Falling Oil Prices Bode Nothing Well For Azerbaijan, Expert Proposes Draft Budget Review For 2019

Fuad Muxtarlı Analysis 27 November 2018
Falling Oil Prices Bode Nothing Well For Azerbaijan, Expert Proposes Draft Budget Review For 2019

Oil prices continue to fall at the world market. Economists believe that oil prices may go down in the light of the political processes in the world. One of the main reasons for the decline in oil prices is an increase in oil supplies to the market.

Azeri expert's gloomy prediction 

This situation makes oil-producing countries to think and reassess their economic strategies for the next year. Some economists say that the situation also promises nothing good for Azerbaijan.

From this point of view, experts believe that Azerbaijan should set a price for oil at $40 in the budget as against $60 now. Economist Fikrat Yusifov predicts this tendency would continue and is calling for a revision of oil price in the budget for 2019:

"I have already forecasted a sharp fall in oil prices and this is happening now. Indeed, it is not right to rely on oil prices. Because the course of events that have taken place in recent years shows that the price is more dependent on the political events in the world than in the economic processes. That is, the change in oil prices is less dependent on economic processes. From this point of view, we cannot rely on oil. The average oil price in the middle of 2018 raised $50 per barrel. At the time, I even suggested that this price is high and no need to rely on it. In the 2019 budget, the oil price is $60 per barrel. This, of course, is a high value. Currently, the price of oil is predicted at around $35per barrel by the Russian Central Bank and entities. Our budget has not been approved and can be adjusted. True, experts and other officials say that the fall in oil prices in the world market will not affect the budget. But I do not think so.

"The issue should be treated with a common prism. If oil prices fall, the budget expenses should be reduced for all items in the overall budget. A large number of budget expenditures, that is to say, access to the market with these expenditures will increase the pressure on the manat’s exchange rate. The budget envisages increase in salaries and pensions and they will remain unchanged. However, there are secondary, third costs that can be stopped. A new approach to the draft budget should be from this prism," the expert added.

"A lot of work has been done in non-oil sector since 2015 and there are very good results. No one can deny this. Indeed, large-scale work has been done in recent years on the non-oil sector for the development of the agrarian sector and tourism. All necessary decisions were made and steps were taken. But there is one truth that we must reconcile. Today, we have exported AZN1.2 billion worth non-oil sector goods within 10 months.

"This shows that the volume of our non-oil exports is very low. This figure is a small part of our total imports. Therefore, we can say that there is rapid development in the non-oil sector as a whole. However, there is no substantial turnaround in the amount of currency we bring to our country. That's the most disturbing issue. The main condition for stable exchange rate of the national currency is the availability of sufficient currency reserves in the country. True, today we have reserves in both the State Oil Fund and the Central Bank. But if the price of oil drops dramatically, the predictions will prove to be worse in the first place. To avoid this, I suggest that oil prices be revised in the budget. Undoubtedly, the decline in oil prices will affect the budget."

JP Morgan Cuts Its Oil Price Outlook For 2019

JP Morgan has revising its outlook on Brent crude to US$73 per barrel on average, CNBC reports. The bank’s earlier forecast was for an average Brent crude price of US$83.50 a barrel.

The head of the bank’s Asia-Pacific oil and gas operations, Scott Darling, told CONB analysts had factored in the increase in supply in North America that will occur in the second half of 2019 and will eventually pressure prices even lower in 2020, to an average US$64 in that year.

With everything that has been happening to oil in the last few days, with prices getting pummeled by mass short covering and pessimistic economic forecasts for global growth, chances are investment bank will soon begin revising their forecasts unless they are certain OPEC will agree a production cut at its Vienna meeting next month.

This cut is by no means certain although bulls are pinning their hopes on it in the absence of any other significant positive factor working for oil right now. On the contrary, even the latest production numbers from OPEC’s number-one, Saudi Arabia, were bearish for prices: Bloomberg’s Javier Blas yesterday reported, citing industry insiders, that the Kingdom’s oil production since the beginning of this month jumped to new highs, reaching 10.8-10.9 million bpd. Supply, including production and inventory drawdowns reached 11 million bpd on some days.

JP Morgan’s Darling said if OPEC is to balance the market and prop up prices, it would need to reduce its combined production by as much as 1.2 million bpd. The cartel itself is discussing cuts of between 1 million bpd and 1.4 million bpd. Russia has yet to weigh in but a Reuters report citing two senior Russian government officials said the country would rather not join an OPEC-led cut this time, even as President Putin said at an industry event that Russia will cooperate with OPEC on oil prices.

Could Oil Prices Fall To $40?

Crude market volatility has soared in the second half of 2018, with prices touching a four year high before entering their longest losing streak in three decades. Analysts were calling for $100 oil but now seem to think prices will head as low as $40. While inventory build-ups and oil traders continue to impact prices in short term, it is the KSA’s (Kingdom of Saudi Arabia) actions in December, a potential hike in U.S. interest rates and a rumbling trade war between China and the U.S. that will really move the market. Between them, these three factors have the potential to drive oil prices in the $40s.

Saudi Arabia

With fears of a supply glut growing, the oil market is waiting to see if the KSA is going to lead a production cut at the next OPEC meeting. It appears that Saudi Arabia and its allies have gone too far in their attempt to avoid a supply shortage as sanctions on Iran loomed.

As prices continue to fall, many in the oil market appear to be waiting on another OPEC agreement – but the outcome of OPEC’s meeting in December is far from certain. Trump appears to be againstany production cut from OPEC, enjoying the low oil price environment. Russia, responsible for the largest production cut outside of OPEC, also appears to be against joining in with any production cut.

While most in the market are expecting some sort of cut from the KSA and its allies, there remains a chance that the cut will either be less than expected or will simply not happen. Furthermore, the U.S. may at any point alter the waivers it has given to countries importing oil from Iran – upsetting oil markets once again and hurting any potential OP
EC agreement. All of these factors will have to be carefully considered by Saudi Arabia before pulling the trigger on another production cut.

Trade War

There have been very few signs from either Beijing or Washington that the trade war will come to an end any time soon. There is, however, a flicker of hope. Trump and Xi are set to meet at the G20 summit at the end of November, with Trump having planned a dinner after the summit where both leaders will try to find a way to end the trade war. If these two superpowers were able to come to an agreement then oil prices would get a significant boost.

Most observers, however, are not very hopeful. Michael Spence, a Nobel prize winning economist, does not see a quick fix for the economic tensions between the two countries and thinks the trade war will continue for some time. Chinese fund managers are also doubtful of any success at the meeting. It should be noted here that even if there is an agreement at the G20 summit, it will only produce a “framework” for future negotiations - not a solution or easing of tariffs. It would appear that any oil bulls resting their hopes on the meeting between Trump and Xi are being rather ambitious.

Interest Rates

The U.S added 250,000 jobs in the month of October, with the overall unemployment rate falling to 3.7 percent. The U.S economy has been showing robust growth of late and wages have also been increasing. All of this forms a strong case for another interest rate hike when the FOMC (Federal Open Market Committee) meets in December. This would result in a stronger U.S dollar which would make commodities more expensive for other countries to buy. This would lead to a fall in oil prices due to relatively low demand.

Each of these three factors will more or less coincide with one another: The OPEC meeting, G20 summit and FOMC. There remains very little certainty over what exactly the KSA/OPEC will agree upon. It seems unlikely that the U.S.-China trade war will be resolved at the G20 summit. The factor that seems most predictable is an interest rate hike and a stronger dollar – both of which will put downward pressure on oil prices.

If the most bearish outcomes were to come to fruition for each of these three events – OPEC refusing to cut production, Trump & Xi failing to agree on a framework and a rising dollar due to an interest rate hike – the prospect of oil prices falling to $40 is not an unimaginable one.