As a frontier market, the countries of Africa represent both tremendous opportunities and tremendous risks. On the risk side of the ledger are all the usual complications of international trade and investment compounded by the problems inherent in a developing, emergent continental market consisting of 54 countries and 1.1 billion people – it’s a lot to keep track of.
To help with that, AFKInsider has compiled news you need to know now in order to slim down your currency risk. Let’s see what’s happening out there.
Good news from West Africa has been scarce of late, what with Ebola, Boko Haram, and a coup in Burkina Faso, but perhaps the gravest threat facing the region is oil.
That’s because after a long oil boom with oil prices more or less on an upward trajectory for years, the price collapsed 29 percent since June. Given how dependent Africa’s largest economy is on oil, the ramifications are potentially dire. What caused the collapse and how will it influence events there?
First, a basic outline of the situation: since June when the price of Brent crude breached the $110-per-barrel mark, prices have been going down. By mid August prices had fallen to the $105-per-barrel mark and then fell off a cliff, slumping below the $100-per-barrel point in mid September and then collapsing from there to about $85 per barrel today. Unfortunately, while the odd geopolitical event may yet still hold potential to stir up prices, the fundamentals of the oil market have shifted into what can only be called oversupply — greatly benefiting consumers but, obviously, also greatly hurting suppliers.
How and why has this shift from scarcity to oversupply come about? There are several factors at work. The first is the continuing lack of a meaningful economic recovery for many Western consumers. Europe is more or less dead in the water and in the U.S. the great middle class consumer remains moribund after seeing all the benefits of the so-called recovery go to the nation’s top income earners. In such a situation the marginal propensity to spend and consume is not going to be great and as a result Western consumption of petroleum continues to decline.
Ah, one might say, what about China? Well, once again the principles of globalization and the interconnected nature of the world economy are made manifest. Despite Beijing’s best efforts to jump-start domestic consumption, China’s prosperity is still driven by exports to the West. If those consumers aren’t buying, which they aren’t, then necessarily the manufacturer of all those consumer exports is going to be hurt. That’s exactly what’s been happening. In September Chinese factory employment hit a five-year low as the country’s employers tried to trim labor costs to stay competitive in a slumped market.
What’s more, there are serious signs of overcapacity in China’s industrial sector, suggesting that prices for many of the goods it produces could go even lower. While this is good for consumers because it means products are about to become a lot cheaper, this is terrible for the industry as a whole because deflation quickly sets in. If consumers think goods will become cheaper, they will put off buying which will starve industry, which in turn forces manufacturers to become even more cost competitive — meaning more workers being laid off. In the long run rationalization will make China’s manufacturing sector more efficient, but in the short run this creates a disincentive to invest in those energy-hungry factories fed by oil, pushing prices down further. Combined with the looming bust in China’s over-the-top housing market, oil consumption might slump further.
Then there is oil supply, which has grown tremendously. While conventional oil continues to decline year after year, unconventional oil sourced from shale and, to a lesser extent, the deep ocean, continues to increase. Hydraulic fracturing in the U.S. and Canada have unleashed a meaningful amount of oil onto the world markets — so much oil in fact that the U.S. Congress will soon reconsider a ban on petroleum exports that have been in place since the energy crisis of the 1970s. While shale oil is expensive to produce and isn’t expected to last long, shale development has at the moment exceeded supply just when the great drivers of oil demand — Western and Chinese consumption — have slumped.
Compounding this expansion of oil production in North America is the Middle East. The past several years have seen a number of geopolitical shocks to the world’s most important oil-producing and exporting region, but so far the effect on oil has been relatively muted. True, Libya was taken off the market for some time due to the anti-Qaddafi revolution, but output and exports there are well on their way to recovery. Likewise with Syria and Iraq, where chaotic, multi-sided civil wars threaten oil production in Kurdistan, but not anywhere else.
This in turn leads us to the final factor influencing oil prices: Saudi Arabia. On Oct. 1 the country, widely regarded as the “central bank” of oil due to its large production potential, turned on the spigots by announcing a price cut. Ostensibly the reason was to maintain the country’s market position, which had been declining of late due to flows of crude from places like the U.S. However, an additional reason may be the very real Cold War taking place between Riyadh and Tehran, which are battling one another via proxies throughout Syria and Iraq. Iran is much more vulnerable to declines in crude prices than Saudi Arabia, so the Saudi move could be part of a larger ploy to put its regional rival in its place.
To put it simply, the short-to-medium-run factors influencing the oil market are all leveraging it towards lower prices, and they may stay that way for some time. America’s frackers aren’t going anywhere. Prices will have to go much lower than they have done so far in order to really hurt fracking. Likewise with the Saudi Arabia-Iran Cold War. Unless something changes dramatically the two oil giants may be using the oil weapon against one another for quite some time. These low prices could mean consumer demand could pick up again, but that is still some way off.
Which is all bad news for a country like Nigeria, where the government recently announced that it had two to three months of “rainy day” savings to cushion it from the drop in oil prices. After that, reports the Financial Times, the country will have to put in place contingencies in order to face up to the loss of all that oil income. At present that rainy-day fund, known as the excess crude account, has about $4 billion in it — about $2 billion less than the International Monetary Fund advised and far less than the $22 billion Nigeria had in the account in 2008, the last time the price of oil collapsed.
To compensate, the government is looking to other sources of revenue besides oil, meaning that taxes elsewhere in the Nigerian economy are likely to go up. Currently Nigeria has one of the lowest tax bases on the continent, and it has retained McKinsey, a U.S.-based management consulting firm, to help it find additional sources of revenue. Prior to its engagement with Nigeria tMcKinsey assisted South Africa with its tax base and found ways to add $3 billion to its bottom line. The Nigerian government is hopeful the consultancy can do the same for them, too.
Raising taxes will no doubt be unpopular, especially going into an election year that incumbent, Goodluck Jonathan, is finding tough going. What’s worse is what might happen if oil prices continue to stay low or go lower. Then Nigeria might have to crack down on oil theft, which is an endemic problem tied deeply to the country’s corrupt political establishment. It is not far fetched to speculate that a hard crackdown on oil thievery in places like the Niger Delta could precipitate a violent political reaction not unlike the rebellion the government faced there in prior years. If such a crackdown came amid a fresh renegotiation over the split of the country’s oil revenues that may be forced by a long oil-price crisis, then Nigerian politics could get very interesting, very quickly—and not in a way most investors would like.
So looking ahead, Nigeria appears to be in for a spot of trouble. The best case scenario for the country is that the drop in oil prices is only temporary and after a few months of belt-tightening and hand-wringing, the price goes back up and everyone breathes a sigh of relief. The worst case scenario: prices remain low for quite some time and a slow-motion fiscal crisis develops that puts downward pressure on growth, the currency, and government finances. How long could Nigeria survive such a crisis unscathed? That’s not yet clear and probably something investors don’t want to find out.
Jeffrey Cavanaugh holds a Ph.D. in political science with a specialization in international relations from the University of Illinois at Urbana-Champaign. Formerly an assistant professor of political science and public administration at Mississippi State University, he writes on global affairs and international economics for AFK Insider and Mint Press News.
