The fall in oil prices and its impact on the Colombian economy

The price of oil has dropped considerably over the past nine months. The Brend variety, the benchmark for Colombia, dropped from US$ 115 to US$ 55 a barrel, between June 2014 and March 2015. The lowest price was recorded on January 28 of this year, when it traded at US$44.45 a barrel. Such a rapid and pronounced fall had not happened before. The price variation and the way in which it took place were due as much to factors of demand as of supply.

Demand has been significantly reduced, behavior that is explained by, among other reasons, the global economic recession that began in 2008, and, above all, the low growth of China, which had been recording at more than 10%, but is currently at 7%. It also highlights the development of new technologies aimed at saving energy, the increased use of alternative energies such as wind and photovoltaic, and the greater participation of biofuels in the energy market.

Moreover, supply has increased due to the use of new extraction techniques (hydraulic fracturing - fracking), especially in the US, a country that has increased its production to 9.42 million barrels per day (average for March 2015), exporting during last December, 442 000 barrels per day. In addition, the increase in production of countries such as Saudi Arabia, Iraq and Libya -the first of which is currently producing 11, 525,000 barrels per day, which ranks it as the largest producer in the world, because of the large reserves it possesses and the low costs of extracting crude oil (US$6 a barrel on average) - the disagreement within the Organization of Petroleum Exporting Countries (OPEC) to reduce production and thus diminish the supply, and in consequence, increase oil prices. It should be emphasized that while Venezuela and Iran are in favor of lowering production, Saudi Arabia and Kuwait are opposed to this proposal.

For the Colombian economy the reduction in oil prices has affected several fronts. Exploration activity, according to Francisco Lloreda, president of the Colombian Petroleum Association (ACP by its acronym in Spanish), is practically stagnant as seismic surveying has fallen by 92% and exploratory wells by 82.6%. During this year (May 15, 2015) nine wells have been drilled, while last year there were 52. According to the union leader, sustainability of the million barrels that Colombia is currently producing daily is at risk. In addition, the fall in international oil prices will reduce economic growth by between 1.5 and 2% this year. This is explained due to the fact that crude oil exports represent 50% of total sales abroad and 20% of the tax revenue of the nation.

In fact, the deficit of 6.293 billion dollars in the balance of trade is a result of the aforementioned. In the last trimester of 2014 it was more striking: the deficit in those three months amounted to US$43.986 billion, noting that oil prices fell, but without reaching their lowest level. In the first two months of this year, the deficit was 3.038 billion dollars, an amount that is quite worrying, as it implies a rise in the exchange rate, which, if it remains at very high levels, besides benefiting some export products, could cause inflation, depending on the imports component, generate uncertainty in the evolution of the economy, and, in turn, alter the decisions of investors.

Simultaneously, the fall in oil prices affects 110 000 direct and indirect jobs, according to Labor Minister Luis Eduardo Garzon. Direct jobs, because oil companies have cut their investment plans, and indirect jobs (transporters, engineers, assembly and drilling firms, among others), because their activities (in late April) decreased by 47%, with the aggravating circumstance that oil companies are asking them to reduce their rates in order to continue their business relationship. The situation is so worrying that, according to Minister for Labor, the unions affiliated with the General Confederation of Workers (CGT by its acronym in Spanish) are willing to postpone their employment benefits, provided that they are not dismissed from their jobs.

In taxation the situation is critical; bearing in mind that one-fifth of the nation's revenue depends on oil, which has led the national government to rescheduling the budget so as to address the decline in oil prices. According to the Finance Minister, Mauricio Cardenas, a budget deficit of 9 trillion Colombian pesos is expected this year. Half of this is to be financed by resources from the last tax reform and the other half with more debt, which would bring the deficit from 2.3 to 2.8% of GDP. This deficit can be largely explained by the fall in oil prices, which necessarily results in a reduction in profits for Ecopetrol, even more so if one considers that the state oil company gave the nation dividends for more than 9 trillion pesos in 2014.

In general terms, the fall in oil prices will affect the economy as a whole. Variables such as employment, economic growth, national revenues, royalties for the departments, among others, will be hit, imposing the need to consider alternatives to lessen the impact. To the extent that the supply of crude oil increases by extracting it through unconventional methods, it is impossible that oil reaches the high prices that it had a year ago.

Luis E. Vallejo Zamudio

Director of Revista Apuntes del CENES