Plenty of oil commodity producers are in trouble, and that includes more than a handful of countries whose economies are heavily dependent on oil, gas, and other natural resource exports.
In the 1980s, a wave of defaults swept emerging markets, with a large portion of the blame put on the crash in oil prices. The latest crash in prices for a range of commodities – not just for oil, but also gas, coal, copper, nickel, etc. – is once again raising the prospect of defaults for emerging market economies that are dependent on commodity exports, according to a report released in late January from Oxford Economics.
The collapse of oil prices has gutted the finances of oil exporters. Or as Oxford Economics sums it up nicely: “These are bad times for oil producers and their creditors.”
According to the research firm, emerging market economies that depend on natural resource exports are not being realistic about the state of the markets, and many are using vastly overoptimistic assumptions about oil prices. On average, these countries assumed an oil price for 2016 that is more than 50 percent above what futures market is telling us that oil will trade for this year. Related:Oil Prices Down Again On Energy Debt And Inventories Data
While many have suffered, the pain is not over. “We expect widespread rating downgrades and further bad performance across commodity-producing sovereigns,” Oxford Economics wrote in its January 27 report. The markets are already pricing in downgrades of around two to three notches for many of the countries in question.
Several of the Gulf States in the Arabian Peninsula, such as the UAE and Qatar, have massive sovereign wealth funds, which will allow them to withstand the bust in oil prices for quite some time. But for others, such as Venezuela, Libya, or Iraq, there is a limited and shrinking availability of fiscal firepower to weather the storm. Venezuela probably tops the list of countries that are facing the possibility of debt default, as its economic crisis deepens by the day.
One of the buffers that would allow commodity exporters to cushion the blow of low prices comes in the form of flexible exchange rates. Letting a floating currency depreciate during a downturn allows for non-energy exports to become more competitive, and it reduces the burden on foreign exchange reserves. Trying to hold onto a fixed exchange rate, such as what Nigeria or Saudi Arabia are trying to do, will lead to governments quickly burning through their FX reserves. Saudi Arabia, with reserves at nearly 100 percent of GDP, can keep up this policy for a while. Nigeria, on the other hand, only has reserves that amount to 5 percent of GDP, and it is coming under increasing pressure to abandon its currency peg. Related: OPEC-Russia Rumors Persist After Comments From Rosneft Chief
A flexible exchange rate will also offset some of the falling revenues from low oil prices. In Russia and Canada, for example, a weakening exchange rate in the face of the oil crash has reduced the costs for the oil industry. Costs are priced in the local currency and revenues come in the form of dollars.
But flexible exchange rates also lead to higher inflation, and make paying off dollar-denominated debt much harder. There are no easy answers.
The Oxford Economics reports concludes that today’s emerging market oil producers are in better position than they were in the 1980s during the last bust in oil prices. In the 1980s, 17 out of the 25 countries surveyed suffered from a debt default, or a rate of 68 percent. And six of the eight that did not default were wealthy countries in OPEC, meaning that when leaving aside the handful of wealthy oil-exporters, most emerging market commodity exporters defaulted at some point during the 1980s downturn. Related: Supreme Court Keeps Coal Alive…For Now
The one very important difference between the 1980s bust and today’s downturn is the fact that interest rates are at historical lows. In the 1980s, long-term U.S. bonds saw yields peaked at 15 percent. Today’s low interest rates will allow struggling sovereigns to borrow and service debt much more cheaply. Another reason for optimism is that this time around, unlike the 1980s, most emerging market oil and commodity producers are relying much less on dollar-denominated debt than they did decades ago. More debt is issued in local currency today, reducing the vulnerability of many countries to the price crash.
Still, more credit downgrades are likely, at the very least. Nigeria, for example, has sovereign bonds that trade 400 basis points higher than Vietnam’s, even though the two countries both have the same credit rating. That suggests that Nigeria’s rating is overvalued and needs to come down.
And, of course, defaults are not out of the question.
By Nick Cunningham of Oilprice.com
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