Crude Oil – Fueling The Good Times!

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Keshav Bagri's picture

Oil has definitely been the most debatable commodity of 2014. It was a cause of relief for many governments and a nightmare for some. The flimsy fall in its prices was concocted by forces of Economics, Strategy and Politics together. From Economics, the oil from unconventional sources, mainly from the US Shale reserves increased the world supply in the recent years, outstripping demand which pressured the prices downward. From Strategy, OPEC has been adamant about its short term objective for greater market share, thus, doing all it takes to keep its market share intact. From Politics, OPEC cannot stand any new entrant in the oil market, hence, the efforts to forcing the US producers out with non-feasible price. Although OPEC itself needs oil price at $100 a barrel (much more than the current price), it would temporarily endure the losses with huge reserves of oil dollars earned over the years until the new players go out of the market.     

Most Asian countries are net importers of oil and depend upon supplies from Middle East. Thus, any fall in oil prices would be a significant relief on their Balance of Payments. It will allow the governments more fiscal room to reduce their subsidy burden and spend the saved funds more productively. It will also help fight inflation in countries like India. In the political and strategic play between OPEC and the other oil producers, Asia stands to gain by a transfer of wealth from oil exporters. The task at hand is to determine the biggest gainer and the biggest loser in Asia.   

For the purpose of objective evaluation, a mathematical index for major Asian economies can be constructed which will allow ranking the countries according to relative importance of petroleum in their economies. The index consists of three main energy indicators –

  • Energy Intensity – Total primary energy consumption per dollar of GDP
  • Energy use (kg of oil equivalents) per capita
  • Energy imports – proportion of imports in total energy consumption

The higher the energy intensity, the more the country is dependent on oil for generating its GDP. The more the energy use per capita, the more vital is oil in the day to day activities of citizens of the country and a higher proportion of energy imports reflect dependence of these countries on foreign producers. The more the proportion of imports, the more the country is vulnerable to external supply shocks, like the current one.

The index score = Energy intensity * Energy use * proportion of energy imports

Although very simplistic and crude, the index value gives a rough idea of importance of oil in the respective economies. The higher the index score for a country, more important oil is to that country. The major Asian countries are ranked below according to the index score –

 

 

 

 

 

 

Energy Intensity (1)

Imports (proportion of total energy consumption) (2)

Energy intensity per capita (3)

Index Value (1)x(2)x(3)

Singapore

11389.64

0.97

6452.32

71437246.87

Korea, South

9852.54

0.81

5231.87

42247111.55

Japan

5614.29

0.88

3610.37

18000082.21

Hong Kong

4283.20

0.99

2106.11

8988830.98

Thailand

8198.00

0.42

1789.63

6206482.052

China

10692.84

0.10

2029.36

2348560.323

India

6323.97

0.27

613.71

1079795.506

Philippines

3952.40

0.40

425.57

688749.3763

Pakistan

4864.76

0.23

481.61

546161.234

Sri Lanka

1772.66

0.48

499.33

432461.8777

Cambodia

1544.4

0.28

365.14

162835.9302

Bangladesh

2234.96

0.16

204.72

76091.88735

Bhutan

17707.2

0

0

0

Maldives

6646.96

0

0

0

Laos

2934.40

0

0

0

Afghanistan

1518.41

0

0

0

Timor-Leste (East Timor)

4683.32

0

0

0

Vietnam

7030.49

-0.08

696.83

-431048.136

Malaysia

7502.98

-0.11

2639.43

-2180846.7

 

A positive index value shows that the country is a net importer of oil and a negative value implies a net exporting country. Obviously, net importers gain from oil price slump and net exporters lose. So, we take the countries at the top and the bottom for country specific analysis to boil down to two nations – the winner and the loser.

Among the table toppers, benefits to some are accompanied by doubts. For example, in Japan, cheaper crude oil prices would reduce the price of LNG (LNG prices are directly linked to crude oil prices) on which Japan heavily post the Great Japanese Earthquake of 2011. However, it will slow down the pace of inflation and stymie the target of 2% inflation set by BoJ to be achieved by fiscal 2015. Also, a lower import bill will appreciate Yen, discouraging exports which have anyway remained flat since 2012. In the same breadth, Singapore, as an importer of almost all of its oil consumption will gain by improvement in Current Account balance. It is a major hub for refining and storage of crude and refined products. There has been no corresponding fall in costs of these services. Also, the major players in the region are looking elsewhere to avail these services. Adding fuel to the fire, China would now route its imports through rail from the port built by it in Myanmar and South Korea & Japan are planning to import oil from the US, potentially cutting volume of Middle - Eastern oil and gas through Singapore by 20%.

Countries like South Korea and Hong Kong also stand to gain from crude price drop as prices are passed on to the consumers. South Korea boasts of 3 of the world’s top 10 refineries in the world and exports refined petrol. The cost of production at refineries will go down with price fall.

The countries, however, which deserve the most attention are Thailand, China, and India. China, now the largest importer of crude oil in the world, stands to gain heavily from the current episode. Firstly, inflationary pressures would ease. Secondly, the Chinese economy has been slowing down for the last two years. Lowered cost of production due to low oil price will help it grow. Thirdly, China is ramping up its stocks of oil by importing heavily in the face of falling prices. High volume of stocks will help it absorb the benefits of current low prices even in future. However, price rigidities in passing on price changes to the end consumers will restrict the extent of short term gains from price changes accruing to consumers.

In case of India, oil price drop was a much needed relief and came at just the right time. India imports two thirds of its oil requirements and every dollar drop in oil price reduces India’s current account deficit, notoriously high in recent years, by roughly $1Bn. Also, India’s stubborn inflation will be put to rest with fall in oil prices. Best of all, with the new government in place, there would not have been a better time and chance to deregulate diesel and petrol prices without any controversy. With government’s huge subsidy burden removed, it has more fiscal room to spend on infrastructure. Also, it has allowed the interest rates to be cut, which had been high for some time, as inflation seem to be within the target range.

Thailand has three major reasons to rejoice from falling oil prices. Firstly, it has just come out of a political turmoil and stability seems to return with military junta taking control. Oil prices would provide a boost as well as a distraction to the Thai economy. Secondly, as Thailand relies more on road rather than rail for transportation and the proportion of oil in its energy basket being very high, oil prices would benefit it immensely. Thirdly, at low prices, Thai government can re-impose excise duty on diesel without opposition. Government can obtain much needed revenue to be spent productively.

Talking of countries that loose the most from oil price slump, Malaysia clearly leads the pack. It’s the only major exporter of oil in the region. For Malaysia, problems come from more than one direction. While oil related revenues may fall from 5.9% to 3.1% of GDP according to Bank of America Merrill Lynch estimates, Malaysia, the second largest producer of palm oil, would also lose by a fall in palm oil exports led by the rout in crude oil prices. Since palm oil prices are now trading at a premium over crude oil prices, it makes conversion of Crude Palm Oil (CPO) into Bio Diesel more expensive. Also, with 30% of government revenues coming from oil, even removal of oil subsidies will not help it meet the fiscal deficit target of 3%. Another concern for Malaysia is the value of Ringgit. With US rates getting normal and US dollar strengthening, capital flight from the country seems unavoidable. A weaker China and weaker global economy tell a sad story for the more open, export led Malaysia.

From the discussions above, the tough competition between China, India and Thailand seems to be won by Thailand as the biggest gainer out of the crude oil price tumble, not only for economic reasons but for social and political benefits. Generally, the whole of Asia and especially the three countries mentioned above benefit the most from current trend in oil price, except of course Malaysia, which turns out to be the biggest loser, in fact.

 

References: 

 

1) Oil Market report, International Energy Agency, 12 December 2014

2) Positive and Negative Impacts of Rapid oil Price Drops, The Institute of Energy Economics, Japan, December 2014

3) Implication of lower oil prices, CIMB, October 29, 2014

4) Industry Focus SE Asia Oil & Gas Sector, DBS Group research, 20th October, 2014

5) Falling Oil Price: An Opportunity for Asia? By Lee Chia-Yi, RSIS commentary, January 2, 2015

6) Understanding the Plunge in Oil Prices: Sources and Implications, Global Economic Prospects, January 2015

7) OPEC monthly oil market Report, 10 December 2014

8) Oil price effects on Asia, the US and Latam, Standard Chartered Global Research, October 24, 2014

9) http://loanstreet.com.my/learning-centre/falling-oil-prices-malaysia-effect

10) http://drdzul.com/2014/12/02/oil-price-drop-could-be-malaysias-achilles-heel-tell-pm-najib-that-ya-please/

11) http://www.thestar.com.my/Business/Business-News/2015/01/14/Palm-touches-oneweek-low-as-soy-crude-oil-drop/?style=biz

12) http://news.xinhuanet.com/english/china/2014-11/28/c_133821067.htm