-1999. This wave stopped completely when oil prices increased.

One of the sad results of the decline in prices in 1998-1999 was the massive layoffs that occurred, as documented by U.S. officials: “Government statistics show that the number of jobs in the U.S. oil and gas extraction industry fell by more than 38,000, while over 20,000 jobs were lost in the oil field services.”

Will the decline this time be as severe as that of 1998-1999? The percentage change in prices is the same (at the time of this writing, oil prices were in the high $50s), but the impact of the current decline is significantly less. To put it differently, the impact of a decline in oil prices from $20 to $10 is more severe than a decline from $100 to $50. As the recent recession ended, oil prices increased $75 after major cuts by Saudi Arabia and some OPEC members. The increase beyond that level, to above $100, was caused by political disruptions, related mostly to the Arab spring and sanctions on Iran.

In addition, the decline in 1998-1999 was caused by several factors that are related mostly to demand—the Asian financial crisis and two consecutive mild winters. Most of the current decline is caused by increased supply in North America. Therefore, while the trends mentioned above will be repeated again, the magnitude should be significantly less.

REFERENCES

1. Alhajji, A. F., “What have we learned from lower oil prices?”, OPEC Review, Vol. 25, No. 3, September 2001.