Beyond Borders | April 2, 2009 at 1:29 am

After the Oil Price Crash

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Understanding the impact on oil-exporting countries

On June 23, 2008 the price of oil peaked at over U.S. $140 a barrel, and by the following February fell drastically to below $39 a barrel. As Venezuela, Russia, and oil-dependent economies across the Middle East saw their oil revenues dry up over the course of a few months, a devastating impact seemed inevitable. However, the economic and political effects of the recent drop in oil prices have varied widely depending on fiscal policy and regime type. Although all oil-exporting countries have suffered economic setbacks, more democratic states integrated with the world economy have been hit the hardest. With less protection from the international financial crisis and greater vulnerability to internal political pressure, states like Iran, Venezuela, and Russia are more sensitive to changes in oil prices than Middle Eastern monarchies. As a result, these states are experiencing heightened economic and political turmoil that seems unlikely to subside in the near future.

Sheltered States

While the fall in oil prices has presented challenges for all oil exporters, countries like Kuwait and the United Arab Emirates have fared best in the downturn. Because they are monarchies with small populations, both governments are typically not subject to the pressure of populist protests and as a result have implemented economic policies that soften the blow. Richard Cooper, professor of international economics at Harvard, explained to the HPR that “They’re more conservative fiscally, and they have sovereign wealth funds, so they have tens of millions of dollars in foreign assets abroad.” Moreover, decades of protectionist policies have shielded the Middle Eastern markets from the world economy; the impact of the current global financial crisis is thus mostly indirect, noted Emad Shahin, visiting professor of government at Harvard. “The region as a whole has not been fully integrated into the global economy,” making these countries less vulnerable to price drops in spite of heavy dependence on oil revenue.

Fueling Political Turmoil

Alternatively, oil-exporting countries with partially democratic regimes, large populations, and preexisting financial problems face the greatest risk of instability when oil prices fall. Iran’s budget mishandling, for example, with over U.S. $1 billion in unaccounted revenue, has been exacerbated by a decline in oil revenue. Increasing debt has severely limited President Mahmoud Ahmadinejad’s ability to continue the subsidies and welfare programs that previously garnered him so much support, causing unrest and growing political liability as a June 2009 presidential election draws near.  Like Ahmadinejad, Venezuelan President Hugo Chávez relies heavily on subsidies and welfare programs directed at the urban poor to ensure his popularity. The drop in oil prices has also perpetuated flawed economic policy in Venezuela by pressuring the government to either retrench spending or expand the money supply, thereby heightening inflation. Given Chávez’s populist image, Cooper noted, the second option is more likely in spite of the serious danger inflation poses to the health of the Venezuelan economy.

In the East, the fall in oil prices has battered a Russian economy already suffering from rapidly depleting oil reserves, stoking political unrest. The government has historically used oil reserves to pay back foreign loans rather than using company shares, which would cede control of Russian firms to foreign hands. According to Cooper, this is the process by which the Russian government is “covertly nationalizing” many firms. Thousands of protestors rallied in Moscow in January, demanding more financial transparency. But Charles Ebinger, director of the Energy Security Initiative at the Brookings Institution, told the HPR that these demands for accountability are unlikely to result in substantial political change. Russia, Ebinger argued, has “enough of an authoritarian tradition to keep the lid on,” but may need to reform financial practices in light of the heightened political turmoil.

Out in the Cold

The price crash has thus already begun to expose key economic and political vulnerabilities in oil exporting countries, and a turnaround in oil prices seems increasingly unlikely. For Iran and Venezuela in particular, the crash reveals the weakness of relying on oil for economic growth while turning a blind eye to industrial development. Leaders like Chávez and Ahmadinejad have invited unrest by failing to meet popular expectations, even as analysts forecast greater turbulence in financial markets and oil prices. Unlike the sheltered, fiscally conservative oil monarchies of the Middle East, these regimes will have no choice but to weather the storm.

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