The Sight of inevitability II

A week late, but last weeks Economist [economist.com, some registration necessary, "Pegs under pressure" 7 oct 2015], seems to have an article inspired by a graph we posted earlier. It could be completely coincidental of course.

The sight of inevitability

Kazakhstan has been devaluing it's currency since last month. See the story in the FT for some comments by the Central Bank Chief Kairat Kelimbetov.

Azerbaijan has been doing the same at the beginning of the year, while Saudi Arabia has been running down its reserves. I put some of these series together in a graph (sorry for the overflow to the right).

Jacques Delors (Former President of the European Commission) on a European Energy Policy.

Jacques Delors writes [energypolicyblog.com] to back a new phase in European integration focussing on energy. His letter is backed by a report [delorsinstitute.eu] written by the Jacques Delors institute.

Some quotes, my emphasis.

Making this a priority in Europe involves placing energy efficiency on an equal footing with other energy resources, and to deal with them together as part of a single energy transition. To make this happen, a decisive step must be taken towards the transition, guided by a stable and credible carbon price. The optimum instrument, in particular against the backdrop of a downward trend in oil prices, remains EU-wide carbon taxation. At the same time, subsidies for fossil fuels must be phased out as soon as possible.

Apparently aware that some major energy producers are not in the EU, he writes

Relations with immediate neighbours must be strengthened with a view to creating a pan-European area already outlined by the European Energy Community, without forgetting the Mediterranean countries. Energy relations with Norway and Switzerland must be embodied in more extensive partnerships than that of ETFA or the EEA. Similarly, relations with Russia and Turkey must be taken to a strategic level that reflects the interdependence of our respective economies rather than counting on short-term actions lacking an overall vision.

Based on the report, Switzerland is singled out for being less integrated in the EU energy market than Norway, while there may be substantial advantages in integrating in the European energy network. Turkey features as a strategic partner as a major (future) transit country for gas.

Sliding oil price and the solvency of governments

As the oil price continues to slide to lower levels, the potential effects on government finances becomes more evident, especially since the slide does not appear very likely to be reversed majorly [FT.com] in the near future. (Opec did not cut [FT.com], but the major new supply from unconventional oil in North America such as fracking and the Canadian oil sands is not profitably at the current levels. It is only natural that the this new production will be cut [econbrowser.com] if prices do not increase for other reasons.)

One major difference in how countries may handle this new reality comes from their exchange rate regime. Although the Russian rouble appears to be impacted most [FT.com], or at least receives the most attention, all currencies of oil exporting countries with flexible exchange rates have been tracking the fall of the oil price [FT.com]. In fact, the Russian central recently stopped defending the currency against depreciation recently making it in fact more free floating than previously. The fall in real revenues in terms of their domestic currencies is mitigated by the depreciated currencies. Since governments have a major part of their expenses in the local currencies, the impact of the fall in oil price is partially offset by simultaneous nominal exchange rate depreciation. However, debts to external creditors, in particular those denominated in foreign currency, will become harder to finance. So even countries with floating exchange rates will probably make some adjustments to their budgets.

In contrast, the Venezuelan Peso is fixed against the US dollar. As the central government is heavily reliant on the oil revenues for squaring its budget, the impact of the oil price is stronger [FT.com] relative to the floating exchange countries. Prices of it's bonds have tumbled, reaching an annual yield of close to 20%. Venezuela is reported as having argued the most strongly for an OPEC production cut in order to support the price, but countries that argued for this lost the decision as OPEC decided to leave production unchanged [FT.com].

It should be noted that the oil price dynamics functions more like a looking glass that reveals the true characteristics of governments and an economy. Although Norway may have to make some changes in their budget, their massive savings funds allows them any adjustment to be smooth and balanced. The decisions to manage revenues in this way have been taken years ago, exactly to account for a volatile oil price. The recent Russian assertiveness into its western neighbours, with the EU and US response just adds to the nervousness of the economic prospects. That Venezuela has been mismanaged for years becomes only clearer as the government runs out of cash to finance its unfortunate welfare programs.