The impact of coronavirus (COVID-19) and the global oil price shock on the fiscal position of oil-exporting developing countries

 Fragile, oil-exporting developing countries will be hard hit by the consequences of the Coronavirus (COVID-19) pandemic, and the opportunity exists to assist these countries to transition towards a low-carbon, more diversified and resilient economic future

Countries that are net exporters of oil are experiencing an unprecedented double blow; a global economic contraction driven by the COVID-19 pandemic and an oil market collapse with the benchmark price for United States crude oil, the West Texas Intermediate, briefly going negative for the first time in history (in April 2020). Based on an oil price of USD 30 per barrel, the International Energy Agency projects that oil and gas revenues for a number of key producers will fall by between 50 to 85% in 2020, compared with 2019, yet the losses could be larger depending on future market developments (IEA, 2020[1]). The present crisis is happening in the wider context of a structural decline in the market for fossil fuels, driven by a commitment towards decarbonisation by a number of countries as well as the wider technological changes that are gradually making renewable energies the preferred energy option (Lahn and Bradley, 2020[2]; Elgouacemi et al., 2020[3]).

The current crisis is expected to hit oil-exporting developing countries particularly hard, for two reasons:

• First, the dependence of many of these countries on a single commodity for their exports and revenues renders them extremely vulnerable to market volatility. Although the largest share of commodity-dependent countries1 globally are in sub-Saharan Africa, oil and gas make up the majority share (over 60%) of total merchandise exports in a range of developing countries, including Algeria, Islamic Republic of Iran, Iraq, Libya, and Timor-Leste (UNCTAD, 2019[4]). In the period 2011-2013, the proceeds of crude oil sales by the top ten sub-Saharan Africa oil-exporting countries amounted to more than 50% of their combined government revenues and more than 75% of export earnings (Gillies, Guéniat and Kummer, 2014[5]). Indeed, UNCTAD reports that despite the global focus on energy transitions, and repeated calls to diversify their economies, some countries are more concentrated on commodities than ever (UNCTAD, 2020[6]). Other developing countries are still looking to expand their oil sectors as a source of future economic growth.

• Second, many of these countries were in vulnerable positions already before the current crisis, and further deterioration may exacerbate existing fragilities. Over half of low and lower middle-income countries dependent on oil and gas for their exports and revenues are classified as ‘fragile’.2 Decision makers in resource-rich countries have frequently struggled to translate resource wealth into poverty reduction and sustainable development, performing poorly across a number of development metrics, including on economic growth (Sachs and Warner, 1995[7]), democratic governance (Ross, 2012[8]), and conflict prevention (World Bank, 2011[9]). Although variation amongst countries exist, oil-exporting developing countries frequently score ‘weak’, ‘poor’, or ‘failing’ on metrics for good governance (NRGI, 2017[10]), with decision makers often having been found to overspend on consumption and wasteful infrastructure projects while neglecting priority sectors such as education and health (de la Croix and Delavallade, 2009[11]). The result is that social services in oil rich developing countries are often deficient and fail to cater to the most vulnerable populations. Although pockets of efficiency in the form of more capable and resourced state institutions often do exist in these countries, these institutions have tended to focus on the extraction of additional resources rather than on providing public goods that enhance the collective welfare (Hertog, 2010[12]; Soares de Oliveira, 2007[13]).

In the context of these mounting pressures, opportunities exist for official development assistance (ODA) and particularly blended finance to be deployed to assist oil producing developing countries to transition towards a cleaner, more diversified and resilient future.

 With Coronavirus (COVID-19), an already volatile market has reached a flashpoint, accentuating the drawbacks of high dependence on non-renewable resources

The global oil price has become increasingly volatile3 since the 1970s. The advent of futures trading brought about greater speculation in the market. Increasing demand in developing countries, as well as rising supply led by new production in the United States, have additionally contributed to fluctuations in recent years.Yet the fallout of the current COVID-19 pandemic has taken everyone by surprise, pushing oil prices to a new low. Such was the turmoil that the benchmark for US crude oil fell into negative territory for the first time ever in late April, and the price of Brent Crude, the benchmark for Europe and the rest of the world, also fell significantly (Figure 1).

Although prices have since recovered, it is unlikely that there will be the same buoyancy in prices as witnessed following the 2008 global economic recession. Aided by technological advances and the rapidly decreasing cost of renewable energy, a growing commitment towards decarbonisation, and waning investor appetite, the fossil fuel industry is faced with the prospect of structural decline (Lahn and Bradley, 2020[2]). In the current context, it is plausible that oil prices may not fully recover to the levels seen pre-COVID-19 as the world transitions to cleaner forms of energy (BNP Paribas, 2020[14]). These stark projections underscore the perils of over-reliance on fossil fuels in resource-rich developing countries, and present an opportunity to place decarbonisation at the centre of recovery agendas.

 

Figure 1. Oil price developments, 2000-2020

Note: Price developments crude oil in USD dollars, from 2000 until April 2020.

Source: BBC (2020[15]), BBC Coronavirus: Oil price collapses to lowest level for 18 years, https://www.bbc.com/news/business-52089127 (Accessed 24 Sept. 2020).

Current conditions in the oil market are due to a number of factors impacting both supply and demand;

• On the demand side, containment measures and economic disruptions related to the COVID-19 outbreak have led to a slowdown in production and mobility worldwide, producing a significant drop in global demand for oil. In April, the International Energy Agency (IEA) estimated that demand was down 30% compared to a year ago, reaching a level not seen since 1995 (IEA, 2020[16]). Faced with a significant glut in demand, producers were scrambling for facilities to store surplus crude oil, with stocks reaching an all-time high in June 2020. Since then, the pressure on storage capacity has eased somewhat as the effect of production cuts takes hold and the market starts to rebalance (IEA, 2020[17]).

• On the supply side, arrangements that have historically allowed oil producing countries to respond collectively to drops in demand have so far not been sufficient to curb production, signaling the reduced traction of multinational solutions in recent years. Just as the global impact of the COVID‑19 crisis was becoming apparent in March 2020, the members of the OPEC+ alliance (OPEC members plus other oil producers amongst them the Russian Federation) failed to extend their agreement to cut production, resulting in some producers, including Saudi Arabia and Russia briefly flooding the market (Blas and Pismennaya, 2020[18]). With oil demand starting to collapse as lockdowns took hold, an agreement to cut production was eventually reached by OPEC+ on 12th April 2020. The agreement, which involved cutting the collective daily output of these countries by almost one quarter for the next two months, represented the largest cut in the history of the producer cartel (Brower, 2020[19]). Yet, the rapidly evolving crisis and its impact on oil demand, makes it unclear whether the intervention will be sufficient to rebalance the market as soon as the OPEC+ countries had anticipated or if at all.

 The oil price fall will aggravate existing vulnerabilities in oil-exporting developing countries, and could push countries towards a tipping point of a macro-fiscal crisis, and social and political unrest

Many oil producing developing countries are non-diversified, sector-dependent economies, with oil contributing the majority of their exports and government revenues. The current fall in oil prices is limiting the ability of these countries to respond to the multidimensional domestic pressures produced by COVID-19, at a time when more money is needed to finance service delivery, mitigate health risks and ease macroeconomic pressure. In March of this year, the IEA estimated that key oil producing countries, including Iraq, Nigeria and Angola, would likely see a drop in their net income for 2020 of 50%-85% compared with 2019 (IEA, 2020[1]). This would amount to the lowest income received from the sector by these countries in over two decades, and the IEA has cautioned that revenues could fall further depending on future market conditions. Accentuating the challenges, there has been a decline in investor appetite for fossil fuel projects, and with the onset of COVID-19, companies have been shelving new projects and permanently shutting-down high-cost operations in response to the oil price collapse (IEA, 2020[1]). Smaller or new producer countries are expected to be hardest hit by the drop in discoveries and investments (Petroleum Economist, 2020[20]).

The scale of the current oil price shock will vary by country depending on their export concentration, as well as their estimated oil reserves and cost of production. For example, Saudi Arabia and Iraq can produce oil relatively cheaply, not needing a price of more than approximately USD 30 per barrel to break even, while countries like the Bolivarian Republic of Venezuela (“Venezuela”) and Nigeria depend on a price of over USD 50 per barrel (Statista Research Department, 2020[21]) (Figure 2).

 

Figure 2. The breakeven oil price, USD per barrel, for a selected number of countries (2015)

Note: Data on the breakeven oil price is only available for a limited number of countries.

Source: The Economist (2016[22]). Sale of the century? https://www.economist.com/briefing/2016/01/09/sale-of-the-century (Accessed 23.09.2020)

Low cost oil-producers are anticipated to be able to continue producing for a substantial amount of time even in a low-carbon scenario. For countries with higher cost reserves, discontinuing production might be necessary. The current crisis presents new incentives and brings an urgency to the efforts of countries to halt or reverse costly fuel subsidies to free up fiscal space and stem pollution, and to diversify towards less carbon-intensive industries (Pezzini and Halland, 2020[23]; OECD, 2018[24]). Yet tighter public finances are also expected to limit the funds available for public services and infrastructure projects, and changing gears will require carefully calibrated contextual approaches. At the onset of the COVID-19 crisis, foreign exchange reserves were considered high by historical standards but these are expected to be insufficient to meet the multifaceted demands that developing countries now face (UNCTAD, 2020[6]).

The longer term systemic issues that characterise many oil dependent developing countries – including their tendency to direct money away from priority sectors such as health in favour of rent-generating institutions (Karl, 1997[25]) – will also impact on their resilience capacities. Historically, many resource-rich countries have exercised limited fiscal prudence and heavily invested in the extractive sectors to the exclusion of others (Corden and Neary, 1982[26]). Diversification efforts are often also stymied or complicated by factors such as poor conditions for private sector growth, weak competitive capabilities and entrenched political interest in fossil fuel production activities (Lashitew, Ross and Werker, 2020[27]; IEA, 2018[28]; Elgouacemi et al., 2020[3]).

As has been the case in many fragile developing countries since independence in the 1950s and 1960s, the stability of resource-rich fragile economies is often based on political power-sharing arrangements among elites political factions, underwritten by rent creation and distribution mechanisms (Cooper, 2002[29]). In other words, where countries are rich in resources, resource rents tend to provide the backbone for distributive regimes (Soares de Oliveira, 2007[13]; de Corral and Schwarz, 2013[30]). As a result, the sharp contraction of financial inflows from the oil sector that many countries are now experiencing has the potential to exacerbate existing fragilities by sparking political instability and social unrest. Although patterns of rent distribution can take different forms – such as fuel subsidies targeting the middle-class in Nigeria and Angola, direct government contracting in South Sudan, and social distribution programmes for the poorest in Venezuela – the common trend is that the political elites of oil-exporting countries recurrently distribute rents in strategic ways, to those who are seen as crucial to consolidating their position in power (Barma et al., 2011[31]). A fall in distributive power resulting from the structural decline in the demand for oil and exaggerated by COVID-19 could make it harder for decision makers in these countries to keep competitive constituencies happy, generating increased risks of domestic upheavals and instability. Whether the reduction of rent distribution capabilities directly impacts upon the larger populations in these countries depends upon how inclusive such distributive schemes were before the crisis. Should oil rents dry-up, social unrest and conflict could follow as a result of the breakdown in political power-sharing arrangements.

Many oil-exporting developing countries are experiencing intensified capital outflows due to heightened economic uncertainty and perceived risks of political upheavals. Known as a ‘flight to safety’, investors are scrambling to move their assets to benefit from the security and stability of advanced economies. Banks in offshore financial hubs have noted a significant rise in activity so far in 2020 (Williams, 2020[32]), and there has been a growth in demand for golden visa schemes, which allows wealthy individuals trade investments for residency (PRNewswire, 2020[33]). Oil exporting countries have historically proven particularly vulnerable to capital flight, accounting for 55% of total outflows from Africa between 1970 and 2015 (Ndikumana and Boyce, 2018[34]). Although money that finds its way across borders illegally is trickier to measure, existing literature warns of increased risks of illicit outflows under current conditions, where large amounts of money are being moved and oversight and audit functions are overstretched (OECD, 2020[35]). With the extractives sector particularly susceptible to corruption – the OECD Foreign Bribery Report shows that one out of five foreign bribery cases comes from the extractive sector, by far the highest of any industry (OECD, 2014[36]) – illicit outflows are expected to increase among oil exporting countries during the current crisis.

 Debt risks that had already increased before the crisis due to the particular profile of oil-exporting developing countries are expected to worsen

Many oil exporting countries had high debt levels at the onset of the COVID-19 pandemic, having responded to the lower commodity prices from 2014 with increased borrowing. From 2013 until the end of 2018, oil-exporters’ median debt-to-GDP grew from 31 to 54%, significantly faster than that of their resource-poor counterparts. Angola and the Republic of Congo saw their debt levels more than double during the five-year period, while the debt level of Equatorial Guinea grew five times larger (Calderon and Zeufack, 2020[37]). Cameroon, Chad, and the Republic of Congo, and Ecuador approached the International Monetary Fund (IMF) before the crisis for programme financing and/or lines of credit, and Angola, Equatorial Guinea and Gabon had already entered into IMF’s Extended Fund Facility, demonstrating that the difficulties these countries faced in self-financing even in times of higher oil prices (IMF, 2020[38]).

The risks of heightened debt faced by these countries is closely tied to the changing composition of their debt portfolio, away from traditional concessional sources of financing, from multilateral and bilateral partners, towards non-Paris Club governments and private creditors (OECD, 2020[39]). In the case of commodity exporters in sub-Saharan Africa, debt held by non-Paris Club countries including the People’s Republic of China, accounted for 90% of total bilateral debt at the end of 2016 (Calderon and Zeufack, 2020[37]).Yet, the largest share of long-term public debt in low-income countries is held by private creditors (bondholders, banks and commodity traders), amounting to 41% in 2018 (Watkins, 2020[40]). In some oil-exporting countries the situation is more extreme, like in Chad, where 49% of total debt is to private lenders (see Box 1).

What distinguishes loans from private creditors and non-Paris Club governments from those of the traditional concessional lenders is that financing from these sources typically comes at shorter maturities and higher interest rates, translating into costlier external debt servicing. Since 2010, the cost of servicing Africa’s total public external debt has increased by about 4% (Calderon and Zeufack, 2020[37]), an increase driven by the higher cost of private sector loans. Private creditors account for 55% of the continent’s external interest payments, or USD 6 billion, in 2016, compared to 28% to bilateral and 17% to multilateral financiers (Jubilee Debt Campaign, 2018[41]).

Another feature of many of the new loans extended by non-Paris Club governments and private sector actors is that they are resource-backed loans, where the repayment is made in the form of natural resources, often times crude oil, as opposed to traditional loans, which are repaid in cash. These loan agreements often entail repayment in kind, based on volumes of natural resources and where the quantities are valued at an agreed benchmark price. Collateralised loan agreements with commodity traders as well as bilateral lenders in both Chad and Angola followed this model. Alternatively, repayment terms might be set in value terms or equivalent where the resource acts as the source of the income revenue stream or serves as collateral (Mihalyi, Adam and Hwang, 2020[42]).

The IMF reports that collateralised loans have been on the rise in low-income countries (LICs) in recent years, amounting to approximately 20% of commercial debt issuance in 2016-2017 (Imam, 2019[43]). Although beneficial for countries in lieu of more conventional sources of financing (such as Eurobonds and unsecured bilateral credits), collateralised lending agreements come with particular risks. For one, the markets for such loans are often uncompetitive, and the few actors who offer such loans typically do so through private rather than public channels. Commodity trading firms have become increasingly active in this space in recent years, with one trader reporting a 600% increase in collateral loan activity between 2013 and 2019 (Trafigura, 2020[44]). Risks appear to be significantly elevated in the case where these types of loans are extended by commodity trading firms, given that they often come both with shorter maturity and higher costs (Mihalyi, Adam and Hwang, 2020[42]).

Another of the risks associated with resource-backed loans is that they are often more difficult to restructure. A number of these loans are held by creditors who are not part of the typical forums for debt rescheduling, such as the Paris Club or the Institute of International Finance. The presence of resource backed loans might also complicate the co-ordination of creditors and therefore the debt resolution processes, as these loans are often treated as more senior to other, unsecured debt (Mihalyi, Adam and Hwang, 2020[42]). To the extent that resource-backed borrowing is seen as negatively impacting a country’s ability to service future loans, countries that have heavily subscribed to these type of loans might also find that their future access to concessional sources of financing is jeopardised (Imam, 2019[43]).

Collateralised loan agreements are characterised by their greater opacity, including lending terms and fees that are often undisclosed. Resource-backed loans are often excluded from countries’ official debt statistics or databases, and only more recently have these type of loans been brought on the agenda by initiatives like the Extractive Industries Transparency Initiative (EITI). One explanation for the lower degree of oversight and accountability surrounding collateralised lending agreements is that both governments and state owned enterprises, including national oil companies, may be empowered to borrow, with or without an explicit state guarantee or Parliamentary approval. A recent report by the Natural Resource Governance Institute (NRGI), found that of all the resource-backed loans identified in sub-Saharan Africa and Latin America, in as many as 40% of the cases, the borrower was a SOE (Mihalyi, Adam and Hwang, 2020[42]).

In some cases, lenders contribute to the greater opacity surrounding collateralised loan agreements. Non-Paris Club and private creditors are typically not subject to the same levels of scrutiny or safeguards that govern other lenders. For instance, there is no specific regulation governing the lending practices of commodity traders, who are the holders of many of the resource-backed loans extended to the countries in question over recent years. For the most part, the financial institutions who regularly help traders finance these private loan arrangements, only extend their risk analysis to their counterparty, the trading company, with a limited view on the ultimate borrowers in the oil-producing country and the country’s fragility landscape.

The opaqueness of these complex loan agreements means that, amongst other things, the sustainability of the country’s public debt or overall fiscal position becomes harder for national governments (and their partners) to grasp. In the case of the Republic of Congo, the country’s official debt-to-GDP ratio had to be adjusted upward by over 50% overnight in 2017 after the IMF learnt of debt owed to commodity traders Glencore and Trafigura, which had previously been unknown (White, 2019[45]). The risk is therefore high that countries might continue to borrow using these type of collateralised instruments, until they arrive in a position where they have difficulties servicing them, i.e. over-borrowing. The latter scenario played out in the case of the Republic of Congo in 2017. The country only revealed the extent of its resource-backed loans (70% of total public external debt) once it was forced to seek assistance from the IMF. At this stage, the country’s debt servicing burden, which was estimated to reach an average of USD 1.5 billion (about 12.5% of GDP) between 2019 and 2022, had become unmanageable. A large part of Congo’s debt servicing was on debt owed to commodity trading firms (IMF, 2019[46]).

That oil-backed loans are hard to oversee and are typically off-budget – even if they end up being the state’s responsibility when crisis strikes – significantly adds to the danger that these funds might be misappropriated or diverted. On several occasions, including in the Republic of Congo and in Angola, corrupt intermediaries have been linked to the securing of these deals. There are instances where the loans cannot be accounted for, as was the case during a UN investigation in South Sudan. The investigation detailed how the Government of South Sudan had received resource-backed loans totalling just under USD 400 million from commodity traders in 2017 and 2018, some of which was later linked to arms purchases (Mednick, 2019[47]). The greater discretion that these loans offer to the people in positions of authority are of course part of their appeal for borrowing countries. Research also shows that resource-backed loans are particularly popular amongst poorly governed states (Mihalyi, Adam and Hwang, 2020[42]).

 Despite the risks involved, oil-exporting developing countries can be expected to try to borrow their way out of the current crisis

In the context of a progressive structure decline in the demand for oil, oil-prices might never recover to its pre-crisis levels, and many oil-exporting developing countries will need to brace for long lasting trade and fiscal deficits, which could produce a long-term decline in GDP (IMF, 2020[48]).

Diversification away from fossil-fuel income and carbon-intensive industries is a sine qua non for long term recovery. Yet, in the short term, oil-exporting developing countries, like other countries, are likely to turn to borrowing in an effort to manage the current multidimensional crisis and shrinking fiscal space. The list of over 90 countries that have so far requested emergency financing from the IMF include oil-exporting countries like Nigeria, Iran, and Ghana (IMF, 2020[38]). In April, the IMF stated that it was responding to this unprecedented number of calls for emergency financing with USD 100 billion in emergency loans to low-income countries, in addition to making available USD 1 trillion in lending capacity. The IMF also expanded its Catastrophe Containment and Relief Trust (CCRT), a donor-funded programme of debt relief for low-income countries. The World Bank similarly announced that it would deploy up to USD 160 billion in financing, including over USD 50 billion of IDA resources on grant and highly concessional terms (World Bank, 2020[49]). Still, concessional financing is likely to be insufficient and financing from official and private sector creditors will be needed to fill the financing gap.

In line with recent trends, and in the absence of viable alternatives, oil-exporters are expected to turn to private creditors and non-Paris Club governments to address their financing gaps. Yet, access to international capital markets is severely curtailed, reducing the scope for rolling over maturing liabilities. Most financiers are also expected to favour safer assets and therefore not be willing or capable to take on the high risks that these oil-exporting developing countries present (IMF, 2020[50]). The credit rating agency S&P Global downgraded a number of high-profile sovereign ratings in March 2020, including Nigeria, Mexico, Angola, Ecuador and Oman, following the fall in oil prices, in turn impacting on the type of financing they can access and on what terms. Nigeria’s credit rating was downgraded by the credit rating agencies to what they refer to as “junk” territory, while Angola and Ecuador are considered by the same agencies to be in the “default danger zone” (Jones, 2020[51]).

Given the likely increased demand for financing, commodity trading firms may seek to position themselves favourably vis-à-vis producer countries, possibly by extending financing in return for access to fossil fuels, potentially locking these countries into an unsustainable industrial future. Producer countries and their national oil companies can be expected to be harder pressed to find buyers in the current market environment. Commodity trading firms, on the other hand, have well-developed risk management capabilities and storage facilities (although these are expected to reach saturation point in the very near future), giving them significant leverage vis-à-vis producers. Under these conditions of tightening fiscal liquidity, the risks are high that oil producing developing countries contract non-commercial loans from private creditors on suboptimal terms and under conditions that leave scope for corruption and illicit financial flows.

Given that oil price may never fully recover and that oil reserves could become stranded, many oil producing developing countries face an increasingly uncertain future. A timely and coherent responses is needed: one that creates fiscal space; reduces the risks of unsustainable debt, corruption and illicit financial flows; and builds resilience through cleaner and more diversified industrial policy. Whether through ODA, blended finance or private sector investments, this is the moment to catalyse a transition to a cleaner and more sustainable future.

 How to help mitigate the challenges and risks facing oil-exporting developing countries and help build resilience

As the previous sections have shown, the current crisis will hit oil-exporting developing countries particularly hard due to, amongst other factors, their high resource dependence, which exposes them to significant market volatility and climate risks, as well as their existing socioeconomic and political fragilities. Several of these countries entered the crisis with already high debt levels and are now experiencing a double blow due to the global economic contraction fuelled by the COVID-19 pandemic and significant decline in oil prices. Going forward, the short-term focus will be on freeing up fiscal space in transparent and accountable ways, avoiding a downward debt spiral, and ensuring that the recovery is based on a cleaner, more diversified and sustainable future.

 Acknowledgments

This brief was written by Rebecca Engebretsen, Policy Analyst, Effective, Inclusive and Accountable Institutions, under the guidance and supervision of Catherine Anderson, Team Lead, Effective, Inclusive and Accountable Institutions.

 Contact

Catherine ANDERSON (✉ catherine.anderson@oecd.org)

Rebecca ENGEBRETSEN (✉ rebecca.engebretsen@oecd.org)