With the Benefit of Hindsight: The Impact of the 2014-16 Oil Price Collapse

Oil rigs

January 10, 2018//-Between mid-2014 and early 2016, the global economy faced one of the largest oil-price shocks in modern history.

The 70 percent price drop over that period was one of the three largest declines since World War II, and the most persistent since the supply-driven collapse of 1986.

The decline— triggered by a combination of surging U.S. shale oil production, receding geopolitical risks involving some key producers, shifts in policies by the Organization of Petroleum Exporting Countries (OPEC), and weakening global growth prospects—brought oil prices in line with other industrial commodities and ended a prolonged period of historically elevated prices that started in 2003.

International prices have rebounded since their early 2016 trough, reaching nearly $60 per barrel at the end of 2017, in part due to prospects of strengthening demand and extensions of production cuts agreed by OPEC and non-OPEC producers.

In constant U.S. dollar terms, oil prices are still somewhat above their long-term (1970–2017) historical average. The oil price decline followed a broad-based commodity price boom that started in the early 2000s and lasted more than a decade.

The boom, which unfolded after two decades of relatively low and stable prices, was mainly driven by surging demand prospects from emerging market and developing economies (EMDEs), especially China.

The individual factors contributing to the oil price plunge have been extensively analyzed, but their respective roles remain subject to debate.

Moreover, lower oil prices did not provide the expected boost to global activity, and policy responses and outcomes have varied considerably across countries.

To shed light on these issues, this Special Focus addresses three questions: • What were the main drivers of the oil price plunge from mid-2014 to early 2016? • How did the recent oil price collapse impact the global economy? • What was the policy response in oil exporters and oil importers?

The Special Focus concludes with an assessment of the outlook for oil prices and its implications for oil-exporting economies.

What were the main drivers of the oil price plunge?

Several key developments in the global oil market occurred prior to and during the plunge in prices that began in mid-2014: A growing role of the U.S. shale oil industry as the marginal cost producer, a shift in OPEC policy, a reassessment of geopolitical risks, and deteriorating global growth prospects.

Although supply factors appear to have been the dominant force in the sudden price collapse in 2014, weakening demand prospects were also an important contributor, particularly in 2015–16.

The latter could partly explain why the oil price plunge failed to provide the anticipated boost to global activity.

U.S. shale oil production

A surge in U.S. shale oil production was one of the main drivers of the global oil supply glut in the period leading up to the price collapse in the second half of 2014.

While U.S. shale oil represents less than 6 percent of world oil output, it accounted for nearly half of the growth in global oil production from 2010 to 2014.

This rapid expansion was initially underestimated, as reflected in repeated upward revisions to the outlook for U.S. oil production by the International Energy Agency (IEA). It was also overshadowed by a series of supply disruptions in the Middle East, which held back global oil output.

These disruptions included conflict in Libya, the impact of sanctions on the Islamic Republic of Iran, and fears of supply outages in Iraq. Concurrent with the dissipation of some of these geopolitical concerns during 2014, shale oil production continued to grow rapidly, reaching a peak of more than 5 million barrels per day (mb/d) in late 2014.

That year, gains in U.S. oil production alone exceeded those of global oil demand. The technology to extract natural gas and oil from shale formations (hydraulic fracturing and horizontal drilling) has existed for decades, but its application became widespread in the oil sector only in the late 2000s, as oil prices peaked (Wang and Krupnick 2013).

Such an endogenous supply response to elevated oil prices was observed in the past. In particular, during the early 1980s, high prices led to a similar expansion of oil extraction from Alaska, Mexico, and the North Sea, which contributed to a subsequent supply glut and price collapse in 1986. During the recent oil price plunge, however, shale technology proved more flexible and resilient (Bjørnland, Nordvik, and Rohrer 2017).

Production from existing U.S. shale oil wells was sustained during the price collapse from mid-2014 to early 2016, but drilling fell nearly 80 percent, about five times more than the estimated response of conventional oil drilling to price fluctuations (Newell and Prest 2017; Anderson, Kellogg, and Salant forthcoming;).

The resilience of the shale oil industry to lower oil prices was also echoed in rapid efficiency gains that became increasingly evident after mid-2014. Production costs fell considerably, dropping by around 25 percent since the start of the oil price decline, reflecting the improved design of wells, shorter drilling and completion times, and higher initial production rates (Curtis 2015).

Overall, efficiency gains and technological innovation helped spur a near tripling of output per well in the Eagle Ford and Bakken basins (Curtis 2016). The combined impact of lower production costs and efficiency gains caused average break-even prices for the shale oil industry to fall from more than $70 per barrel (bbl) in 2012 to less than $50/ bbl in 2016–17 (Rystad Energy 2017).

The resilience also reflects the decline in input costs (especially labor and rental equipment), as well as the ability of shale producers to hedge their entire production, as the shale oil cycle spans only a few years (as opposed to conventional oil, which spans decades).

The U.S. shale oil industry is likely to remain the marginal cost producer in coming years, and thus will continue to cap global oil prices (IEA 2017). Even if oil prices were at $30/bbl, about 50 percent of technically recoverable U.S. shale reserves would be economically viable (Smith and Lee 2017). U.S. shale oil reserves are assessed to be approximately 80 billion barrels (Bbbl), or around 20 percent of global shale reserves (EIA 2015; BP 2017).

Technological improvements achieved in the United States could also stimulate faster production elsewhere. Shale reserves in the Russian Federation are close to those in the United States, at an estimated 75 Bbbl.

China and Argentina follow, with 32 and 27 Bbbl of reserves, respectively. Although shale oil reserves represent a relatively small share of global reserves (around 10 percent), greater flexibility in production implies that shale oil will continue to have a major effect on prices.

The role of OPEC policies

Despite the shale oil boom, oil prices remained high over the period 2011–14, supported by supply disruptions and heightened geopolitical concerns involving some key producers, as well as expectations that OPEC members would continue to adjust production to stabilize prices.

Following the beginning of the price collapse in mid-2014, however, OPEC decided against reducing output, as it had done in the past, including during the price plunge in 2009.

Instead, it announced in November 2014 that its objective was to retain its market share; a policy shift that reflected the increasing clout of shale oil and reduced cohesiveness within the cartel (Behar and Ritz 2016).

That decision, which defined OPEC’s strategy throughout 2015 and 2016, was followed by a large and sustained decline in oil prices. Amid mounting fiscal pressures and in view of shale oil’s resilience, several OPEC members, along with 10 non-OPEC countries led by Russia, agreed to revert to production cuts to shore up prices (World Bank 2016a).

The initial six-month agreement, which went into effect in January 2017, was subsequently extended twice: first to March 2018 and then to December 2018. Relatively high compliance with the agreed cuts, especially by Saudi Arabia (the dominant OPEC member) and Russia (the most important non-OPEC oil producer) contributed to some rebalancing of oil markets during 2017.

However, actual and expected prices did not rise following policy announcements, illustrating the reduced ability of OPEC to influence market conditions as U.S. shale oil has effectively become the new marginal cost producer.

The role of demand conditions

Changing demand conditions for oil, including short-run movements in market sentiment and expectations, play an important role in driving oil price fluctuations (Lippi and Nobili 2012; Alquist and Coibion 2014; Jacks and Stürmer 2016).

This was particularly visible during the boom years from 2003–08, when a positive reassessment of demand prospects from EMDEs contributed to a near doubling of the real price of oil (Baumeister and Peersman 2013; Kilian and Hicks 2013).

That process reversed after the global financial crisis, as long-term prospects for advanced economies and, later, for EMDEs began to be downgraded. Evidence of the slowdown became more visible around 2011, as global industrial production, goods trade, shipping freight, and major industrial commodity prices all trended down (Kilian and Zhou 2017).

Deteriorating growth prospects for EMDEs led to a continued decline in oil consumption expectations for these economies. Concerns about global growth prospects intensified during 2015 and early 2016, amid signs of a simultaneous slowdown in China, major commodity-exporting EMDEs, and the United States.

In January 2016, oil prices reached a 15-year low of $31/bbl. A decline in the average oil intensity of global GDP, which has nearly halved since the 1970s, also explains an undercurrent of weakening longterm demand.

By 2016, the level of oil consumption in advanced economies, which had begun to fall prior to the global financial crisis, was nearly 7 percent below its 2005 peak.

Technological improvements and substitution away from oil have been significant driving factors underlying the slowdown in oil consumption since 2005.

In non-OECD countries, technology and environmental policies have also started to influence crude oil demand patterns. For example, China became the world’s largest user of energy-efficient vehicles in 2015, reflecting in part policies to reduce air pollution (Ma, Fan, and Feng 2017).

Electric vehicles continue to account for a low share of global transportation, but could become an important force affecting oil demand prospects over time (Cherif, Hasanov, and Pande 2017).

From a long-term perspective, technological improvements on the consumption side, along with policies to limit fossil fuel usage and increase energy efficiency, are likely to constrain demand growth, thus preventing oil prices from reverting to levels seen during the boom years (IEA 2017).

The oil price collapse: The relative importance of supply and demand

While changes in underlying supply and demand conditions pre-dated the start of the oil price plunge in mid-2014, a convergence of geopolitical factors triggered a sudden and abrupt price realignment, later amplified by OPEC’s policy shift and signs of a further weakening of global growth.

To help disentangle the contribution of supply and demand shocks around the 2014–16 collapse, a Bayesian structural vector autoregressive model was estimated.

The model explores interactions between international oil prices; global oil output; and common demand indicators such as global industrial production and metals prices, the latter of which co-move with oil prices in the presence of demand-driven shocks.

Results confirm that changing supply conditions played a dominant role in triggering the initial oil price decline from mid-2014 to early 2015, explaining about 60 percent of the drop.

These results are consistent with previous analyses (Baffes et al. 2015; Arezki and Blanchard 2015). The role of oil demand shocks, however, strengthened in the second half of 2015 and early 2016, when global activity showed signs of deceleration and metals prices continued to slide.

Around that period, changes in supply conditions are estimated to have accounted for about 40 percent of the price drop. Various other indicators used to proxy demand shifts in commodity markets also point to downward demand pressures on oil prices (Kilian and Zhou 2017).

 How did the recent oil price collapse impact the global economy?

 The plunge in oil prices that began in mid-2014 led to expectations of global growth windfalls (Baffes et al. 2015). Estimates produced at the time suggested that a 50 percent supply-driven decline in oil prices could lift global GDP by around 0.8 percent over the medium term.

Such a boost to global aggregate demand was expected to result from a transfer of income and wealth from oil-exporting economies, which tend to have a high aggregate savings rate, to oil-importing economies, where the propensity to spend is higher.

And while lower oil prices were anticipated to negatively impact investment in the oil industry, this was expected to have been more than offset by lower energy costs for consumers and for energy-intensive sectors, including transportation, manufacturing, and agricultural sectors. Rather than lifting activity, however, the oil price plunge was accompanied by a global slowdown.

Global growth moderated from 2.8 percent in 2014 and 2015, to a post-crisis low of 2.4 percent in 2016, amid weakening global trade, subdued capital flows to EMDEs, and broad -based weakness in commodity prices.

A sudden contraction in government spending, domestic demand, and imports in oil-exporting economies had some dampening effects, but the most important factor behind disappointing global growth during and after the oil price plunge was a failed recovery in oil-importing EMDEs and advanced economies, particularly the United States.

Growth disappointments among oil importers were partially reversed in 2017, as a broadbased cyclical recovery got underway (Chapter 1).

However, forecast downgrades continued among a number of oil-exporting EMDEs. Overall, global growth was overestimated by an average of 0.2 percentage point per year over the period 2014- 17, with 40 percent explained by oil-exporting EMDEs, 34 percent by oil-importing EMDEs, and the remainder by advanced economies.

While the impact of low oil prices on growth in oil-importing EMDEs was less than expected, lower oil prices have helped reduce vulnerabilities in some of these countries, as reflected in improved current account positions and lower inflation.

In turn, reduced vulnerabilities supported investor confidence and allowed monetary policy authorities to regain some space for policy easing (World Bank 2016b).

Impact on oil exporters

The oil price plunge from mid-2014 to early 2016 had broad-based and long-lasting effects on economic activity in oil exporters. More than 70 percent of oil-exporting EMDEs registered slowing growth in 2015 and 2016, with many facing a collapse in consumption (e.g., Nigeria, Russia, the United Arab Emirates, República Bolivariana de Venezuela) and investment (e.g., Angola, Russia, Venezuela).

Termsof-trade shocks can impact both actual and potential output growth, particularly for oil exporting countries, which are generally less diversified than other commodity exporters (Aslam et al. 2016).

Investment growth tends to respond particularly strongly to a deterioration in terms of trade, which can in turn negatively affect capital deepening and total factor productivity growth (World Bank 2017a).

The oil price plunge quickly depleted oil revenues, forcing abrupt cuts in government spending that accentuated the slowdown in private sector activity in many regions (World Bank 2016b, 2016c, 2017a; Danforth, Medas, and Salins 2016).

This effect was amplified in countries that entered the most recent oil price decline with weaker fiscal positions and higher private sector debt than in previous episodes. This contributed to a more pronounced slowdown in aggregate demand, particularly in investment, in the Middle East, Sub-Saharan Africa, and Eastern Europe (BIS 2016).

The effects of the price shock were also exacerbated by idiosyncratic factors, including sanctions on Russia, and conflict and geopolitical tensions in the Middle East and North Africa region.

Headwinds in Russia and the Gulf Cooperation Council (GCC) economies also had adverse spillovers through reduced within-region flows of trade, remittances, foreign direct investment, and grants (World Bank 2015b, 2016d).

Oil-exporting low-income countries (e.g., Chad, South Sudan) were hit particularly hard, as the effect of the oil price shock was exacerbated by conflict and deteriorating security conditions.

Delayed adjustments contributed to a depletion of reserves and a sharp increase in public debt. In general, activity in oil exporters with floating exchange rate regimes (e.g., Albania, Russia) and a relatively high degree of economic diversification (e.g., Bahrain, Ghana, Malaysia, Qatar) recovered more quickly from the fall in oil prices than those with fixed exchange rates and low diversification.

Oil exporters with relatively large foreign reserves and low historical inflation volatility also showed greater resilience (Grigoli, Herman, and Swiston 2017; World Bank 2016b).

High income inequality and political instability also weakened the ability of oil-exporting economies to weather low oil prices (Ianchovichina and Onder 2017).

Impact on oil importers Contrary to expectations in 2014–15, the collapse in world oil prices did not provide a boost to activity among oil-importing economies, most of which experienced slowing growth in 2015–16.

Growth disappointments were concentrated in EMDE oil importers, but an unexpected slowdown in the United States in 2016 also had an outsized effect. Adjustments costs and uncertainty associated with large oil price changes could have disrupted activity and investment in the short term (Hamilton 2011; Jo 2014).

The most important factors behind the lack of a positive growth response to lower oil prices are assessed to be the following:

China’s energy mix and rebalancing needs. China is the second-largest oil importer in the world, but the share of oil in its overall energy consumption is the lowest among G20 economies.

Instead, China relies heavily on coal, which accounted for 65 percent of energy consumption in 2016. Regulated fuel costs and a low energy and transportation weight in consumer baskets also mean that lower oil prices lead to limited real income gains for consumers (World Bank 2015c).

The direct impact of the oil price plunge on China was relatively modest. Meanwhile, a near halving of investment growth since 2012 has weighed significantly on activity, and is estimated to have accounted for 40 to 50 percent of the import deceleration in 2014–15, with significant knock-on effects for trading partners (Kang and Liao 2016).

Since much of investment is resource intensive, the impact of slower investment growth was particularly significant for industrial commodity prices and activity in commodity exporting EMDEs (World Bank 2016b; Huidrom, Kose, and Ohnsorge 2017).

Lower sensitivity of other oil-importing EMDEs to oil shocks. A number of recent empirical studies suggest that activity in oil-importing EMDEs is less responsive to oil supply shocks than that in major advanced economies (Aastveit, Bjørnland, and Porsrud 2014; Caldara, Cavallo, and Iacoviello 2016).

These studies explore several factors, including different energy mixes, consumption patterns, and energy price controls that limit the pass-through of world prices to domestic retail prices.

Since many oil-importing EMDEs took advantage of lower world prices to reduce energy subsidies, real income gains from declining oil prices for consumers were more limited, even if it created potential fiscal savings.

For non-oil commodity exporters, which represent approximately half of oil-importing EMDEs, adjustments to past terms-of-trade shocks continued to weigh heavily on activity in 2014.

Because investment has responded strongly to deteriorating terms of trade since 2011, both actual and potential output growth may have been negatively affected (World Bank 2017b).

Some oil-importing EMDEs had also made significant investments in new oil production capacity and biofuels during the period of high oil prices, including in a number of low-income countries (World Bank 2015d).

The reduced profitability of these projects as prices collapsed led to a sharp contraction in capital expenditures in those sectors. Per fact that oil-importing EMDEs have become a major source of global growth and international spillovers could help explain the lack of a global stimulus effect from falling oil prices (Huidrom, Kose, and Ohnsorge 2017).

The impact of low oil prices on investment in the United States. In the United States, the boost to private consumption from lower oil prices was partly offset by a sharper-than-expected contraction in capital spending in the energy sector (Baumeister and Kilian 2016).

Mining investment was cut in half in the two years that followed the mid-2014 oil price plunge. This dragged private investment down, curtailing GDP growth by 0.2 percentage point in both 2015 and 2016.

The collapse of energy investment reflected both the magnitude of oil price changes and the specific nature of shale oil production, where capital expenditures are more price elastic than conventional production (Bjørnland, Nordvik, and Rohrer 2017; Newell and Prest 2017).

U.S. business activity was also dampened by the sharp appreciation of the U.S. dollar, which adversely affected manufacturing exports and profits.

Monetary policy constraints in the Euro Area and Japan. Declining oil prices coincided with a drop in long-term inflation expectations in a number of advanced economies, raising particular concerns about persistent deflationary pressures in the Euro Area and Japan (Arteta et al. 2016).

With these economies experiencing interest rates close to their lower bounds before the oil price collapse, reduced inflation expectations could have resulted in upward pressures on real interest rates. Central banks in both the Euro Area and Japan responded to these deflationary risks by pursuing more aggressive monetary policy accommodation, including negative interest rate policies and expanded asset purchase programs.

Coupled with more supportive fiscal policies, these steps helped to support an acceleration of activity. Hence, there is little evidence that monetary policy constraints were a key factor explaining the muted response of global demand to lower oil prices since 2014.

What was the policy response in oil exporters and oil importers?

The sharp oil price decline elicited widely different monetary, fiscal, and structural policy responses in oil-exporting and oil-importing economies. Monetary policy and fiscal policy was nearly universally tightened among oil-exporting EMDEs, while the policy response in oil importers was varied.

Among oil-exporting EMDEs, those with flexible exchange rates or lower-than-average reliance on oil for government revenue experienced less abrupt deterioration in fiscal balances than those with fixed exchange rates or higher-than-average reliance on oil revenues.

For some major oil-exporting EMDEs, the oil price plunge triggered structural reforms, including subsidy reforms, which may in turn support the longstanding need for economic diversification, but more sustained efforts are required.

Although some oil-importing EMDEs took advantage of the period of depressed oil prices to reform energy subsidies, there has been no noticeable improvement in fiscal sustainability since 2014.

Policy response in oil exporters

 Monetary policy

Many oil-exporting EMDEs experienced sharp currency depreciation or rapid declines in foreign exchange reserves in 2014–16. Countries with floating exchange rates were better able to stabilize reserves, but generally suffered sharper initial depreciations.

Monetary authorities in several countries intervened in foreign exchange markets to support their currencies (e.g., Angola, Azerbaijan, Bolivia, Kazakhstan, Malaysia, Nigeria, Russia, Sudan, Turkmenistan), and many hiked policy interest rates in response to rising inflation (e.g., Angola, Azerbaijan, Colombia, Ghana, Kazakhstan, Nigeria, Russia, Trinidad and Tobago) or to support currency pegs (e.g., Bahrain, Kuwait, the United Arab Emirates).

Per erosion of foreign reserves contributed to the welcome adoption of more flexible exchange rate regimes in Azerbaijan, Nigeria, and Russia as part of the adjustment to low oil prices.

In contrast, Gulf Cooperation Council (GCC) countries, with larger reserves before the oil price decline, were able to use their reserves to maintain their currency pegs, despite intermittent periods of pressure on exchange rates (World Bank 2016c).

Central banks in oil-exporting EMDEs also took steps to mitigate tightening banking sector liquidity as oil prices declined. In a small number of countries where liquidity pressure was severe, the monetary authorities responded with unconventional measures, such as placing deposits from sovereign wealth funds (SWFs; e.g., Azerbaijan) and pension funds (e.g., Kazakhstan) in commercial banks (Sommer et al. 2016).

In oil-exporting advanced economies, Canada and Norway, inflation remained better anchored than in EMDEs. In light of weakened growth prospects, monetary authorities in these countries were able to pursue accommodative monetary policy—each lowered policy rates two times during 2015—as a complement to an easing fiscal stance.

Fiscal policy

Many EMDE oil exporters, which rely heavily on hydrocarbon revenues, undertook severe fiscal consolidation to realign spending with revenues despite rising economic slack and diminishing long-term growth prospects (e.g., Algeria, Angola, Azerbaijan, Iraq, the Islamic Republic of Iran, Kuwait, Nigeria, Russia, Saudi Arabia, the United Arab Emirates; Danforth, Medas, and Salins 2016).

Compared with previous episodes of declining oil prices, the impact on public finances in EMDE oil exporters was compounded by weaker initial fiscal positions. Fiscal sustainability gaps continued to widen in 2015 and 2016, and government debt ratios rose on average by 11.4 percentage points, compared with an average of only 0.9 percentage point in past episodes (IMF 2017a; World Bank 2017a).

The need for fiscal adjustment was greater in oil exporting EMDEs that lacked the necessary buffers (Husain et al. 2015; World Bank 2015d).

Oil-exporting EMDEs with higher reliance on oil related revenues faced a more pronounced deterioration in fiscal balances than in those economies that managed to diversify government revenue away from oil before 2014.

Fiscal balances also fared better in oil-exporting EMDEs with more flexible exchange rate regimes, in part because real exchange rate depreciation mitigated revenue declines and spurred needed adjustment within the private sector.

A number of oil exporters that had previously built up buffers in SWFs—approximately 60 percent of oil-exporting EMDEs have at least one SWF—appropriately used these resources to alleviate fiscal and exchange rate pressures (e.g., Algeria, Azerbaijan, Kazakhstan, Kuwait, Saudi Arabia, the United Arab Emirates; World Bank 2015c).

However, policymakers continue to face tradeoffs in their choices between drawing down assets—in particular, from SWFs—and issuing sovereign debt to finance budget deficits.

Given benign global financing conditions, many have chosen to issue debt (Lopez-Martin, Leal, and Martinez 2016; Alberola-Ila et al. forthcoming).

Expenditure cuts have helped lower the fiscal break-even oil price in most oil-exporting EMDEs since 2015, although they remain higher than the current oil price in some countries (e.g., Bahrain, Saudi Arabia, Oman, Libya, the United Arab Emirates; Baffes et al. 2015; World Bank 2017b; World Bank 2017c).

Absent a stronger-than expected rebound in oil prices, further fiscal reforms in many oil-exporting EMDEs will be necessary.

Contingent liabilities associated with potential bailouts of stated-owned oil companies and banks also remain a source of fiscal vulnerability, highlighting the importance of strengthening fiscal frameworks to mitigate such risks (Bova et al. 2016).

For some oil-exporting EMDEs, the fall in oil prices has helped spur longer-term fiscal reforms, including the introduction or planned introduction of additional indirect taxes (Malaysia, GCC countries). However, only one-fourth of oil exporting EMDEs have fiscal rules to act as buffers to smooth the impact of oil price cycles on activity and public finances.

Moreover, some countries failed to satisfy their existing fiscal rules (e.g., Nigeria), or subsequently modified them (e.g., Russia). This suggests the need for stronger fiscal frameworks to help reduce the procyclicality of fiscal policy and to establish a firmer foundation for long-term fiscal sustainability (Mendes and Pennings 2017).

Oil price hedging and indexation of government bonds to oil prices could also help reduce exposure to short-term fluctuations in oil prices (Frankel 2017).

In oil-exporting advanced economies (e.g., Canada and Norway), the availability of fiscal buffers provided space to loosen fiscal stances, as measured by changes in the structural budget balance (i.e., the budget balance adjusted for the gap between actual and potential output levels).

For example, Norway’s fiscal rule of allowing up to 4 percent of its SWF to be drawn down to fund fiscal deficits provided a countercyclical policy tool to support growth.

Structural policy

Many oil-exporting EMDEs entered the 2014 oil price bust still heavily reliant on oil. Hydrocarbon sector activity represented more than one-third of GDP in a number of countries in Central Asia, Sub-Saharan Africa, and, in particular, the Middle East.

Oil production represented the majority of government revenue and exports in most oil exporting EMDEs in 2013.

Cross-country studies underscore that greater diversification of exports and government revenues can bolster long-term growth prospects and resilience to external shocks and increase per-capita income growth (Lederman and Maloney 2007; Hesse 2008; IMF 2016).

In oil-exporting EMDEs that have previously successfully diversified, a combination of measures to stimulate non-energy exports and broad reforms to improve the business environment, education, and skills acquisition have been vital (e.g., Malaysia, Mexico; Callen et al. 2014).

Efforts to attract capital flows to non-resource sectors may also encourage diversification. Following the recent oil price collapse, several large oil-exporting EMDEs have laid out medium to long-term plans to reshape their economies by reducing reliance on the energy sector.

For instance, Saudi Arabia’s 2016 National Transformation Program targets an increase in non-oil commodity exports of 62 percent and non -oil government revenues of almost 225 percent by 2020 (Kingdom of Saudi Arabia 2016; World Bank 2016d).

A GCC-wide implementation of a 5 percent value-added tax, expected to become effective in 2018, is intended to boost non-oil revenues in these countries.

Nigeria has identified several sectors to promote greater diversification of export earnings and government revenues.10 Kazakhstan’s “100 Concrete Steps” program, adopted in 2015, aims to diversify the economy and improve competitiveness and transparency.

Other recent examples of efforts to encourage diversification include: reducing labor market rigidities (e.g., Saudi Arabia, Oman), supporting foreign investment (e.g., Saudi Arabia), expanding infrastructure investment (e.g., Malaysia), and broadly improving the business environment (e.g., Algeria, Bahrain, Brunei Darussalam, Kazakhstan, Nigeria, the United Arab Emirates).

Reforms have also been encouraged by multilateral initiatives, including the World Bank’s assistance to diversification efforts in some countries (e.g., the Republic of Congo, Nigeria, Qatar, and members of the Central African Economic and Monetary Community).

However, in some cases, the structural reform agenda has faced legislative or implementation delays (e.g., Algeria, Kazakhstan) or has been scaled back as fiscal pressures recede (e.g., privatization efforts in Russia).

The sharp reduction in government revenues among oil-exporting EMDEs has also led to an increased emphasis on energy subsidy reforms. These have been aimed at restoring fiscal space, discouraging wasteful energy consumption, and generating capacity for programs that better target the poor (IMF 2017b).

Between mid-2014 and end-2016, more than half of oil-exporting EMDEs reformed energy subsidies, including a geographically diverse set of countries in the Middle East and North Africa, Sub-Saharan Africa, East Asia, Latin America, and Central Asia.

A number of oil exporters have reduced utility subsidies as well. In some cases—for instance, in GCC countries— subsidy reform was a significant break from past policy (Krane and Hung 2016; World Bank 2017c). Yet the need for reforms in this area is underscored by the fact that energy subsidies represented an average of nearly 6 percent of GDP as of 2014 among those oil-exporting EMDEs where subsidy reform occurred between 2014 and 2016.

Encouragingly, the design and implementation of recently-implemented energy subsidy reforms has been superior to past efforts, which were poorly phased and hampered by insufficient communication to the public about the rationale for reform (Clements et al. 2013; Asamoah, Hanedar, and Shang 2017).

In many cases, recent reforms have also helpfully included measures to mitigate the impact on the poor and to strengthen social safety nets (e.g., Algeria, Angola, Saudi Arabia). Available data suggests that fuel price reforms since mid-2014 have succeeded in raising gasoline and diesel prices in oil exporting EMDEs closer to international prices.

Policy response in oil importers

Monetary policy

The plunge in oil prices, coupled with a weak global growth environment, exacerbated the existing disinflation trend in many oil-importing EMDEs. In this context, several central banks cut interest rates, or otherwise pursued accommodative monetary policy during 2015–16 (e.g., China, Croatia, Dominican Republic, Hungary, India, Pakistan, Poland, Romania, Thailand).

Yet, a number of non-oil commodity exporters raised rates during part of the 2015–16 period because they experienced significant currency depreciation, in part due to increasing concerns about external vulnerability (e.g., Brazil, Kenya, Mongolia, Peru, South Africa, Uganda, Ukraine, Zambia) and above-target inflation (e.g., Brazil, Mexico, Peru, Sri Lanka, Ukraine). For major advanced economies, the fall in oil prices put significant downward pressure on inflation in 2015 and 2016.

Several central banks responded by further cutting policy rates or expanding unconventional measures after reaching the zero lower bound of policy rates.

In particular, the European Central Bank and Bank of Japan introduced negative interest rate policies and expanded their asset purchase programs.

Fiscal policy Depressed oil prices were expected to provide oil importers an opportunity to rebuild fiscal space, but fiscal positions instead worsened in a number of these countries over the period 2014-16 (e.g., Argentina, Brazil, Turkey).

In fact, cyclically adjusted fiscal balances of oil-importing EMDEs deteriorated significantly, and government debt ratios increased. In some cases, this reflected the effects of the broader decline in commodity prices, which reduced government revenues and necessitated spending cuts (e.g., Mongolia, Mozambique, Namibia, Rwanda, Ukraine).

But even in countries where growth remained relatively robust and output gaps positive, governments missed the opportunity of lower energy prices to rebuild necessary fiscal space (Kose et al. 2017).

For advanced economies, fiscal stances continued to tighten in 2014-15, on average, but then became slightly expansionary in 2016, amid concerns about persistently weak growth and increasingly constrained monetary policies (IMF 2017a).

Lower oil prices implied smaller direct fiscal windfalls in advanced economies compared to EMDEs given the smaller prevalence of subsidies (Coady et al. 2017; IEA 2016).

 Structural policy

Like oil-exporting EMDEs, oil-importing EMDEs have taken advantage of declining oil prices to begin dismantling energy subsidies, which tend to benefit high-income earners, can crowd out public investment, and encourage more intensive use of fossil fuels (Arze del Granado, Coady, and Gillingham 2012).

Since mid-2014, a number of countries have implemented such reform (e.g., China, the Arab Republic of Egypt, Mexico, Morocco, Tunisia), while others have raised energy taxes (e.g., China, Rwanda, South Africa, Vietnam; IEA 2015; IMF 2016; Kojima 2016).

These steps have also included measures to avoid energy subsidies re-emerging if oil prices rebound—automatic pricing mechanisms or full energy price liberalization have been common (e.g., China, Côte d’Ivoire, India, Jordan, Madagascar, Mexico, Thailand, Ukraine; Asamoah, Hanedar, and Shang 2017; Beylis and Cunha 2017).

Concluding remarks and implications for the future

The plunge in oil prices from June 2014 to January 2016, one of the three largest declines since World War II, was accompanied by an unexpected slowdown in global growth and a host of policy responses in oil-exporting and oilimporting economies. The key takeaways are as follows:

What were the main drivers of the price plunge from mid-2014 to early 2016?

Supply factors appear to have played a predominant role, particularly during the initial drop from mid-2014 to early 2015. Rising production and efficiency gains in U.S. shale oil, diminishing supply disruptions in the Middle East, and OPEC’s decision in November 2014 to abandon price controls amplified market perception of a significant supply glut.

However, disappointing global growth, particularly from mid-2015 to early 2016, played a significant role as well, underpinning expectations of weakening demand.

How did the recent oil price shock impact the global economy?

In contrast to earlier expectations, the oil price plunge did not provide a noticeable boost to global activity, and was instead accompanied by slowing growth from 2014 to 2016.

Despite a significant upturn in 2017, global growth was overestimated by an average of 0.2 percentage point per year over the period 2014-17, with 40 percent explained by oil exporting EMDEs, another 34 percent by oil importing EMDEs, and the remainder by advanced economies.

In oil importers, the shortfall reflected the low responsiveness of activity to falling oil prices, ongoing economic rebalancing in China, and the dampening impact of a sharp contraction in U.S. energy investment and a rapid appreciation of the U.S. dollar on growth in the United States.

Growth slowdowns in oil exporters were sharper and longer-lasting than expected, contributing to global growth shortfalls despite the limited size of these economies.

What was the policy response in oil exporters and importers?

The collapse in oil prices provided a new impetus to implement policy reforms in oil exporting EMDEs. Some have adopted more flexible currency regimes, which appear to have buffered the negative fiscal impact of falling oil prices in countries where they were already in place in 2014, while a large number of these countries have reduced or eliminated fiscally costly energy subsidies.

Some oil exporters have started reducing or are planning to reduce their reliance on the energy sector. A number of oil-importing EMDEs have also lowered energy subsidies.

What are long-term prospects for oil prices and for oil-exporting EMDEs?

Looking forward, oil prices are likely to remain markedly below levels prevailing before 2014. In particular, shale oil has altered long-term price expectations, increasing global recoverable oil reserves, and turning an energy scarcity challenge in the late 2000s into a “supply glut.” Forecasts in 2014, which envisioned the Canadian oil sands as the world’s marginal oil supplier, projected a nominal oil price of $100/bbl in 2025.

Yet technological advancements and rising productivity in the U.S. shale oil industry, coupled with efficiency improvements on the consumption side and substitution away from oil, have brought the 2025 nominal oil forecast down to $65/bbl.

Despite a rebound in oil prices in the second half of 2017, which was supported by prospects of strengthening demand and production cuts by OPEC and non-OPEC producers, numerous factors limit upside risks to the outlook.

First, greater price responsiveness of shale compared with conventional oil should ensure a rapid recovery in supply if upward price pressures materialize.

Second, on the demand front, an accelerated uptake of more fuel-efficient technologies (e.g., electric vehicles and natural gaspowered commercial trucks), or new technological breakthroughs (e.g., self-driving cars or fuel cell technology) could considerably reduce oil consumption prospects (Cherif, Hasanov, and Pande 2017; International Energy Agency 2017).

Third, environmental concerns (driven by pollution or climate-change considerations) could accelerate the use of policy tools that favor renewable energy.

However, oil supply shocks (notably geopolitically-driven disruptions) or demand shocks (especially from large EMDEs, such as India and China, where most demand growth is expected to originate) could still trigger sharp fluctuations in oil prices and overshooting in both directions (Arezki et al. 2017).

The episode of falling oil prices in 2014-16 illustrates that large price changes can have disruptive effects on global activity, including by discouraging investment in both energy and some non-energy sectors. While persistently low oil prices could help sustain aggregate demand in oil importing economies, positive effects would likely be limited in view of the recent experience. Low oil prices could also deter oil conservation efforts and incentives to develop renewable energies, which carry significant economic opportunities, including in low-income countries (World Bank and International Energy Agency 2015).

For oil exporters, the 2014–16 oil price plunge has cast a long shadow, as significant declines in investment and output tend to lead to weaker potential output growth in subsequent years. The expectation that oil prices will remain markedly lower than previously expected increases the urgency of reforms to restore growth and fiscal sustainability, whereas efforts so far have been mixed.

The successful diversification experience of some energy producers (e.g., Malaysia, Mexico) suggests the need for both vertical diversification in oil, gas, and petrochemical sectors, as well as horizontal diversification beyond these sectors, with an emphasis on technological upgrades and competitiveness. Policy should help support investment in human capital, entrepreneurship, and employment in the non-oil private sector.

Global Economic Prospects, January 2018


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