Key Points
Price shocks are a feature of international oil markets, with the oil price collapse in the second half of 2014 being the most recent example. These episodes are a source of macroeconomic disruption that harm economic activity in the short and medium term, particularly for oil-exporting countries.
The recent emergence of non-conventional oil – such as light, tight oil – represents a critical change in oil markets. Investments in non-conventional oil react very aggressively to changes in oil prices, impacting the structure of oil markets, and could reduce volatility in the future.
Three approaches to stabilizing the economies of exporting countries can provide different ways of achieving specific objectives:
Sovereign wealth funds, which invest current oil and gas revenues in long-term assets so as to increase future economic welfare, are the most widely used strategy. In particular, stabilization funds essentially boost savings from oil revenues in good times, when prices are high, so these can be released through increased expenditures to stimulate the economy during bad times, such as during a price shock. The type of fund and investment strategy to be used depends on the policy objectives and time horizons.
Economic diversification addresses the reality that oil-exporting countries tend to have their producing sector concentrated in oil and oil-related activities. Diversification is a way to reduce the resulting gross domestic product (GDP) volatility. In the case of the Gulf Cooperation Council (GCC) countries, it appears that higher growth with lower volatility could be achieved by increasing the share of the manufacturing sector in the countries’ GDP, while reducing the shares of services and oil and gas.
Diversifying the energy mix of the GCC would not, by itself, reduce oil-fueled volatility in the economy. It would reduce domestic consumption of oil and gas and permit increased exports. Stabilization, though, will only be brought about by diverting these funds to broader economic diversification or increasing the size of stabilization funds. Otherwise, higher exports would also increase the countries’ exposure to oil price shocks.