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The geography of cheap oil

  • Written by  Oksan Bayulgen
  • Published in Energy
The geography of cheap oil Shutterstock
16 Jan
2015
Norway and Russia, both oil-exporting countries, are likely to experience two very different outcomes from the slump in oil prices

The deep plunge in oil prices is hurting all oil-producing countries across the board. But the extent of the vulnerability and pain depends on how economically and politically prepared these oil-rich countries are to oil price shocks.

In many ways, Norway and Russia represent the two polar ends of the spectrum. First the similarities: Both countries generate almost a quarter of their GDP from oil and gas. They are two of the largest oil producers in the world and the two biggest exporters of energy to Europe. The oil and gas sector is the engine of growth and employment in both countries. As the price of oil plummeted since June, the currency in both countries depreciated against the dollar, prompting drastic monetary policy measures from the governments. While the Russian Central Bank raised interest rates to strengthen the plummeting rouble and reduce inflation, the Norwegian government cut interest rates to encourage economic growth.

Falling oil prices3Oil prices have more than halved in the past six months. Image: Digital Look

Despite the similar external shock, many experts predict that these two countries will be affected very differently in the long run. The oil price collapse compounded by Western economic sanctions is leading Russia into a recession. The impact on Norway, on the other hand, is expected to be much limited. In fact, some even predict that the current state of the oil market will be a blessing in disguise for Norway.

In my opinion, the main reason for this difference is the political structures that manage the massive oil wealth and apparatus in these countries. Historically, Norway has relied on its robust democratic system and professional bureaucracy to make investment, production and distribution decisions regarding the energy sector. Since oil was first developed in the 1970s, the Norwegian people – through their interest groups and political parties – have debated every stage of the oil and gas development and reached decisions in a collective and deliberative manner. This reigned in some of the ill effects of sudden riches that we observe in other countries, including Russia. Early on, Norway was able to establish an oil fund which, over time, became the world’s largest ‘sovereign wealth fund’ with $870billion today. The self-imposed caps have helped accumulate the wealth over time while at the same time allowed the government to use the investment returns for welfare and other government spending.

Norway today is better situated than any other oil producer to weather the current oil price shock thanks to its long-term strategic planning and democratic decision-making structure. No doubt, there are and will be fierce debates about the sustainability of some of the welfare spending and what to do about weakening job market. But already, the discussion is moving towards how best to cut costs and increase efficiency in the oil sector, invest more in renewable energy technologies and make the non-oil sectors more competitive and profitable in the long run. The economy in Norway is showing resilience due to the deliberative and constructive ways its political system is dealing with the crisis.

Russia’s aggressive foreign policy behaviour, as recently witnessed in Ukraine, makes the oil-induced pain more acute. With oil at its current level, it is predicted that Russia will spend all its reserves within two years

Russia, on the other hand, in the past 20 plus years has created an oil and gas complex that increasingly dominated the economic as well as the political system. The lack of diversification in the economy beyond oil has made Russia inevitably vulnerable to a price shock. Moreover, the lack of transparency and collective decision-making in the political system narrows down the choices in front of the government and weakens the legitimacy of the response to the crisis. The aggressive foreign policy behaviour, as recently witnessed in Ukraine, does not help the situation either. In fact, it makes the oil-induced pain more acute. Similar to Norway, Russia has also saved some of the oil wealth but without the similar restraint mechanisms in place, the Russian oil fund is fast dwindling. With oil at its current level, it is predicted that Russia will spend all its reserves within two years.

The bottom line is that Norway is better situated than Russia in dealing with the plunge in oil prices. Surely, belts will be tightened and some painful decisions will be made in the short run in Norway as well. As in most economic crises, the popularity of the current government will also be hard hit. But what I foresee happening in Norway is a much more deliberative, transparent, equitable and reasonable debate and reaction. In Russia, on the other hand, the inseparability of oil industry interests and state power and the increasingly constrained political space make a legitimate and sustainable response difficult, if not impossible. If I were an investor, I would surely bet my money on Norway.

Oksan Bayulgen is Associate Professor of Political Science at the University of Connecticut, and author of Foreign Investment and Political Regimes: The Oil Sector in Azerbaijan, Russia, and Norway

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