Are Oil Prices Latin America's Newest Threat?
6 Apr 2015
By Roberta Nadine Rosania Gerevasi for International Security Observer (ISO)
This article was external pageoriginally published by external pageInternational Security Observer on 17 March 2015.
The dramatic fall in oil prices that has taken place since the second semester of 2014 was not exactly unexpected, even if it did take the world by surprise. As of February 5th, Brent crude has dropped from $115 to $56 a barrel, and West Texas Intermediate to $50. external page[I] Widely ranging from energy policy to the fight against the Islamic State, political changes have affected the oil market and will surely have long-term repercussions. Evidently enough, the situation has harmed the economy of many producing countries, especially the ones where revenues depend highly upon oil exportation. The implications of the current circumstances transcend states, reaching their own individual consumers. As it will be noticed, this will represent a major security threat for Latin America, as reduced prices will bring deeper economic distress.
The Supply/Demand Chain: Mirroring Latest Developments
The gradual reduction in oil prices undoubtedly reflects economic grievances and policy changes around the world. In fact, the oil industry, like financial markets, is driven by governments’ present or forthcoming actions. external page[II] Given that prices are determined by the supply-demand dynamism, the industry has been influenced by the world’s shrinking economy, the substantial increase in oil output, and the contradictory effects of conflict afflicting various oil-producing countries.
In the past few years, the global economy in general has suffered numerous ups and downs; and Europe in particular has not been able to bounce back. Since 2009, several Eurozone member states have been engaged in a debt crisis that will not dissipate anytime soon. Prices started falling around June 2014, as a result of the elevated decrease in demand caused mainly – but not exclusively – by slow economic growth not only around Europe, but also in Asia, specifically in China and Japan.external page[III] Furthermore, as envisioned by the International Monetary Fund, the economy is expected to worsen, which will eventually broaden the already existing gap between oil’s supply and demand.external page[IV] This is because the profits of lower oil prices do not seem to outweigh the costs.
Likewise, prices have been susceptible to OPEC’s negligence towards reducing the supply and the United States’ spiking oil inventories. On one hand, the Organization of the Petroleum Exporting Countries (OPEC) is determined to preserve oil production as it is because, otherwise, it would serve as a disadvantage for countries holding the highest market shares in the cartel, expressly for the ones where the price of production is low, such as Saudi Arabia and other Gulf countries.external page[V] On the other, the United States’ drilling activities have increased, raising daily oil production by around 6 million barrels and reaching 413.1 million barrels by the last week of January. external page[VI] Both factors have contributed to an oversupply trend that, for now, cannot equalize global demand.
Last but not least, conflicts in Russia and in several Middle Eastern countries have not played a transcendental role in the oil industry, since production has rather kept a steady pace. Even though Libya, Iran, Iraq and Syria – among others – have experienced supply cutbacks, such losses have been compensated with the afore-mentioned output increases from fracking in North Americaexternal page[VII] and a temporarily stable production in Russia. external page[VIII]
Latin America’s Dependence on Oil
Considering that (most) part of Latin American states’ revenues come from the export of crude oil, the economy will be hurt if oil prices do not pick up. By 2014, growth had already dropped to 1.1%, due to lower oil and other commodity prices, and a stronger dollar. external page[IX] Thus, pessimistic predictions for this year are not shocking taking into account that the alteration of the oil market has caused the hope for a better economic prospect for this year to slowly dim away.
Venezuela will be affected the most. According to Petróleos Venezuela S.A. (PDVSA), for each $1 oil prices drop, the country loses approximately $700 million per year in earnings.external page[X] This huge economic loss has provoked shortages in food and health products and a rise in inflation that could make prices reach a 115% increase. external page[XI] Therefore, the conditions under which Venezuelans will live during the next months will deteriorate. Moreover, the government has not really reconsidered the Petrocaribe settlement, which accounts for 3% of its GDP, even if their benchmark bonds are now valued at 39 cents to the dollar, and the country has been downgraded to Caa3 (the closest to default) by the rating agency Moody’s. external page[XII]
Ecuador has embarked on a similar path. Extremely susceptible to oil prices, the country has been forced to cut down the annual budget and resort to Chinese loans – again. On January, the country cut its fiscal budget by 4% for 2015, taking as reference an oil price of $79.70. external page[XIII] The crisis that Ecuador will soon face is not due only to crude’s prices, but also to public spending. Since the beginning of Correa’s administration in 2007, the state has not saved any part of the revenues generated by the 2008 oil boom that priced oil at $133 per barrel. external page[XIV] On top of that, the state has overly relied on China; Ecuador is going to receive five more credits from the Chinese government worth $7.5 billion, external page[XV] in addition to the estimated $11 billion the country has already borrowed.external page[XVI] Hence, Ecuador has sold itself to China and it’s far from solving its economic problems.
Though nearly half of Colombia’s exports are comprised by oil, the country is in a better place than Venezuela and Ecuador, albeit the challenges that its producers will have to deal with. In order to protect producers, Colombia has assessed a series of measures such as reducing investment costs, lowering the amount of royalties paid to the government, and lessening charges paid by companies. external page[XVII] Still, this approach will not prevent investment from decreasing. Oil prices have devaluated the Colombian peso, and Ecopetrol’s market value has contracted from $129bn in 2013 to $31bn by the end of 2014, cutting its investment budget by a quarter for this year. external page[XVIII] Notwithstanding output modifications and possible falloffs in foreign investment, growth projections aren’t as negative as Ecuador’s and Venezuela’s.
Unlike these countries, Mexico’s issues can be analyzed from another angle. While Mexico’s budget will also have to cope with new prices, its energy reforms might be more worrisome than its economy. Despite the hedging program that, to a certain extent, has shielded the country from at least some of the consequences of plunging oil prices, the government will have to slash public spending to outweigh cash-flow shortages and target fiscal deficit reduction. external page[XIX] These actions have been taken preemptively should oil prices remain low by 2016, when the economy could be hit harder. external page[XX] Inextricably linked to its economy, Mexico’s energy program is an immediate concern. Settled last year, it will closely feel the shockwave of oil prices. The reforms intended to boost output and simultaneously prompt Mexico’s growth will not have the desired outcome if they do not attract as much investment as planned. external page[XXI]
On a similar note, Brazil and Argentina will not be safe from the aftermath. The third producer of the region, Brazil may have to change its exploitation strategies. The drop in oil prices will prevent the country from taking full advantage of its pre-salt fields, given that the expenses incurred to exploit the deep-water reserves are too high. Brazil’s economy will not be damaged as a result, but it will not improve either. The Economic Commission for Latin America (ECLAC) established that Brazil grew only 0.2% in 2014. external page[XII] With this background, the fields discovered in 2007 will not be able to help the economy if prices remain low. Comparably, prices have sparked doubts over whether Argentina’s attempt to strengthen its oil and gas production is sustainable or not. By the end of last year, the economy was already downgraded by a decrease in private consumption, exports, and investment.external page[XXIII] In this sense, if oil prices continue following the same trend, the economy will evidently degenerate.
Dropping Prices: An Emergent Security Threat
There is no question in that Latin America’s growth will contract; yet the economy has overshadowed another threat intimately related to the latter one. Right now, the afore-mentioned countries are experiencing internal disruptions rooted on diverse provocations that are not precisely recent. Under the present conditions, the dissatisfaction that has embraced societies for some years is going to exacerbate. And, more importantly, the emergence of a conflict in one state could have spillover effects on the others.
Once again, Venezuela is heading the list. With Maduro’s mandate, the deplorable situation in which Venezuelans lived when Hugo Chávez was still in office declined. It will not take long for individuals to resist their government if scarcity aggravates with the ongoing oil crisis. In January, Maduro had assured “food, education and life” even at $40 per barrel, which is unattainable considering that oil accounts for 96% of Venezuela’s revenues. external page[XXIV] This will reinforce last year’s political crisis, threatening to elicit a civil conflict that will not be easily appeased.
Ecuador is on the same track. The crisis might not have reached Venezuela’s alarming levels, but the country will be struggling for a while. Though the explicit implications of this year’s budget cuts are uncertain, it is a well-known fact that a reduction of public spending will create unemployment and an additional reduction of imports and investment. Consequently, a resilient sentiment of discontent will cause people to oppose the government and to concurrently contest the ones who support it. If oil prices keep on falling, a financial crisis will spawn a series of protests and demonstrations, making any possible forecast volatile.
Mexico might be provisionally spared from financial distress, but it drags on years of internal violence that have constantly thwarted efforts to maintain peace. The sudden disappearance of 43 students associated to a drug cartel generated an outburst of anger across the population that translated into protests against Peña Nieto’s government. This has been accentuated by allegations of corruption and embezzlement that have undermined the president’s support.[XXV] Bearing in mind that security is a priority for Mexico, failing to effectively address internal threats represents a severe breach. With these precedents, it will not take much for unrest to spur if budget cuts upsurge suspicion regarding the allocation of funds and the ways in which they are used.
Though not quite the same for Colombia, the Revolutionary Armed Forces of Colombia (FARC) have too engendered violence and insecurity. Luckily, the peace talks that started in 2012 have progressed in several aspects, agreeing to work for rural development, the inclusion of insurgents in politics, and the elimination of illicit drug production, which will all come into effect once the peace deal is enforced.external page[XXVI] Yet these reforms are not at all inexpensive. external page[XXVII] Conceding that oil prices have limited spending for this year, the achievement of peace will depend on the availability of sufficient funds to do so. After all, peace comes with a price.
Finally, Brazil and Argentina are both entrenched in scandals of their own. The Petrobras corruption scandal that started in March 2014 and Brazil’s economic setbacks have continued to withdraw support from Rousseff. Being Brazil’s largest company and representing meaningful amounts of capital investment, Petrobras is connected to other production sectors in the country that have been equally affected by oil prices, along with the related investigations of corruption.external page[XXVIII] The combination of these elements will foster renewed violence as growth will again stagnate. Analogously, Argentinians will not wait long to take to the streets because of the economy. On February 19th, hundreds of thousands protested against the death of Alberto Nisman, a prosecutor who investigated the involvement of President Cristina Fernández de Kirchner, in covering up the bombing of a Jewish community center in 1994. While Argentinians wait for the truth to be uncovered, disruptions will continue. In the face of these developments, a pessimistic economic backdrop caused by sliding oil prices would be undesirable for the government’s stability.
Needless to say, these countries will experience snowballing effects in the long run. The dangers of these events are not only domestic, but also regional. Political discontent and restlessness do not have boundaries. If things remain as they are, the economic consequences of falling oil prices will expand well beyond borders, and governments’ independent actions will ultimately be unable to completely determine the extent of internal turmoil.
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