The implications of the Coronavirus (COVID-19) will be heterogeneous, but oil prices will likely be lower in the medium-term
Synopsis: This paper models the impact of COVID-19 on Brent; controlling for the price war between Saudi Arabia and Russia as well as sever and more benign outcome from the virus, oil prices will range between $56/bl and $67/bl in both scenarios. Meanwhile, developing countries in the Cemac zone will see their deficits and debt-servicing costs rise. This paper argues for targeted and quantifiable targets to increase the number of people employed in the formal and renewable energy sectors. Furthermore, the findings control for changes in the global demand-supply balance as well as consumption in Europe and North America and industrial production in China.
Oil prices have plummeted as the Coronavirus has intensified across much of Europe and North America. The Energy Information Agency (EIA) has revised down its global oil demand forecast, which suggests that major importers such as China as well as European countries will reduce demand for oil. The latter has followed the trend of industrial production, which has slowed as manufacturing of waxes, perfumes, dyes, shaving creams, shampoos and conditioners that rely on refined oil have been disrupted by the virus. As such, Brent and WTI both fell by 24.59% and 30% to $31.13 and $30 per barrel respectively on Monday, March 9th. Not only has the virus halted manufacturing supply chains in China, it has exacerbated the global cyclical slowdown, with both Euro Area and German industrial production plummeting in recent months (see figure 1).
The trend of falling industrial production is even more noticeable across all grades of fuel spanning gasoline to diesel, which also fell by 2.9% and 3.8% respectively (Fig 2). As such, the implications for developing economies will be much more pronounced in the near term, as a weaker currency and higher interest payments will compound budget constraints. As the virus has spread across continents, oil prices will likely remain under pressure as OPEC and Russia are locked in a price war. This will cause prices to rise at a more gradual pace in the future, and lower oil demand and staling investment will have more lasting economic consequences for commodity exporters. Crude oil imports have fallen by 13.4% (Fig 2), which will cause the economy to grow at a slower pace. Furthermore, inflation will rise in developing and emerging economies due to a weaker currency, and a deterioration in external positions will slow the impact of economic reforms agreed in the current extended credit facility with the IMF such as Cameroon’s three-year arrangement was approved on June 26, 2017, for SDR 483 million (about US$666.1 million, or 175 percent of Cameroon’s quota. Furthermore, the impact of the COVID-19 will also be contingent on the portion of economic growth generated from domestic demand and services, as opposed to imports and oil prices in most developing economies that present downside risks.
Implications of falling oil prices for CEMAC member countries
Five of the six CEMAC countries are oil producers; oil accounts for about 40% of regional GDP and 85% of total exports. Oil revenue, channelled through government spending, is the main driver of economic activity, but volatile oil prices and procyclical fiscal policy have caused boom and bust cycles, hence the need to reduce reliance on commodity exports.
Furthermore, oil accounts for about 20% of GDP and covers roughly 75% of the region’s exports of goods while tax and nontax revenues related to oil contribute to more than 40% of total revenues. Furthermore, an analysis of CEMAC balance of payments data suggests a strong correlation between recorded oil export and recorded capital outflows. In other words, the higher is the total value of recorded oil export, the higher is the estimated capital outflows. This is probably an indication that part of the counterpart to oil export is not repatriated into the exporting country and is recorded as capital outflow (see chart). As exports fall due to the COVID-19 and prices fall further due to Saudi Arabia and Russia price war, capital will likely flow out of the economy, the currency will depreciate and prices for basic food products will rise. In addition to falling oil sales, repatriating incomes from oil sales will likely reduce the macroeconomic impact of this trend, but the government should ensure that over 21% of exports are high-value exports by 2025 by working with the consumer protection society and local business groups to standardize packaging, improving the quality of components of consumer products such as household products, yogurt to non-consumer products such as industrial machinery and intermediate products for the auto sector. Consequently, the currency will likely depreciate in the near term depending on the fallout of the virus and policymakers can incentivize capital outflows by quarterly reports on the effectiveness of private sector reforms such as digitizing business registrations and reducing wait times to five days or less.
Figure 2: The downturn in oil prices is broad-based and visible across categories
Even as global oil prices have fallen to historic lows, the economic impact of COVID-19 will be more heterogeneous as a pharmaceutical company in Japan is currently producing vaccines from antibodies; an approach first used in China. As such, deferred spending in China could reduce the adverse impacts of the virus, while a recovery in manufacturing activity will increase demand for oil over the medium term.
I modeled the impact of falling oil demand, increased supply from OPEC and Russia as well as a severe and more benign outcome from the Corona Virus. In the event where viral infections increased across Africa, North America and Europe, lower consumer demand, a faltering service sector and the absence of an OPEC + Russia agreement on output restrictions, oil prices will see-saw for much of Q2, before ending 2020 at $56/bl. This is however not my base case as 70% of the cases have been treated in China and policy coordination with our second-largest partner should help stem the spread in Cameroon.
70% of Coronavirus cases have been treated in China, suggesting a more heterogeneous impact on developing economies
In another scenario, the Chinese get COVID-19 under control using via transfusions of blood products while Takeda, a Japanese pharmaceutical company produces and markets a global anti-virus. This will accelerate the recovery in Chinese manufacturing and industrial sector, while the service sector will benefit from deferred spending. Under such a scenario, oil prices will recover to $67/bl as monetary and fiscal measures boost the economies affected by the virus. My model also adjusts for additional demand and stimulus measures undertaken by governments across the world. (See table 1). Meanwhile, the impact of the Coronavirus will be heterogeneous as 70% of the cases have been treated in China according to the World Health Organization. As such, the recovery in domestic demand and manufacturing activity will become evident in the upcoming PMI’s ( a gauge for manufacturing activity), while commodity exporters will likely see a marginal, albeit belated, recovery in oil prices. However, the price war occasioned by the lack of an agreement between Saudi Arabia and Russia could place further downward pressure on oil prices.
Figure 3: The Breakdown of oil consumption suggest a greater impact on Cemac fiscal balances
Meanwhile, Gasoline and Automotive diesel comprise the majority of crude oil consumption in the U.S.A, while domestic heating oil and industrial activity comprise 37% and 31% of the distribution for Europe. As such, the interlinkages between European supply chains and developing economies will determine the extent of the negative impact of the virus. Additionally, a majority of developing economies are increasingly linked to Chinese industrial activity, while Europe is dependent on Chinese and global external demand; As such the impact of the virus will be equally damaging to Europe as it will be to Africa in the absence of a targeted and transparent Chinese-style response of using blood transfusions of treated patients to stem the spread of the virus. As such, Cemac countries that export petroleum and its distillates will be severely hit by the virus and increased production capacity will only exacerbate the adverse impacts of the downturn in oil prices.
Table 1: Targeted fiscal policy will reduce the negative economic impact of COVID-19
Source: Henri Kouam
Oil prices will average between $56 - $62 per barrel on a more pessimistic and optimistic scenario respectively
The COVID-19 means slower manufacturing and less travel, which explains low oil prices. This is further explained by the absence of an agreement between Saudi Arabia and Russia, who have different budget needs, fiscal deficits and market outlooks. Whilst Saudi Arabia hopes to keep oil prices high, Russia is seeking a greater share of global oil markets, hence the price war. Consequently, my model controls for changing domestic and industrial demand outcomes in Europe and China, as well as a gradual recovery in manufacturing output.
This is contingent on the number of treated cases in China increased from 70% to 85% and sufficient information sharing with the most affected European countries. Furthermore, deferred spending in China and Europe will eventually support an economic recovery as the impact of more accommodative monetary policy and targeted fiscal responses from governments engineer a recovery (Table 1). As such, oil prices will likely hit new lows, but a recovery is in sight in the near-to-middle term. Furthermore, it is important to note that unemployment insurance in China and frozen tax payments in some advanced economies to support businesses will likely boost business and consumer sentiment and prevent a pronounced economic slowdown or falling demand due to a loss of consumer income.
Fiscal consolidation will be needed to reduce the structural impediments to growth
Admittedly, CAR and Cameroon had some success in increasing these revenues between 2016 - 2018, while Congo and Gabon saw their non-oil revenue decline significantly (see chart). Furthermore, public debt increased from 20.7% of GDP at end-2012 to 53.6% of GDP at end-2017 as countries such as Cameroon took out 669 million in infrastructure loans from the Chinese on concessional terms between 2016 - 2018. Over the same period, BEAC’s international reserves have declined from CFAF 8,865 to 3,128 billion (and from 5.6 to 2.3 months of prospective imports). To put public debt firmly on a downward path while contributing to the rebuilding of an adequate buffer of international reserves, member states should urgently pursue their fiscal consolidation efforts while implementing structural reforms to support higher and inclusive growth. In addition, after rebounding to about 7?% in 2018 owing to the recent increase in oil prices, the oil revenue-to-GDP ratio is expected to decline further from 2019 onward to 4? percent by 2023. As such, policymakers should set quantifiable targets to digitize the workforce and boost the potential growth rate.
For example, rather than seek to increase employment by 2000, policymakers should set explicit targets such as 250 people employed in the tech sector to digitize the public sector, 250 people to digitize the electricity grid and work with ENEO during summer holidays to help implement software designed to reduce power outages and measure electricity flows, 250 people in the health care sector to utilize machine learning to conduct cutting edge research and 250 for other roles as needed by the public sector. The increases to government spending will be modest, given our interest payments but such an approach will have a lasting impact on the potential growth rate and ensure Cameroon’s achieve its nationally determined targets as stipulated in the Paris Climate Accord whilst reducing structural impediments.
Admittedly, the central banks will adjust monetary policy to reduce funding constraints in financial markets and support equity valuations, but the positive spillovers are unlikely to affect the real economy, which is susceptible to changes in fiscal policy that can have a more direct impact on household’s incomes. As such, monetary accommodation will only serve to extend the financial cycle and reduce the risk of a financial crisis rather than support consumer incomes and domestic demand on a sustained basis. Cemac countries are net commodity exporters, and the impact of COVUD-19 and the price war between Saudi Arabia and Russia will have lasting implications for the government’s finances as tax revenues and dividends from oil companies such as SONARA will be adversely affected. Policymakers should design quantifiable targets to increase the number of people employed in highly-skilled sectors such as renewable energy driven by off-grid solutions as well as clear research objectives facilitated by I.T students and researchers to provide solutions for the digitization that will boost the potential growth rate on a much more sustained basis. Furthermore, in other to reduce the economic impact on the domestic economy, policymakers should ensure that intra-African trade is cleared in African currencies such as the Nigerian Naira, South African Rand, and Ghanaian Cedes, etc. This will reduce the impact of a weaker currency on interest payments and trade as clearing intra-African trade in the dollar increases the cost to the domestic economy and African countries. Oil prices will undoubtedly cause macroeconomic uncertainty, but policymakers can reduce the adverse impacts of the Coronavirus. References
1) Chris Dalby (2020) Industries Worried About Peak Oil. Available here
2) Mathew Herper and Adam Feuerstein, March 2020. How blood plasma from recovered patients could help treat the new coronavirus. Available here
3) IMF (2020). Fiscal Policies to Protect People during the Coronavirus Outbreak. Available here
4) OECD (March 2020) Industrial production in the Euro Area