from Follow the Money

Hey big spender (or why conservation is perhaps a bit more than just a personal virtue) ….

January 30, 2007
4:29 pm (EST)

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In the past, I have noted that oil exporters saved rather than spent the windfall from the surge in oil prices.    The IMF calculated that the average oil producer in the Middle East “spent” 30% and “saved” 70% of the increase in their oil revenues between 2002 and 2005.   I think the IMF is using spending in a broad sense – counting an increase in domestic investment as well as an increase in domestic consumption.     The reason for this restraint wasn’t hard to find.   Lots of oil states were budgeting for $20 a barrel oil in 2004, and oil was well above $20 then.   Budgets inched up in 2005, but not as fast as oil prices. 

But that seems to be changing.  In 2006, both Russia and Saudi Arabia seem to have only saved about ¼ of the increase in their oil revenues.   That is a bit misleading – part of the increase in spending in 2006 reflects the impact of higher oil prices in 2004 and 2005 and so on.   Still, at the margins, ratios changed.  In 2007, the Russian and Saudi budgets balance is their oil is a bit above $40 a barrel – which works out to balancing if WTI is north of $45 or so.      That is a big change from balancing at $20 a barrel (local blend) or WTI in the low twenties.

Then again, the Saudis and the Russians aren’t the big spenders.    Iran, Venezuela (at least when it comes to fiscal policy), Bahrain, Subsaharan Africa and (believe it or not) Kazakhstan are.

That shows up in the following chart – one of many I have been working on for a paper on oil and global adjustment.  It shows the oil price (roughly) needed to cover the import bill of various oil states through 2006.    Imports here are used in a loose sense to refer to imports net of non-oil exports, income payments and transfers – the definition the IMF generally uses for these kinds of calculations.   It is a bit rough.  Some data is still lacking (especially for many of the GCC countries).    I am not sure that Rachel Ziemba and I have adjusted for gas correctly.    But it still gives some idea of the basic trends.

Crude oil price that covers oil exporters import bill; 2007 = forecast  


I am not 100% confident in the Venezuela calculation.  We took a few short-cuts in adjusting for Venezuela’s heavy crude (which trades about $10 below sweet light crude), and, more importantly, our calculations work off Venezuela's oil export and current account data.  If the data is off, our calculations will be off.   If anyone has a good estimate of Venezuela's actual oil and gas export revenues/ current account surplus, do share!

Calculations of the “break-even’ oil price needed to avoid a current account deficit are a bit different than calculations of the “break-even” oil price needed for the budget.  Budget numbers are usually a bit higher.  

That is especially the case for countries like Venezuela and Iran.   Venezuela ran a comfortable current account surplus in 2006, but looks to have run a small fiscal deficit.     That could become a big fiscal deficit in 2007.    Ben Ramsey and Andres Ortiz of JP Morgan’s Latin American Data watch on Monday calculated that Venezuela could easily run a $6b-12b fiscal deficit if WTI is around $50 in 2007 (and Venezuela’s blend sells for $40).   $23.5b in oil revenues would fall to $18b, bringing total revenue down to around $48b.  2006 spending is estimated at $54.5b.  Sustaining that would imply a meaningful deficit, and continuing to ramp up spending would imply an even bigger deficit. (Venezuela’s formal budget for 2007 only includes $52.7b in spending, but, like most oil exporters, it has tended to overspend the budget in a big way recently).

Iran could be even worse fiscal shape – though a lack of transparency makes it hard to tell ….  But back in December, when oil was a bit higher, Monica Malik of Standard Chartered was forecasting than Iran would run a small fiscal deficit in 2007. 

Now Michele Bilig of PIRA (a friend of mine, quoted in yesterday’s Journal) is quite right to note that both Venezuela and Iran have substantial assets – neither is in any real financial trouble is oil stays in the $50-55 range.     But both are potentially in a position where they start having to make some real choices.  The 2007 Iranian budget supposedly includes a 20% increase in spending.    Priorities start to matter when you cannot spend money on everything. 

Now, it is quite possible that Iran’s number one priority is the development of some form of nuclear capability – if not a nuclear weapon, the option to develop a nuclear weapon in relatively short order.    So a fiscal squeeze alone may not be enough to stop Iran’s nuclear program. 

But it certainly seems like one element of a viable counter-proliferation plan.   It sure beats some of the alternative counter-proliferation policies that may be under consideration.

Alas, best I can tell, the US has outsourced its counter-proliferation policy – at least this aspect of it – to Saudi Arabia.  The US has consistently encouraged the Saudis to flood the global market with oil, squeezing the Iranians.  The New York Times:

Several European officials said in interviews that they believe that the United States and Saudi Arabia have an unwritten deal to keep oil production up, and prices down, to further squeeze Iran, which is dependent on oil for its economic solvency. No official has confirmed that such a deal exists.

The Saudis do seem rather worried by growing Iranian power; it is possible that they have concluded that they prefer lower oil prices to an Iranian bomb (and growing Iranian influence in the Gulf).  

On the other hand, the Saudis also export a lot more oil than the Iranians – and they don’t want the price of oil to far too low.  Their interests are not totally aligned with those of the US.  The Saudis seem happy with $50 a barrel oil.  But, given their budget, I rather suspect they don’t want oil to fall much below $45 (WTI) on a sustained basis – they would rather not go back to the structural fiscal deficits that they ran in the 1990s.    Of course, the Saudis now have a lot of money in the bank, so they could outlast the Iranians if oil was at $35 or $30.   But life inside the Kingdom wouldn’t be so comfortable … 

Greg Gause, writing for Abu Aardvark:

The Gulf states are supposed to "bring down the price of oil" to make life difficult for Iran.  Well, if they bring it down too much, they will make life difficult for themselves as well.  Saudi Arabia and the Gulf states have gotten very used to the nice level of oil revenues over the last few years.  How much of that they are willing to sacrifice in the name of an American-driven strategy against Iran remains to be seen. Remember, one of the things that helped to break the Saudi-Iranian ice back in the 1990's was cooperation to bring oil prices up after the Asian financial crisis.  

Of course, the global price of oil is a function of demand, not just supply.   And while demand for oil is inelastic (it takes a big change in price to reduce the amount people demand), even Americans do respond to higher prices (see this Krugman graph, via Mark Thoma).    US oil imports actually fell in volume terms in 2006.  Not by much, but a fall is a big change from the 5% y/y growth back when oil was in the 20s.   

The Bush administration is talking up alternatives to oil now.   Higher CAFÉ standards are now on the table (maybe -- see Kevin Drum).  But the US policy on ethanol does more to help corn farmers than to reduce US demand for imported oil … and CAFÉ standards take time to work their way through the auto fleet.    More importantly, energy policy works with a lag.    And back when the Bush Administration could have taken steps to try to reduce US oil demand, a rather important member of the administration ….

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