Most of us are well aware of oil’s recent, precipitous decline. Happily, prices at the gas pump are now below $2/gallon, home heating bills this winter have been less painful and airlines, in a show of generosity, are once again handing out free pretzels. The negative impact of lost energy sector jobs and profits are also generally well understood. But when a key commodity like oil makes such a major move, there are bound to be some unanticipated, knock-on effects. Here are a few you might have missed.
Sovereign Wealth Funds (SWF) Liquidate: Countries use SWFs to invest the excess cash they have on hand. Over the last several years, oil producers like Norway have come to dominate SWF ranks and today they make up an estimated 56% of the worldwide market total (see above). The recent oil price decline has forced many SWFs to shed their more liquid assets in an effort to plug operating budget holes. Experts expect that if oil prices remain weak, another $404 billion could be withdrawn from public equities this year. It is difficult to determine exactly how responsible these market players are for the recent stock market weakness but the increasing tendency of oil prices to move in lock step with global stock prices certainly looks like a bit of a smoking gun.
Russia Cuts Defense Spending: In 2011, Russian President Vladimir Putin embarked on a decade long, $321 billion effort to update the country’s armed forces. As The Wall Street Journal chart below shows, these combined initiatives have resulted in a 1,000% increase in defense spending since 2000. Russia derives about 45% of its revenues from oil taxes so the recent decline in energy prices is wreaking havoc with everything from the value of the Ruble to vacation travel to the Black Sea. The country’s defense spending is not escaping the axe and is expected to drop 10% this year, the first significant decline since 1998.
Saudi Arabia Issues Debt: Up until now, high oil prices and growing production helped Saudi Arabia internally fund all public spending and amass a nice foreign reserve nest egg. But the 50% oil price decline has caused foreign reserves to plunge from a high of $737 billion in 2014 to $640 billion today. To plug deficits, the country reduced spending last year and also issued its first domestic currency bonds since 2007. This year, to open up the pool of investors, the country expects for the first time to issue dollar denominated debt.
Cuba Opens Up: While no one is claiming that cheaper oil prices directly caused the thawing of U.S./Cuba relations, there is a link here. Cuba and Venezuela have had an interesting and somewhat mutually dependent relationship over the last decade or so. Over this time, Venezuela has provided oil to Cuba on subsidized terms while, in return, Cuba has provided medical, education and military support to Venezuela. The drop in oil prices has made it increasingly difficult for Venezuela to hold up their end of the bargain and highlighted the benefits, to Cuba, of seeking out economic reform and alternative forms of trade.
As the above examples illustrate, economic forecasting is tricky business. While the first order effect of any major change may be clear -- in this case the likely decline in energy sector jobs from an oil price drop -- the second, third or fourth order effects can be anything but obvious. This is especially true today given the complex interconnections inherent in a globalized economy.