Cheap oil: The threefold effect on Africa -‐ and how to mitigate it Discussion paper Mattias Goldmann, February 2015
1. Background
The world price of oil has within a short time period roughly halved, and the price seems to remain at the current level for at least a few years to come. However, given the high volatility of the oil price, it is as yet unknown how the price will develop in the future. In this discussion paper, we briefly review a couple of possible implications for the African fuel sector – fossil and renewable – in addition to the global and general consequences that are already widely discussed. Our starting point are the ones that generally characterize the project ABBBA -‐ African Biofuel and Bioenergy Business Assessment; that a switch to renewable energy, including biofuels, can be an important growth engine for Africa, creating jobs especially in rural areas, freeing up capital that is currently used for expensive oil imports and that renewable energy can become an important export sector for the continent. Obviously this is a somewhat unsophisticated generalization, with major regional and national differences, but it serves as a comprehensive starting point for our work.
2. Consequences of lower oil prices
We consider that lower oil prices affect Africa in three general ways; reduced willingness to invest in Africa's oil reserves, decreased interest in Africa's potential in biofuels and a relatively reduced competitiveness vis-‐à-‐vis other countries. These estimates are presented as an overview followed by a discussion.
2.1 First strike: Lower interest in Africa’s oil
The lower oil prices are generally assumed to occur due to the following two reasons: 1. Reduced demand, due to weak economic development in many parts of the world, especially in China. 2. Increased supply, in a first stage, mainly because of America's investment in oil shale and tar sands, and in a second stage, due to Saudi Arabia's decision to sell large volumes of oil. The underlying reasons for the price fall have been discussed by many actors and will not be further addressed in this paper. Nevertheless, the effects are all the more interesting and relate directly to the economic development of a number of African states. Here, we proceed with the assumption – though often questioned – that revenues from oil, at least to some extent, benefit the countries in question. Different sources of crude oil have widely different costs of extraction. As a simple rule of thumb, extracting oil from existing wells is cheaper than drilling for new sources of oil. Furthermore, new drilling methods are more expensive, the more unconventional the extraction methods become. Factors that increase the crude oil price include that the oil has to be taken up from greater depths, from under the polar ice caps or extracted from oil shale or tar sands. In addition, unstable regimes and long distances to the main markets further increase the price. If the lower oil price is more than temporary, it
becomes difficult to finance future projects requiring large investments (capex)1. Several analysts indicate that an oil price below USD 70 per barrel means that half of the planned new projects in the world will either be delayed or completely canceled2. It may also be difficult to get new investment in existing oil production. Reuter’s states that the lower oil price has had a much worse effect on the oil-‐producing African countries than the ebola epidemic has had3. Goldman Sachs estimates that investments of nearly 2000 billion USD are threatened if the oil price remains below $ 70 per barrel for a long time. For example, since the collapse of the oil price, Tullow Oil, which has extensive operations in East Africa, wrote down their assets with 2.2 billion USD, while Statoil and British Gas have reduced their involvement in natural gas in Tanzania and Africa Oil, which invests in new oil discoveries in Africa, reports falling stock prices (see chart below)4. Also, South African SacOil is considering leaving several oil assets in Nigeria, Malawi, Congo DRC and Mozambique because of low oil prices5, and Total is revising their projects country by country in order to reduce their costs and, in some cases, leave the projects6. In its latest Oil and Gas Review, PWC states that Africa accounted for 12% of world oil production, mainly from Nigeria, Libya, Algeria, Angola and Egypt, with decreasing production due to political disorder in Côte d'Ivoire and South Sudan. Africa furthermore accounts for 8% of the worlds known oil reserves, with vast potential in Mozambique, Tanzania, Uganda and Kenya. In addition, it is expected that Namibia, Angola, South Africa, Ghana and Morocco have good potential7. The Global Counsel suggests that the potential in Kenya is very difficult to realize with continued low oil prices, since investment costs are very high, and potential investors can select projects in countries with lower risk, such as countries in North America and
1 http://www.aktiespararna.se/analysguiden/Hitta-Bolag/Olja-och-gas/Africa-Oil/Analyser/2014/Lagre-oljeprisantaganden-
innebar-rekommendationssankningar/
2 http://www.marketwatch.com/story/oils-slump-could-upend-2-trillion-in-investments-goldman-2015-01-12 3 http://www.reuters.com/article/2014/11/27/africa-currencies-idUSL6N0TG3CX20141127 4 ttp://ceo.ca/2014/10/23/africa-‐oil-‐trading-‐at-‐52-‐week-‐low-‐on-‐misunderstood-‐news/ 5 http://www.engineeringnews.co.za/article/south-africas-sacoil-says-could-exit-nigeria-assets-2015-02-03 6 http://www.engineeringnews.co.za/article/totals-major-african-projects-safe-from-oil-collapse-cuts-2015-02-04 7 http://www.offshoreenergytoday.com/dnv-gl-oil-gas-industry-pessimistic-about-year-ahead/
Asia. This may cause upheavals and protests in countries with high expectations of new oil revenues. Mozambique and Kenya are singled out as potential countries with risk of violent conflicts due to falling revenues from oil. It is however far from certain that these revenues actually would have reached the public in the first place. Transparency International indicates that the majority of African oil-‐producing countries -‐ current and potential -‐ are among the most corrupt and that the oil sector is less transparent compared to for example the agricultural sector8. Other analysts believe that low oil prices, at least in the long term, can be positive because it accelerates the diversification of the economy of the countries that have had a unilateral dependence on oil and gas, and reduces the risk of other African countries to end up in a similar situation9. 2.2 Second strike: Tough market for biofuels "If oil stays at current prices […] the impact on new energy would be massive. Weakening oil prices would hamper the competitiveness of new energy. The government has to subsidize the new energy industry to support its development." Lin Boqiang, Energy Economics Research Centre, Xiamen University10 Since the price of oil fell to 50 USD/barrel in late autumn 2014, a halving of the price within a few months, several actors tried to establish that this would not affect the biofuels market at all, or might even have a positive impact. Both individual industry representatives and the global agency World Bioenergy Association (WBA), deem that this is not very realistic. The main direct competitor to biodiesel is fossil diesel; the direct competitor to ethanol is gasoline. Falling prices of gasoline and diesel will most likely have an effect on biofuels11.
In January 2015, WBA collected information from over 50 biofuel producers in 25 countries on how lower oil prices affect them. 75% of the companies indicate that they already have been negatively affected by lower oil prices. Demand has decreased by up
8 http://www.transparency.org/topic/detail/oil_and_gas 9 http://africajournalismtheworld.com/tag/african-oil/ 10
http://washpost.bloomberg.com/Story?docId=1376-NFX9RM6JTSEZ01-4SGJ27FU8798R6F4FIS8A0T68H Times has a similar analysis, http://www.ft.com/intl/cms/s/0/73087796-9e79-11e4-a37e00144feab7de.html#axzz3Qlz2aKX0, see also http://oilprice.com/Energy/Oil-Prices/Ten-Reasons-Why-A-Sustained-DropIn-Oil-Prices-Could-Be-Catastrophic.html samt http://www.renewableenergyworld.com/rea/news/article/2015/01/what-does60-oil-mean-for-the-biofuel-industry
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to 30% with a rapid return to fossil fuels, leading to layoffs and projects that are dropped. 69% of the companies indicate that continued low oil prices would affect them in the future; and that they cannot fully counteract the effects even with better preparation. Among other things, low oil prices result in reduced turnover, lower levels of investment and layoffs. There are some positive effects of lower oil prices, such as cheaper transport and lower prices of machines, but they do not compensate for the negative effects. Miranowski and Rosburg’s study from 2012 found that higher oil prices mean higher investments in biofuels development and production. They state that "global, market-‐based expansion of biofuel production will be limited in the absence of high oil prices or government incentives and of the mandate." The only exceptions are stated to be sugar cane ethanol and biodiesel from palm oil in tropical regions, which are expected to be competitive even with low oil prices. However, this said with the reservation that many African states have higher production costs compared to, for example, Brazil and Southeast Asia. Miranowski and Rosburg’s study does however not account for the fact that these producers can easily switch to production of sugar and cooking oil instead of biofuels, and that the replacement of fossil fuels thus not occurs at low prices. This effect has already been seen in Brazil, where many ethanol producers are now reported to partially convert to an increase in sugar production. The figure below shows the estimated cost of fuel per gallon, where we see that different commodities in different parts of the world have very different breakpoints when they are profitable against fossil gasoline and diesel.12
2.3 Third strike: Lower price reduction relative to other prices The immediate reaction when the oil price plummeted was that oil-‐importing countries
12 http://www.agbioforum.org/v16n1/v16n1a08-rosburg.htm
would benefit because the trade balance improved and operational costs for both industry and households decreased. Based on this, many African states are considered winners, such as Senegal, Tanzania, Zimbabwe and Kenya, where the cost of oil imports is the equivalent to over 50% of the revenues from the total exports of all goods and services. They would thus benefit from lower oil prices, which should lead to lower inflation, lower transport costs and thus better conditions for industrial development. But in practice, these effects are very limited, for two main reasons: 1. Most of Africa has an economy that is much less exposed to oil price changes than other parts of the world, due to the fact that the use of petroleum products is comparatively low. 2. Price movements are slower and occur to a lesser extent than in other countries, although there is a discussion even in Europe about a slow and incomplete impact. Considering that the lower oil price is a new phenomenon, it is still not yet possible to reliably determine the degree to which it has reached the end consumers in different parts of the world13. It does, however, seem probable that the price reduction has been lower in countries where consumers have a relatively weak position, and where state actors have weaker positions against multinational oil giants. Preliminary evidence of this is found in African media right now, with headlines such as "Oil Price Slide Not Matched At Petrol Pump"14. Or this description from Nigeria, which must be considered one of the stronger states in Africa: "During mid-‐December The Two Largest Oil Workers Union in Nigeria held a four-‐day strike to demand lower gasoline prices in light of the rapid slump in oil prices on the global market."15 Since no country is acting in isolation, but relate to their environment, we must note that Africa (with the continued rough generalization of over 50 states and one billion people) is less competitive when oil prices fall, since they tend to fall more in other parts of the world16.
3. Discussion: The solution for Africa
The lower oil prices may be beneficial for large parts of Africa's population, given that the lower burden on the state treasury means increased investment possibilities in important sectors such as education and healthcare, and that the lower price reaches all the way out to the consumer. For Africa's energy sector, with a gross generalization, it is trickier, in part depending on how long the lower price level remains. Many analysts believe that current price levels may persist for several years, so it is reasonable to discuss policy recommendations based on low oil prices17.
13 Världsbanken
sammanställer priset på bensin land för land men med viss eftersläpning, på http://data.worldbank.org/indicator/EP.PMP.SGAS.CD/countries/1W?display=map 14 http://news.sky.com/story/1383753/oil-price-slide-not-matched-at-petrol-pump 15 http://www.workers.org/articles/2015/01/10/oil-price-decline-impacts-african-economies/ 16 För liknande resonemang se t.ex. http://www.chinafrica.cn/english/Opinions/txt/2015-01/01/content_661690.htm 17 http://www.philstar.com/business/2015/01/28/1417460/why-cheap-oil-here-stay
The low prices and the high uncertainty about future price levels should reduce several African countries commitments on oil explorations, especially where it is expensive and where assets are not well known. Thus, a conversion to a higher share for renewable energy should be even more relevant for countries that intend to reduce their dependence on imported energy and create a stronger domestic energy sector. The value of this conversion to renewable energy is supported by the expected adoption of a global UN climate agreement in Paris in December 2015 under the principle of "Common but Differentiated Responsibilities"; which means that even developing countries are expected to contribute to emission reductions. They can, however, be expected to get financing for the conversion, including from the newly established Green Climate Fund18. A possible way out that is being discussed is to create some sort of price guarantee mechanism, so that producers are not brought down -‐ and climate-‐change worsens -‐ when oil prices fall rapidly, while unnecessary subsidies when the oil price rises can be avoided. WBA's survey points to four policy actions that can facilitate a long-‐term transition to renewable energy: • Elimination of subsidies for fossil fuels. These subsidies exceed by approximately five times the stimulus for the production of renewable fuels, and represent both a severe competitive disadvantage for the renewable energy, and a big burden on the state treasury in the countries with the subsidies19. Some African states have abolished subsidies without major internal convulsions, such as Zambia and Tanzania, while others, such as Sudan, underwent major political difficulties when the subsidies were abolished. Several African states have the journey ahead of them, with a low oil price being the ultimate opportunity to implement this change. • Increased investment in renewable energy. In times when the commercial interest in investing in R&D and new production capacity in the renewable sector is low, state participation becomes more important. Furthermore, supranational involvement is also important, with a need for investment banks and aid agencies to increasingly put focus towards environmentally, socially and economically sustainable production systems of biofuels. • Blending mandates requiring a certain share of renewable energy in the fossil fuels, securing the market when a low oil price would otherwise be very detrimental to renewables. It also creates long-‐term predictability, which is extremely important for attracting investors. The blending mainly consists of ethanol in gasoline and biodiesel in fossil diesel, normally with a low initial level, which is then incrementally increased. Several states from Germany to Brazil, Thailand and Zimbabwe have such a mandate, but Kenya and many other African countries have not yet enforced any blending mandates.
18 För
mer information om detta se t.ex. www.unfccc.int, eller www.klimatforhandlingsbloggen.se
19 http://www.iea.org/publications/worldenergyoutlook/resources/energysubsidies/
•
The introduction of carbon tax on fossil fuels and duty on imports of fossil fuels is also mentioned by many of the producers in the WBA's compilation, but this is considered, at least in the short term, to be more difficult to implement. The taxation requires a well-‐developed administration system, with low opportunities for tax evasion and alternative distribution channels. The proposed duties would also require formal acceptance from regional trade legislation and the WTO, which is far from obvious.
How these issues are best combined is not clear, but it is clear that with the current low oil price, some kind of active intervention is needed to prevent a deterioration of the competitive situation for the African energy sector and the transition to renewable energy.