How Oil Price Shocks Impact African Economies

By Dr. Paiman Ahmad and Alexander Ayertey Odonkor

Similar to other regions with abundant natural resources, the BP Statistical Review of World Energy report for 2018 indicates that Africa has 7.5% of global oil reserves.¹ Revenue generated from oil resources on the continent is a key driver of economic growth in energy-exporting African countries. Highlights from the African Economic Outlook report for 2020², shows the economy of Africa grew at 3.4% in 2019 with North Africa, contributing the largest as the region accounted for 44% of economic growth on the continent – the boost in economic growth in North Africa is partly attributed to oil revenue. Revenue from oil has been a major determinant of economic growth in North Africa – the region experienced economic growth decelerations when oil production was interrupted by the Arab Spring which commenced in the latter part of 2010 in Tunisia³. Conversely, higher levels of production and export of oil by Libya contributed immensely to the improved economic growth of the region after 2016⁴.

Although other sectors such as agriculture in Morocco played an instrumental role in propelling economic growth in North Africa, as high yield increased economic growth in the North African country from 1.2% in 2016 to 4.1% in 2017, revenue from oil has been the essential fount of growth in the area.

In Sub-Saharan Africa (SSA), where oil exporting countries account for almost 50% of the region’s Gross Domestic Product (GDP), oil contributes as high as 90% of the total fiscal revenue⁵ of oil exporting countries and serves as a major source of foreign reserve.

Source: International Monetary Fund (IMF) Country Report

Oil exporting countries in SSA rely heavily on revenue from oil, a condition that has tremendous impact on the development⁶ of the region – the decline in GDP growth in SSA from 5.1% to 1.4% in 2014 and 2016, respectively, was due to oil price shocks, when the price of crude oil fell by 56% within a seven-month period. Oil has a significant impact on the African economies. Between 2007 and 2017 oil producing countries on the African continent generated $3.3 trillion⁷ in revenue from oil – this amount is more than seven times the value of foreign aid the region received within the same period. Revenues from oil improves economic output in Africa but fluctuations in the price of oil has an enormous impact on countries in the area – between the middle of 2014 and January 2016, the price of oil declined by 70% as a result of global oversupply of the commodity. This outcome had adverse effect on both oil exporting and oil importing countries in Africa as GDP growth declined⁸.

Source: AfDB, OECD & UNDP

However, an increase in the price of oil is not always deleterious to all net oil-importing countries in Africa as is widely known in energy economics, that an increase in the price of oil will have a positive impact on net oil-exporting countries⁹ or an increase in oil prices will have a negative impact on net oil-importing countries. A study published in the volume 139 of Energy (Elsevier)¹⁰ in 2017, defies this analogy – the research work, which focussed distinctively on the impact of oil price shocks on small oil-importing economies suggests that an increase in the price of oil in Liberia (small oil-importing country) stimulates the country’s economy. This is mainly as a result of the intensive labour and capital employed in the process of reallocating resources from oil-intensive sectors when oil prices are high – the economic output of labour and capital when the price of oil increases, far exceeds the contribution of oil revenue in Liberia. Similarly, findings from another research¹¹ that was published by Heliyon (Elsevier) in 2019 reveals that net oil-importing developing countries: Cape Verde, Liberia, Sierra Leon and the Gambia respond positively to an increase in global oil prices as GDP per capita increases in the short term in these African countries.

The impact of oil price shocks does not only vary in different countries but it also varies across different sectors of the economy. In 2019, the International Monetary Fund (IMF) released a paper¹² that assessed the impact of declining oil prices on banks in oil-exporting countries in SSA – the findings of the research show that the nature of response for banks to a fall in oil price in SSA depends mainly on the ownership structure of the banks. The impact of declining oil prices on domestic banks is relatively severe as these local banks eventually become illiquid and the value of their financial assets depreciates – this is because indigenous banks in SSA constantly lend to a large number of customers during periods of declining oil prices, and fail to increase funding. The quality of assets deteriorates, leading to an increase in non-performing loans.

On the other hand, when oil price declines, foreign banks which are known in Africa to operate with a conservative business model reduce lending and increase the quality of their assets and funding thereby reducing credit growth. In the case of Pan-African Banks (PABs), even though they also increase lending when the price of oil falls, they concurrently reduce their holdings in Government securities – the impact of the decline in oil prices depends largely on the size of the Pan-African Bank. Whiles large PABs record a decline in the quality of assets, small-sized PABs experience an increase in the quality of assets.

Contemporary research has shown that whether a country is an oil exporter or an oil importer, a change in the price of oil has an impact on the expected cash flows of corporations as oil is a valuable commodity across all levels of the economy. According to the International Monetary Fund, oil price shocks have an undeniable influence¹³ on stock markets. Oil price shocks have an impact on inflation, exchange rate, monetary policy, fiscal policy, corporate income and the entire economic activity. In Nigeria¹⁴, Africa’s largest economy (with GDP of $337 billion) and also the largest oil producer and exporter, where oil accounts for 8.4% of GDP¹⁵ as the economy diversifies, the stock market depicts the golden rule thus, ‘‘oil up, stock down’’ – an increase in oil prices results in a decline of stock returns¹⁶.

In contrast, in South Africa, Africa’s second largest economy and the largest importer of oil on the continent, South African stock returns¹⁷ responds positively to an increase in the price of oil that is caused by a positive shock to demand and reacts negatively to supply shocks. Exhibiting, clearly the variation in the impact of oil price shocks in oil-importing and oil-exporting countries in Africa. Quite recently, the Journal of African Trade (Elsevier)¹⁸, published a  study which examines the co-movement between oil prices of the Organization of Petroleum Exporting Countries (OPEC) and Africa’s six largest Stock markets: South Africa (JSE), Egypt (EGX), Morocco (CSE), Nigeria (NSE), Kenya (NSE) and West African Economic and Monetary Union (BRVM10) indicates that apart from Egypt and South Africa, the co-movement of oil prices and the stock market is relatively low in Africa – whiles the Nigerian stock market and the other stock markets are not adequately developed and poorly integrated into the global oil market, the South African stock market which is by far the largest in Africa and the Egyptian stock market have a strong long-run co-movement with oil – a condition that exposes these two stock markets to global oil price fluctuations.

Several factors determine oil price fluctuations on the global commodity market: whiles OPEC + (OPEC Plus) controls 55% of the global oil supplies and about 90% of discovered oil reserves¹⁹ – the group which is made up of OPEC and top non-OPEC oil-producing countries has a considerable influence on global oil prices. However, the OPEC Bulletin Commentary for April 2015²⁰ cites market speculations as a significant contributor to oil price fluctuations.  In a new-fangled development, the outbreak of covid-19 is the latest dominant factor in the form of a pandemic to have an immense impact on global oil prices – the negative supply shocks experienced on a global and regional level, emanates largely from a reduction in oil production as a result of a section of the oil workforce being infected and quarantined for treatment.

The contagious nature of the coronavirus has prompted the enforcement of lockdowns which has a negative impact on business activities, restricts transportation of goods and services in Africa and other regions of the world – the World Bank policy brief for April, 2020²¹ suggests that countries in North Africa and the entire MENA region will suffer a greater impact from a decline in aggregate consumption and investment as the coronavirus continues to spread to Europe and other parts of the world. The shocks from covid-19 is intertwined with the collapse of global oil prices attributed to the failed negotiation between OPEC and its allies – in early march, 2020, OPEC proposed a reduction of 1.5 million barrel per day(mb/d) for the second quarter of 2020. Thus, 0.5 mb/d and 1 mb/d reduction for non-OPEC and OPEC, respectively. Notably, Russia rejected the proposal, an action which instigated Saudi Arabia, the world’s largest exporter of oil to increase oil production to its full capacity (12.3 mb/d) and also offer close to 20% discounts in key markets – The price of oil declined more than 30% and continued to fall after that episode.

Global oil price shocks is mostly pinned on tension between OPEC and its allies as the cartel has not been able to operate as a unified force despite the fact that many different countries joined the organization for a common goal (Ahmad, 2016)²². The diminution in global oil prices will have catastrophic effects on oil-exporting African countries, especially those that rely heavily on oil revenue.

However the oil price-exchange rate nexus for the two largest economies on the continent: Nigeria and South Africa seems to be the identical. Although Nigeria is the largest oil exporting country and South Africa is also the largest oil importing country in Africa, empirical studies for the two countries shows that an increase in oil prices leads to a depreciation of both the South African rand²³ and the Nigerian Naira²⁴ visàvis the United States dollar. This prevailing oil price-exchange rate nexus for Nigeria and South Africa is not the same in all dimensions of the two economies and even other parts of the continent– whiles agricultural commodity prices are neutral²⁵ to global oil prices in South Africa, the situation is quite different in Nigeria.

Even though there is no long-run relationship between oil price and any agricultural commodity in Nigeria, in the short-term, oil price has a positive and a significant impact on local food items such as maize and soya bean – oil price also has a negative effect on the price of commodities such as rice and wheat but the impact is negligible²⁶. In other parts of Africa, such as East Africa²⁷, the dynamics for oil prices and local food prices is quite disparate – analysing data on the price of petrol and maize suggests that global oil price affects the price of local foods (maize) via transportation cost rather than biofuel or production cost.

As a non-renewable energy, oil is a volatile commodity that derives its price mainly from the supply and demand dynamics of the international markets – the current downward trend of global oil prices which began with the spread of covid-19 has led to a decline in oil price from $56.10 per barrel in December 2019 to less than $30 by the middle of February 2020. For many developing countries, where the oil sector is the primary driver of growth, this unexpected fall in oil prices will slowdown economic growth, a challenge Collier (2007)²⁸ identified as one of the traps many resource rich countries in Africa and Middle East frequently experience.

About the Authors

Dr. Paiman Ahmad is an academic with research interest in oil price politics, energy governance, rentier economies and sustainable development in developing economies. She holds a master’s degree in International Affairs and Public Policy Making (Bilkent University-Ankara) and a PhD in public administration from National University of Public Service. Her research works have been published by reputable journals such as Public Money & Management, Journal of Public Affairs and top-tier academic publishers: Palgrave, Springer and many others.

Her Academic Affiliations are: University of Raparin, Lecturer in Law and Administration Departments. Emails: [email protected]. [email protected] Rania-Sulaimania-Kurdistan Region-Iraq. Visiting lecturer at Tishk International University: International Relations & Diplomacy Department, Faculty of Administrative Sciences & Economics, Kirkuk Road, Erbil- Kurdistan Region -Iraq. Email: [email protected]

Alexander Ayertey Odonkor is a chartered financial analyst and a chartered economist with a stellar expertise in the financial services industry in developing economies. Alexander has completed the International Monetary Fund’s (IMF) program on Financial Programming and Policies – with a master’s degree in finance and a bachelor’s degree in economics and finance, he also holds a postgraduate certificate in mining from Curtin University. His research works have been published by the Global Business Review, International Journal of Economic Development etc.


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The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.