Oil price drop may cause short-term slump in African economies – AVM

The fall in the price of oil may be good news for those buying petrol at the fuel pumps but it is presenting problems for some oil producing African countries

 The first quarter of 2015 has been a boom for consumers as the price of oil dropped to around $40-a-barrel, more than half the rate it was at its peak in 2014. European consumers are benefiting from low petrol and energy prices but, for countries with rich natural resources, like those in Africa, the outlook is less positive.
“There is some concern over falling oil prices in Angola because oil revenue is the prime source of income for the government,” says António Vicente Marques, senior partner at AVM Advogados. “The main problem is the government’s finances were based on the notion that oil prices were going to remain high – if oil prices drop from $140 to $40, government revenue also falls and suddenly there is a hole in the public finances.” However, Vicente Marques adds there is no need for panic since this is not the first time the country faced a slump due to falling oil prices. “We have been here before, we have recovered and we will do so again” he says.
The Angolan government recently revised its budget due to low oil prices, slashing billions off public expenditure for the year ahead. While basic supply and demand pressures are increased in such a cheap market, Angola is also feeling the pinch because it effectively operates as a dual-currency market, with US dollars and the local currency – the kwanza. This is because some proceeds from oil and gas operations in Angola (priced in US dollars) must be held in a local bank account and contracts paid in kwanzas. Predictions are Angola will have to devalue the kwanza and increase interest rates to relieve the pressure.
“The danger is some African countries may find themselves in a volatile position,” AVM partner Claudia Santos Cruz says. “A sudden drop in expenditure raises public tensions, which can be intensified in a country such as Nigeria, which already has problems over delays to general elections and terrorist threats – likewise, international investors may become more reluctant to participate in projects.” Other proposed reforms in Angola seem likely to dissuade investors even more – such as new taxes on foreign trade – or have the potential to cause more economic challenges, such as issuing sovereign bonds to raise capital.
“Oil prices are not just hitting oil companies and governments but having a much wider impact that is not immediately obvious,” Santos Cruz warns. “Mozambique has an abundance of natural gas but if oil prices stay low in the long-term, the LNG projects may need to be delayed,” she says. “Banks too may be reluctant to lend to finance the project – after all, why would a company or lender spend billions of dollars developing an LNG scheme if oil can be bought at a much cheaper price?”

Energy project slowdown?
Vicente Marques, while more optimistic in his outlook, does admit that the financial pressure may result in a slowdown in renewable energy projects, which can be notoriously expensive to develop. Solar and wind farms require a great deal of capital and risk allocation – especially in African jurisdictions – so, if there is little incentive for LNG, renewable projects will be even less attractive.
“The same can go for shale gas,” Vicente Marques comments. “Developing new technology suddenly seems very expensive when customers can buy oil at considerably cheaper rates.”
Even with oil prices stabilising around $60-a-barrel, the fall in price has been a stark reminder for African countries too reliant on natural resources. More than 80 per cent of Angola’s tax income stems from oil production so, while dependency is fine in boom times, when prices collapse, the economy suffers considerably. “Governments should look at other potential areas, which may be less lucrative but not as prone to such fluctuations, and able to provide some stability, such as manufacturing and agriculture,” Santos Cruz concludes. “It is a reminder that governments should look to diversify their economy to avoid potential meltdowns in public finances in future.”