Possible Effects of a Hike in BRENT Prices on Turkey's Energy Bills and Current Account Deficit

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Levent Halefoğlu
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Possible Effects of a Hike in BRENT Prices on Turkey's Energy Bills and Current Account Deficit Turbulence in Mosul is threatening global markets pushing up oil prices up due to worries of cuts in

1 Possible Effects of a Hike in BRENT Prices on Turkey's Energy Bills and Current Account Deficit Turbulence in Mosul is threatening global markets pushing up oil prices up due to worries of cuts in supply. WTI and BRENT Crude Oil prices reached the highest levels since September 2013 with the initial effects of the events. BRENT crude oil prices rose above $115/barrel and WTI above $107/barrel. The premium, also, had fluctuations since the turbulence in Ukraine and Libya increased volatility in oil prices. The premium rose up to around 8 dollars recently (Graph 1: WTI BRENT Premium). Graph 1: WTI BRENT Premium Institute for Energy Administration reported last week that the overall demand for oil increased compared to last year s due to better macroeconomic indicators during the first quarter. Demand for oil during the first quarter of 2014 was 91.4 million barrels/day; IEA forecasts oil demand to be around 94 million barrels/day for the last quarter. By that; IEA increased its forecast for oil demand for 2014 to 92.8 million barrels/day. Total oil supply around the globe on a daily basis increased by barrels during May to 92.6 million barrels; despite decreases in OPEC s annual production. Non-OPEC countries oil supply increased by about 1M barrels/day. EIA projects Brent crude oil prices to average $108/barrel in 2014 and $102/barrel in 2015 and the WTI discount to Brent to average $9/barrel and $11/barrel in 2014 and 2015, respectively. Overall, the global demand for oil is expected to increase by 7.6M barrels per day until 2019 according to Institute for Energy Administration. Iraq s oil production makes up 3.7% of the world s total output. In case of a decrease, or a total stop in Iraq s oil production, analysts believe sharp hikes in oil prices, up to $120 - $125 per barrel, will occur.

The premium, also, had fluctuations since the turbulence in Ukraine and Libya increased volatility in oil prices. The premium rose up to around 8 dollars recently (Graph 1: WTI BRENT Premium).

Even though BRENT prices are a little bit down, after the sharp hike, due to the speculations that oil production will not be affected by the events; last week, Iraq s largest refinery in Baiji was

2 Even though BRENT prices are a little bit down, after the sharp hike, due to the speculations that oil production will not be affected by the events; last week, Iraq s largest refinery in Baiji was shut down since it was seized by ISIL militants. Baiji Refinery s daily production is around barrels. ISIL militants seize other parts of the country and the conflict does not seem to be ending soon; on the contrary, escalating every day. Why does the conflict affect Turkey specifically? Turkey s economy expanded 4.3 percent in the first quarter of 2014, but that growth saw inflation balloon 9.66 percent year-over-year in May, the highest since April Crude oil prices at a nine-month high create a serious threat to the Turkish economy, which remains vulnerable to inflation spikes and a further widening of its current account deficit. The Iraqi conflict will not only keep hindering global markets and rising crude oil prices; but it will also keep harming the Turkish economy because of the fact Iraq being Turkey s second biggest export market making up 7.9% of total exports. In addition to higher oil prices Turkey might have to pay, Turkish economy might also suffer from losses in income from exports. Turkish companies selling to Iraq already started whining as trucks are unable to reach markets in the neighboring country. If roads are kept closed for longer; Turkish companies might experience further losses, firings and even shut downs. Turkish Minister of Finance, Simsek stated that the geopolitical risks surrounding Turkey, namely Mosul events, will hurt Turkey s Current Account Deficit and that immediate action should be taken in order to control the situation. In addition; oil and natural gas imports account for over 90 percent of Turkish energy consumption, and a spike will be keenly felt by manufacturers. Even though Iraq produces 3.7% of the world s total output; Turkey relies on Iraq s oil, Iraq making up a considerable amount of Turkey s imported oil (See Graph 2). Graph 2: Percentage of Imports from Iraq Before the Iraqi conflict erupted, North Sea Brent crude oil spot prices had already increased from a monthly average of $108/barrel in April to $110/barrel in May due to geopolitical risks; turbulence in Ukraine, and events in Libya limiting oil output, have been adding to the volatility of oil prices. (Graph 2: BRENT Crude Oil).

ISIL militants seize other parts of the country and the conflict does not seem to be ending soon; on the contrary, escalating every day. Why does the conflict affect Turkey specifically?

3 Graph 3: North Sea BRENT Crude Oil Turkey s crude oil import totaled tons in Looking at past numbers, a very simple formulaic projection shows Turkey will continue importing about and above 20M tons of crude oil in the next years, considering Turkey is not planning on increasing its own production capacity. Graph 4: Turkey s Crude Oil Imports (Tons)

Looking at past numbers, a very simple formulaic projection shows Turkey will continue

4 Considering Turkey does not plan on increasing oil production of her own, and will keep existing import levels from Iraq, we may predict the amount of oil to be imported from Iraq for the next couple years. Assuming the price levels predicted by analysts, we may calculate the extra burden on the Turkish economy using simple forecast functions. Turkey s projected oil imports based on past years data can be seen below: Exhibit 1: Turkey s Oil Imports Projected for Turkey's Oil Imports (Metric Tons) (Projected) Should the violence escalate throughout the region and oil prices climb up to $120 - $125/barrel; Turkey s extra cost on oil imports may be predicted by calculating Turkey s predicted spending on oil without the hike in prices according to the medians forecasted before the Iraqi conflict erupted. Average BRENT price during 2013 was $108/barrel. Excluding the effect of the Iraqi conflict, predicted average oil prices for the next four years were $107; $103.50, $103 and $100 for 2014, 2015, 2016 and 2017 respectively. Had the Iraqi conflict not caused a hike in BRENT prices, then Turkey s payments for oil imports would be as seen below (Numbers exclude all costs related to transportation, other costs related): Exhibit 2: Cost of Turkey s Oil Imports Projected for Projected Prices $$/bbl Cost of Imports ($$) , , , , Now that the Iraqi region is hot and talks of a military intervention adds to the volatility of oil prices and hint that the conflict is nowhere close to come to an end; Turkey faces much higher energy bills to pay for the coming years all other factors kept constant. Turkey may have to pay the following amounts keeping all other cost factors as predicted without the Iraqi conflict; if the predicted $120 $125/barrel levels are reached (Numbers in US dollars).

Turkey s projected oil imports based on past years data can be seen below: Exhibit 1: Turkey s Oil Imports Projected for 2014 2017 Turkey's Oil Imports (Metric Tons) (Projected) 2004 23.917.

5 Exhibit 3: Cost of Turkey s Oil Imports Projected for Assuming Prices Go Up Tons Barrels Projected before Iraq $120 $ These increases in prices would be extra payments Turkey would have to make only on imported oil, had all other factors remained unchanged: Exhibit 4: Extra Burden on the Turkish Economy Projected for Assuming Prices Go Up Tons Extra Cost at $120 Extra Cost at $ Most of Turkey s energy needs is imported (90% of natural gas and oil, both indexed to crude oil prices). Higher energy prices threaten the current account deficit, which stood at $16.32 billion in the first quarter of 2014, 33.6 percent lower than in the first quarter of Taking into account all the threats posed by higher BRENT prices, Turkey s trade deficit might grow by as much as $3 billion in the next quarter per 1$ increase in the price of Crude oil. Higher Crude Oil prices mean higher production costs, possible shut downs, lower capacity utilization accordingly and lower exports. Near future of crude oil prices will depend on the course of events within the Iraqi conflict. US President Barack Obama said the conflict might spillover to neighboring countries, and special US forces were deployed to the region to advise the Iraqi military. Had this turned into a regional conflict, then many other aspects of the regional economy would have to be monitored. As a conclusion; depending on the continuation of the current situation in the Middle East, our initial estimate of 2014 Current Account Deficit of 50 billion USD will be revised upward, hence adding to unreached macroeconomic targets, along with the Consumer Price Inflation.

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