Since the beginning of February 2011, the northern region of Africa has witnessed a series of political protests aiming to oust current political leaders. The wind of change started in Tunisia, followed by Egypt, with the then incumbent presidents leaving their offices. Similar protests surfaced in Libya, which is the world’s twelfth largest oil producer. With the United Nations Security Council ‘no-fly zone’ resolution implemented, world markets have witnessed ensuing high and volatile oil prices. These developments have dire consequences for the majority of net oil-importing African countries. This CAI discussion paper draws attention to the implications of oil price volatility on economic development in Africa. The discussion is motivated by the recent political developments in the African oil producing region. The paper highlights some linkages that may exist between oil price volatility and the macroeconomy.

Background and recent developments

Africa possesses valuable natural resources that include oil, which if strategically used, can help the economic development of the continent. However, out of the 53 countries, 38 are currently net oil importers.⁽²⁾ High and volatile prices are a major threat to all net oil-exporting and net oil-importing African countries due to the key role that oil plays in any economy. Since the 1970s world oil prices have been trending upwards because of the growing demand in emerging market economies (especially China and India), declining spare capacity in major oil producing countries and peaking of production in several important oil-producing areas. Interest in the impact of oil price shocks on the macroeconomy gained momentum since the 1970s.⁽³⁾ Currently, political unrest in Libya is contributing to the ongoing uncertainty of trends in oil prices. The consequence of this political unrest has been directed towards the volatility of oil prices in global commodity markets.

Given the level of development in Africa, the current high and volatile oil prices, combined with the increasing oil import dependence of many African countries, continue to pose a threat to economic development of the continent as a whole. The negative effect of rising oil prices is thus potentially large for net oil-importing countries because they affect businesses, consumers and the government budget, among other things.

A study by the African Development Bank and the African Union suggests that high oil prices can have negative effects on the economies of African oil-importing countries, especially those that are heavily debt-burdened. The rising oil prices could lead to decreases in output and consumption, worsening the net foreign asset position. For net oil-exporting countries, oil resources are a principal source of public revenue and national wealth for the governments.

Currently oil prices continue to surge following the air strikes on Libya because of the implementation of the ‘no-fly zone’ resolution and amid fears that there could be further disruptions in world oil supplies.⁽⁴⁾ The price of Brent crude surged by 15% as Libya’s violence flared up reaching US$120 a barrel on 24 February.⁽⁵⁾ The intensifying conflict in the country drives the further fear that crude oil supply may be affected in the short- to medium-term driving even further oil price movements. Such uncertainty about the future significantly influences the sentiment in the market, perpetuating the likelihood of high oil prices.⁽⁶⁾ Libya’s oil output has been halved as foreign workers have been fleeing as the country continues to fragment.⁽⁷⁾

Oil prices and the macroeconomy of Africa

In Africa, the majority of oil reserves (and production) come from Algeria, Angola, Egypt, Equatorial Guinea, Libya, Nigeria and Sudan, which together produce more than 90% of the continent’s reserves. In some parts of Africa, there are potential discoveries, (for instance Mozambique, South Africa and Tanzania). These prospects for more discoveries can potentially help in transforming the African economy into an important global oil production region. Global oil developments are worth paying attention to because of their effect on key macroeconomic variables such as inflation, exchange rates, current account and fiscal variables.⁽⁸⁾ For instance, the oil price increases will be filtered into the petrol, diesel and paraffin commodities, used daily in the economy. This further drives the cost of living, which can trigger social protests and policymakers will be forced to work out policies that sustain the economy. Net oil-importing African countries remain vulnerable to energy price shocks. Empirical evidence suggests that increases in oil prices tend to exert strong inflationary pressures, contracting real output, slowing down economic growth and exacerbating unemployment in net oil-importing countries.⁽⁹⁾ The bigger the oil price increase, the larger the potential macroeconomic effects are likely to be at the national, regional and global levels.

An oil price distortion has important implications for the oil price-macroeconomy relating across all oil exporting and importing countries. Such distortions may pass through directly or indirectly to all micro and macro levels of the African economy because oil is considerably traded in world commodities markets. Economic sectors that use oil intensively suffer the greatest impact of changing oil prices.⁽¹⁰⁾ The most vulnerable sectors include transport, retail, tourism and agriculture. The transport sector suffers most because the bulk of oil imports are used by the transportation sector which highly depends on liquid fuels. In many parts of African countries, there is heavy reliance on road freight; the retail sector will be affected because a wide range of goods’ prices are affected by the changes in the oil prices. As transport prices rise due to the increase in oil prices, the tourism industry will be negatively affected. The agricultural sector, which sustains many subsistent (peasant) and commercial farmers across the African continent, will greatly be affected as the cost of production rises, reducing the output, putting more pressure on the prices of the much needed basic commodities. This will further worsen the situation of the poor.

Additional empirical evidence suggests that the future demand for oil and the pattern of oil prices tend to be difficult to correctly predict although these are generally highly correlated with the growth in industrial production.⁽¹¹⁾ As a country experiences high economic growth, demand for oil may increase significantly and this subjects the country to adverse effects of oil price shocks. As mentioned above, the effect of oil price volatility and increases affect the country’s economy depending on whether it is a net importer or net exporter of oil. Net oil importers face a high oil import bill, transmitting into adverse inflation, production and employment levels. On the other hand, net exporters may benefit from the increase in revenue which improves their balance of payments and rise in nominal GDP.⁽¹²⁾ Since oil is used as an input in a wide range of production processes, the volatility of oil prices affects the expected marginal costs of firms.⁽¹³⁾ Oil price volatility increases risk and uncertainty which negatively impacts stock prices as well as wealth and investment.⁽¹⁴⁾

Concluding remarks

The currently high and volatile oil prices are likely to continue, brewing up uncertainty about the future and dampening the speedy recovery of the African economy already characterised by political and economic instabilities. Until the political unrest in the major oil producing regions is resolved, there could be further disruption in global oil supply, which further drives the global oil prices. The higher oil prices will increase inflationary pressure by raising production and transport costs, for instance.

Given the large amount of investment by multinational companies, market indices are quick to respond to developments in these oil producing regions. The negative sentiment on Africa due to continued unrest does not benefit the continent as a lucrative investment destination. The geographic scope of the unrest may be perceived by the markets to potentially extend to countries such as Algeria and Saudi Arabia, which hold the bulk of the Organization of Petroleum Exporting Countries’ (OPEC) spare production.

If properly managed, oil exploration in Africa can help promote economic growth and development so that lives of the poor can be improved through increased investment in health, agriculture, education and physical infrastructure, among other things. In this way, oil resources can be a source of growth and development if efficiently explored and properly managed. Net oil-importing countries need to continue to identify and explore alternative sources of energy so that they may be cushioned from the impact of external oil shocks.

NOTES:

(1) Contact Anthony M Makwiramiti through Consultancy Africa Intelligence: African Finance and Economy Unit. (finance.economy@consultancyafrica.com).
(2) African Development Bank and the African Union. 2009. “Oil and Gas in Africa”, Oxford University Press.
(3) Barsky, R. B., and Kilian, L., 2004. “Oil and the Macroeconomy since the 1970s”, Journal of Economic Perspectives, Vol. 18 No. 4 pp 115 -34.
(4) 'Oil prices jump $2 after US leads air strikes on Libya', BBC News, 21 March 2011, http://www.bbc.co.uk.
(5) 'The 2011 oil shock', The Economist , 3 March 2011, http://www.economist.com.
(6) 'Oil prices jump $2 after US leads air strikes on Libya', BBC News, 21 March 2011, http://www.bbc.co.uk.
(7) 'The 2011 oil shock', The Economist , 3 March 2011, http://www.economist.com.
(8) African Development Bank and the African Union. 2009. “Oil and Gas in Africa”, Oxford University Press.
(9) Ibid.
(10) Wakeford, J. 2007. Peak Oil and South Africa: Impacts and Mitigation. ASPO (Association for the Study of Peak Oil & Gas – South Africa).
(11) Basher, S, A and Sadorsky, P., "Oil price risk and emerging stock markets." Global Finance Journal 17 pp224-51.
(12) Bacon, R., 2005. "The Impact of Higher Oil Prices on Low Income Countries and on the Poor", United Nations Development Program/World Bank Energy Sector Management Assistance Program Paper.
(13) Castillo, P., Montoro, C., and Tuesta, V. 2005 "Inflation Premium and Oil Price Volatility", Working Paper.
(14) Basher, S, A and Sadorsky, P., "Oil price risk and emerging stock markets." Global Finance Journal 17 pp224-51.

Written by Anthony M Makwiramiti ⁽¹⁾