The recent decline in world oil prices is likely to constrain economic growth and investment in the Caspian region.

The steep decline in global oil prices has dealt a blow to earnings for many energy-exporting states, pushing their finances and investment projects over the red line. They have suffered slowdowns since crude prices began to slide in mid-2014, but most of them still expect to weather the crisis and will draw on their significant currency reserves to keep their economies and projects floating.

The Caspian states – specifically, Azerbaijan, Kazakhstan and Turkmenistan – are among these believers. This essay will focus on their responses to the price crash.
Nobody knows with certainty when and how this prolonged and unexpected market fluctuation will end.

Even if conditions were to stabilise soon, the consequences of the dramatic fall that has already occurred could be serious. And if the market remains bearish, these countries could have a very hard time, not only with respect to recouping their losses but also in facing much tougher competition for new investment.

Under pressure

Caspian oil and gas exporters are already feeling the pressure from low oil prices and slow global economic growth. Additionally, they are also being squeezed by the knock-on effects of Russia’s economic crisis.

Among the former Soviet republics, Kazakhstan and Azerbaijan are the biggest crude oil producers in the Caspian region. According to the International Energy Agency (IEA), Kazakhstan exported about 1.69 million barrels per day of oil in 2014, while Azerbaijan exported 840,000 bpd and Turkmenistan 280,000 bpd.

Since Turkmenistan is predominantly a gas-exporting country, it is more insulated from the fall in oil prices. But if the market remains at its current level for a long time, the country will soon face more serious problems than it has so far. Its export contracts may soon be generating less money than usual, as they link gas prices to global oil prices, which have sunk by about 50% since last June.

Kazakhstan and Azerbaijan are also bound to be hurt by the deterioration of crude prices. Since these two countries rely heavily on oil exports to generate budget revenues, they have felt an immediate negative impact from the bearish market conditions.

Until this year, oil revenues accounted for 60% of Kazakhstan’s budget and made up 33% of GDP. Now, though, income is set to fall. Last October, Astana revised its 2015 and 2016 budget projections, which were originally based on average forecast oil prices of US$90 per barrel, to a more conservative US$80 because of the fall in oil revenues. Since then, crude has dropped even more dramatically, falling to US$50 per barrel.

According to the International Monetary Fund (IMF), Kazakhstan can only balance its budget if oil prices average about US$65.5 per barrel or more. As a result, the bearish market has pushed the budget well into the red, and the Kazakh economy may well post zero growth in 2015.

Last December, Kazakh President Nursultan Nazarbayev told local television channels in an interview that his government had sufficient reserves to weather the crisis. Additionally, he said, Astana has an action plan to handle the situation if oil prices fall to as low as US$40 per barrel, so the country’s citizens should not worry.

Kazakhstan does indeed have large reserve funds. Its National Fund contains US$76 billion, or three quarters of Kazakhstan’s total reserves of US$104 billion, according to official reports. It remains to be seen, though, whether these can be deployed effectively over the course of the price crash.

Azerbaijan faces much the same situation. That is, its state budget depends on oil for 65% of revenues. Last December, the Azeri government declared that the country would not face any major obstacles in 2015. It also said the economy could remain afloat if crude oil prices averaged US$60 per barrel and that there were no obstacles to the implementation of major infrastructure and social projects.

Since then, though, prices have fallen even further than Baku expected. Even so, President Ilham Aliyev recently promised that the population would not experience hardship from falling oil prices. He claimed that the country had reserves of about US$50 billion, enough to protect itself from global economic upheavals.

As such, both Azerbaijan and Kazakhstan have ample resources to grapple with fiscal shortfalls and to prevent further economic slowdown in the short term, and perhaps in the medium term as well. Both have short- term back-up plans to use those resources.

However, recent developments have highlighted a serious long-term problem – namely, the need to craft new strategies to reduce the current heavy financial dependence on oil income. This could be particularly important for Astana and Baku if the current bear market is a sign of fundamental shifts on world oil markets.

Changing calculations

Meanwhile, the same financial institutions and agencies that predicted steadily higher oil prices last year have now dramatically slashed their forecasts.

At the same time, international oil companies (IOCs) are likely already analysing their mistakes. Their overconfident forecasts of rising prices led them to take what now appear to be overly risky investment decisions. As a result, they are revising investment programmes based on the belief that oil would remain bullish over the long term. This means that huge and costly projects such as Kashagan will be scrutinised and questioned in a much tougher way.

Work at this field, which is the largest oil deposit in Kazakhstan, is already running far behind schedule. Investors must now ask themselves whether Kashagan will be a loss-making operation if oil prices fall further. According to some estimates, production costs at this Kazakh site are already about four or five times higher than at an average Iraqi or Saudi field.

Similar questions may be asked about other potential projects in the region. Though none is likely to equal Kashagan in complexity and expense, Caspian initiatives do tend to entail higher production costs. Thus IOCs have obvious reasons to focus on fields that are less expensive to develop.

This shift was already under way last year, even before oil prices began falling. It is now set to accelerate, which means less money will be available for new Caspian projects. This is not good news for Caspian energy-producing states. Eventually, lower oil prices, shifting investment targets and scarce financial resources could cause these countries’ current account balances to deteriorate significantly, making new projects even less attractive.

In its Short-Term Energy Outlook, released in January, the US Energy Information Agency (EIA) said it expected oil prices to average in the mid- US$50 per barrel range in 2015, close to current market levels. Meanwhile, the IEA has scant hope that crude will return to higher levels.

But even if prices do recover, IOCs are likely to conclude that some oil exports and energy projects are simply not economically justified over the long term. As such, they are likely to scale back investments in the Caspian region in the short term.

(This Commentary was originally published in the January 21, issue of FSU Oil & Gas Monitor. It is reprinted here with permission.)

Najia Badykov is a visiting fellow with the Russia and Eurasia Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2015 by the Center for Strategic and International Studies. All rights reserved.

Najia Badykov