The Oil Prices Plunge
Oil prices in the international market witnessed their lowest drop since 1991 in February this year after Russia refused to roll back production in response to falling demand leading Saudi Arabia to start a price war with Russia. Saudi Arabia started the price war by dropping the selling prices of its oil and threatening to unleash its pent-up stock accumulated from falling demand due to the outbreak of the coronavirus onto the international market. As a result, Brent crude price dropped by US$14.25 (31.5%) to US$31.13, the biggest drop since January 1991 and the lowest since February 2016. The oil was trading at US$35.75 per barrel on Monday, March 9. The US West Texas Intermediate (WTI) crude fell by as much as US$11.28 (27.4%) to US$30 a barrel, also the biggest percentage drop since January 1991 and the lowest since February 22, 2016. The WTI was trading at US$32.61 on Monday, March 9.
According to Reuters, Saudi Arabia plans to increase crude production above 10 million barrels per day in April this year after the current supply deal between OPEC and Russia expires at the end of March. OPEC and other oil producers supported production cuts to stabilize the falling prices caused by the economic fallout from the coronavirus outbreak. Stock markets in Europe and the US are braced for their biggest falls since 2008 financial crisis after the trading in the first week of March began with panic selling amidst the double threat of coronavirus-driven global recession and an oil-price war.
In New York, stocks went into a steep slide on Monday, March 2 on Wall Street as a combination of coronavirus fears and a crash in oil prices spread alarm through the market, triggering the first automatic halt in trading in over two decades to let investors catch their breath. According to Bloomberg, the worst for the world economy is yet to come over the next several months, citing the impact of the virus on demand and supply, weaker Chinese manufacturing and a hit on the global tourism industry. The ratings agency Moody’s said on Monday, March 2 that the risk of global recession was rising as the spread of coronavirus causes a simultaneous supply and demand shock throughout the world economy.
Reactions to the Oil Price Fall in Ghana
Many civil society organizations, the Chamber of Petroleum Consumers (COPEC), individuals are asking oil marketing companies (OMCs) in the country to reduce their ex-pump prices for consumers to reflect the sustained decline in the global crude oil prices. According to COPEC, consumers could benefit from a reduction of between 10%-32%, compared to 2% that they were given over the past few weeks. COPEC also indicated that the relative stability of the cedi compared to other trading currencies should warrant a drop in petroleum prices. Recent figures released by the Bank of Ghana’s show that the cedi recorded an appreciation of over 5% from the earlier depreciation figures of over US$5.85=US$1 and currently trading at below US$5.40=US$1.
The National Democratic Congress (NDC) has also called on the President to ensure that fuel prices at the pumps are reduced by at least 20%. According to the party, the declining prices of crude oil on the international market, amongst other factors, should have led to a drastic reduction in fuel prices locally but the Government has refused to do so. The Party said, it has taken notice of the continuous reduction of the price of Brent crude on the international market in the last two months, especially the over 45% drop from an average price of $63.60 per barrel in January 2020 to $36 per barrel currently. The stability of the Ghana cedi which is attributed to the coronavirus outbreak is also a factor that should have contributed to the reduction of fuel prices in the country. According to the party, within the period that crude oil prices declined on the global market, consumers only saw “an insignificant and paltry reduction” of 28 pesewas at the pump, from GH₵5.62 per litre in January 2020 to the current average price of GH₵5.38 per litre.
In a swift reaction to the sharp drop in oil prices, the Consumer Protection Agency (CPA) has called on the bulk distribution companies (BDCs) and oil marketing companies (OMCs) to respond to the market trends and reduce the price of fuel at the pumps. Crude oil was trading on the world market at US$63 per barrel in November 2019, but the price has dropped to US$32 per barrel in March this year. In addition, the cedi/dollar rate which was GH¢5.9 in November 2019 is now trading at GH¢5.3, indicating an appreciation of 11.3% in the value of the currency. With these two developments, the CPA is of the view that the OMCs and BDCs have no justification not to reduce fuel prices in the country.
The Institute for Fiscal Studies (IFS) is of the view that lower crude oil prices are supposed to be beneficial to the country. For companies, commuters and drivers that use a lot of fuel, lower oil prices would mean more money in peoples’ pockets and every company that sells goods and services would get a piece of that benefit. But first, the biggest problem is whether Ghanaian companies will be able to get products made in Asia, where the coronavirus has been spreading from its origin in China, and whether Ghanaian firms will be able to sell their goods overseas if quarantines continue. Second, the lower oil prices have the potential to wreak havoc on fiscal management in the country. Already, government revenue targets from oil and gas for 2020 which are facing doubts due to Tullow’s cut in production by about 30%, have been further hit with a 25% plunge in global oil prices. Markets opened in early March have seen crude oil prices falling from an already coronavirus-affected price of US$50 per barrel to US$32, the biggest single drop since the start of the Gulf War in 1991. The price collapse was the result of Russia and Saudi Arabia’s inability to agree a deal between them to cut production and keep prices at an appreciable level.
Locally, as global stock and future markets of oil decline, the Government of Ghana should be worrying about the effect of a price collapse on its oil revenues from which it hoped and predicted in the 2020 Budget to raise US$1.2 billion from royalties, corporate income tax, carried and participating interest and surface rentals. Should the international oil price stay around the US$30 per barrel mark till the end of the year, the Government will not be able to get even half of its projected revenue for 2020. The situation could also be compounded by low oil production, as evident in Tullow’s revised production targets.
The collapse of oil prices will thus be a bitter-sweet development for the Government and Ghanaians. On one hand, the deregulated market should lead to drops in fuel prices at the pump. On the other, the drop in oil prices will significantly reduce government revenue, with serious implications for fiscal management. Aside from the fall in international fuel prices by more than 50%, Ghana has experienced an appreciation of the cedi against the US dollar by more than 11%; thanks to the Coronavirus and OPEC decisions.
One would have expected that the drop in oil prices and the appreciation of the cedi would together lead to a substantial reduction of fuel prices at the pump. But consumers may not experience that substantial gains as the OMCs are unwilling to reduce significantly the fuel prices at the pump due to what they claim as ‘depressed margins. As a result, Ghana may lose out on the low oil prices induced by both the Coronavirus and OPEC decisions from two angles: a loss in projected revenue and loss of the possibility of much lower fuel prices.
Call for a Hedging Program
The sharp drop of oil prices in the international market points to the crucial need for Ghana to take immediate steps to implement a hedging program. Currently, Ghana produces about 210,000 barrels of oil per day and its share has risen to nearly 20% of this total output, which it sells on the international market. The country is now a net oil exporter and therefore without a hedging program it stands to lose huge foreign exchange earnings from exports when oil price drops on the world market. Likewise when oil price increases, the country suffers through increases in its oil import bill. Both scenarios are undesirable and can be mitigated by an effective hedging program to ensure stability in the country’s fiscal management.
Since 2015, the IFS has strongly advocated for Ghana to re-introduce the petroleum hedging program that was abandoned in 2013 to cover both imports and exports of oil to save the country from losing millions of foreign exchange earnings and also provide stability to the national budget.
This is because Ghana’s previous experience with hedging showed that with a well-designed program, it is possible to protect the country against volatilities in commodity prices through the “call” and “put” options. In March 2010, the Government implemented a Commodity Risk Management Policy to help protect the economy from the volatilities in oil prices. In line with the policy, the Government hedged Ghana’s oil imports and exports through “call” and “put” options, respectively. The program proved immensely successful that the scope of the hedging program was expanded towards the end of 2011 to provide a 100% cover for the country’s oil imports.
The IFS was pleased to see reports in the media in 2018 about plans by the Government to hedge the country’s oil imports. The Institute welcomed this development as a step in the right direction, given that hedging provides an insurance to mitigate the adverse impact of oil price volatility. The Institute also urged the Government to consider a comprehensive hedging program that covers both imports and exports of oil and as well as interest rates on public debt. Unfortunately, nothing has happened since then and the country is now faced with the vagaries of sharp drop in oil prices as coronavirus spreads across the world.
Ghana’s previous experience with hedging points to one key lesson: with a well-designed hedging program, it is possible to protect the country against volatilities in commodity prices through the “call” and “put” options. Hedging brings predictability and stability in petroleum prices and government revenue from oil production and exports and that is what the country needs now. The IFS therefore urges the Government to take immediate steps to implement a hedging program for both the country’s imports and exports of oil without any further delay.
The writer is the Executive Director, IFS, Ghana