As recent as five months ago it would have seemed insane. Yet, at the time of writing, the benchmark crude oil, West Texas Intermediate (WTI), was trading at an unprecedented US 99.28 $/bbl. This current price build-up actually commenced from a low of US$ 54/bb1 in January 2007. The spiral has been steeper over the last three months when prices have moved a full US$30.00 per barrel. This steady progression combined with the fact that we are entering the peak demand winter season, has heightened expectation that the unthinkable is about to happen – crude oil prices seem likely to top US$ 100/bbl before the end of the year. The scenario has prompted the obvious question from many quarters. What does this mean for Trinidad and Tobago today?
At the onset, it is important to understand the historical economic context of this scenario. The movement in oil price over the last five years has been due primarily to the underlying strong global demand conditions. The main contributors to this have been China and India, both of which experienced real economic growth in excess of 8 per cent. The surge in oil consumption has not been matched by increases in production capacity. OPEC members now have little or no spare capacity while several non-OPEC members such as Russia and Mexico actually experienced decline in production capacity. The weakening US dollar has made oil cheaper for most of the industrialized world and therefore mitigated, somewhat, the impact of the higher prices. Given the underlying supply and demand picture the prognosis is that oil prices will remain relatively high for at least the next 12 months. During that time short term spikes in prices will occur as a result of security threats, cold weather, and pipeline or field accidents. The major downside risk is that of the US slipping into a full scale recession.
The above scenario has several important implications for Trinidad and Tobago and the rest of the region. The first and most important is the impact on the Government’s fiscal position. From a fiscal management perspective, it should not matter whether the oil price is US$85.00, US$ 95.00 or US$ 105 per barrel. At all price levels above the US $ 50.00/bbl set in the 2007 -08 Budget, all incremental windfall revenues should be saved. This is the objective of the Rules of Accumulation in the Heritage and Stabilization Fund Bill. The Bill states that when actual petroleum revenues exceed estimates by more than 10% the full amount of the excess is to be deposited into the Heritage and Stabilization Fund. Such revenue calculations and deposits are to be made on a quarterly basis. Exactly how much excess revenue will be generated is difficult to say at this time, because revenue is also a function of production and the tax regime.
There is a popular but mistaken notion that the Government benefits instantly from any increase in oil prices, however temporary. The facts are that what is deemed to be the ‘Government Take’ from profits of the oil companies comes through taxes. Taxes are paid on a quarterly basis. Therefore it is the average price of crude sold over the quarter that is the more relevant indicator of potential revenues.
Adjustments in the quoted price must also be made for quality and freight differentials before arriving at a price that is relevant to the Trinidad and Tobago transactions. Notwithstanding all these caveats and assuming the prognosis of high prices holds, the windfall revenue outturn could run into billions of dollars. Assuming the rules are followed the price increase would provide a much needed boost to the HSF. A recent survey of natural resource funds – or Sovereign Wealth Funds as they are otherwise known, indicates that because of the rapid growth in some oil rich countries, these funds are causing concern in some developed country markets. As Fund Managers begin to exploit new investment opportunities for these funds, there is a concern in the West about the prospect of blue chip assets falling into the hands of oil rich Governments.
Global Natural Resource Funds are thought to be worth some $2 trillion. The largest single fund is that of Abu Dhabi, estimated to be worth more than US$500 billion. Norway has the second largest fund worth about US$300 billion. With the balance in the HSF at just over US$2 billion, Trinidad and Tobago has quite a long way to go to be ranked among the world’s more substantial funds. The current price conditions provide an excellent opportunity for painless accumulation.
It is also an ideal time to promote transparency in the management of the windfall revenues. This has been a major failing in oil rich states. The HSF rules make provision for the Minister of Finance to make adhoc reports on the Fund to the Parliament and, by extension, the country. Failure to make timely reports in this period of excessive prices would breed mistrust and raise the spectre of corruption. On the other hand if comprehensive statements are made to the public it would send positive messages about the seriousness of Government’s intention to save for the future. It would be interesting to see if and when such reports would be made.
But there are serious downside risks to increasing oil prices which are often overlooked. The first is that higher oil prices increase the burden of subsidy on the Government’s account. A recent estimate put the size of the Petroleum Fuels subsidy at $1.8 billion, with oil prices still below US$75./bbl. Now that crude oil prices are approaching US$100/bbl, there will be a further escalation of the subsidy. The population will continue to be insulated from the high real costs of energy faced by the rest of the world. Such protection encourages households and firms to make choices that may be unsustainable when windfall revenues no longer can support it.
A second negative fall-out is the destabilizing impact of high oil prices on the other member states of Caricom. Thus far these economies have been able to weather the storm but at prices in excess of US$90./bbl, they could begin to feel the pinch in terms of balance of payments difficulties and increased indebtedness. Caricom is the biggest market for T&T manufacturing sector exports. A weakened Caricom could negatively impact export sales and economic viability of the fledging manufacturing sector.
A third negative of skyrocketing oil prices is the psychological impact on our already poor work ethic and warped values. There is no doubt that a prolonged period of exceptional prices will serve to strengthen the rentier mentality that pervades the land. It is a mentality that is reflected in increased consumerism, a reluctance to work in order to meet one’s needs, demands for Government to meet our wants and do so immediately, and a clear tendency to profiteering. These negative attitudes not only constrain Government in its efforts to be fiscally responsible but also stunts all initiatives aimed at building alternative productive sectors. The latter is perhaps the greatest threat posed by the prospect of oil at US$100/bbl and above.
I can already hear the chorus singing aloud ‘Why bother, we have oil.’ (The Trinidad Review December 2007)
