Impact of oil price fall on Asia: Winners and Losers

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Aditya Kumar's picture

 There is no better indicator of the state of world economy than oil prices as it impacts everyone, for better or for worse. Since it is the most traded commodity and one of the most traded financial contracts in the world it becomes important to understand the recent fall in the oil prices and its impact on various regions especially Asia as it has the largest net exporter (Saudi Arabia) as well as the largest net importer (China) of crude oil.

Who stands to benefit the most from the fall in prices in Asia remains ambiguous as it would depend on the respective governments as to how they will use this situation to meet their varying economic and geopolitical goals. Saudi Arabia, the leading member of OPEC by deciding not to cut its production may use this situation to regain its declining market share as sustained low prices may push out its expensive shale oil competitors in the short to medium run. On the other hand low oil prices would come as a mixed blessing for Japan which nearly imports all of its oil requirements, as low prices may improve the competitiveness of its manufacturing sector but at the same time it would frustrate the efforts of combating deflation.

Since June ’14 price of Brent crude has plummeted from a high of $110 to below $50 in January ’15 registering an almost 50% decline in prices. This recent volatility in oil prices, many would attribute to the oversupply caused due to increasing shale oil production and slowing global growth expectations is correct. But the underlying dynamics for this fall in prices has been in the making for quite some time. For the past two decades roughly from mid 1980s to mid 2000s oil prices have hovered around in between $35 to $50 excluding some exceptions caused due to conflicts and OPEC embargoes.

 From the beginning of 1999 as the commodity super cycle started building up, crude oil prices have been steadily increasing up to an all time high of around $140 in 2008. Many factors such as sustained double digit growth of china and other emerging markets like India increasing their demand contributed to this super cycle. Traditional sources of production could not keep up with the demand due to which prices spiked to an all time high until the North Atlantic  financial crisis hit causing steep decline in prices as the major economies slid into recession. As the dire social and economic consequences of declining growth became apparent, economic defibrillator in the form of stimulus from Washington and even bigger one from Beijing running into trillions of dollars along with Quantitative easing and commitment to low interest rates on the monetary front brought back prices to a sustained level of $110. This sustained high level of prices brought in new entrepreneurs, spurred technological breakthroughs and innovation in the industry.  Oil producers started venturing into new avenues of production like shale formations of Dakotas and Texas, tar sands of Alberta and deepwater projects in Brazil and Africa.  These led to an unprecedented increase in difficult to extract “tight-oil” production, with US alone increasing its shale oil production from non-existent in 2008 to 4 million barrels per day in 2014. This increase in production was somehow suppressed due to other geopolitical factors like conflicts in Iraq and Libya during early 2014, as the production got restored during mid 2014 it created a supply glut acting as a trigger for fall in prices. OPEC’s decision to stay on its production target did not help in arresting the slide of prices either.

This plunge in oil prices will have varying repercussions on Asian economies, with major oil importing countries like India and Indonesia may use it to cut back on its subsidy burdens while it would be mixed blessing for inflation-sapping countries like Japan and china.

Major oil producers like Saudi Arabia by deciding not to cut their production have allowed the prices to fall further in the hope of regaining its declining market share by pushing out its competitors. Saudi Arabia already has forex reserves to the tune $750 billion which can be used to finance its deficits in short run. Moreover it might have learnt from its decision to cut back production during 1980’s oil glut which failed to prop up prices and adversely impacted its wider economy. Low oil prices may also help in achieving its geopolitical goals as low prices has hit its nemesis Iran much harder due to already imposed sanctions from west.

Strengthening of dollar and tumbling oil prices would come as a major relief for china, which spent almost $250 billion on oil imports in 2014, although price control would translate 50 per cent slide in Brent crude into only half of its levels. Lower energy costs for its manufacturers will provide a fillip to Chinese economy which is already struggling with slowing industrial growth, bad debt levels and struggling to change its economic model from an investment driven to consumption led model.

Japan which fulfills nearly all of its oil requirements from imports, lower prices could help in curbing its trade deficit by almost 2 per cent. It would also help its manufacturing sector b reducing the input energy costs in turn improving the purchasing power of its households providing a boost to domestic consumption. Some of the benefits of slide in prices may get blunted due to weakening of yen. Japan’s inflation has already fallen to a 13 month low of 0.9 per cent and further decrease in oil prices would blunt the government’s effort to combat deflation putting further pressure on bank of japan to provide stimulus. This would lead to further depreciation of yen preventing any positive impact of lower prices on purchasing power.

 

India which has been struggling with chronic high inflation and high current account deficits, fall in oil prices couldn’t have come at a better time. Its newly elected Modi administration has already taken this opportunity to slash diesel subsidies and increase taxes on fuel. Lower prices would also help in meeting the budget deficit targets of 4.1 per cent giving space to RBI to further cut interest rates without stoking inflation.

Middle-east which houses nearly 5 million NRI’s is also the biggest source of remittances, $32.7 billion dollars in 2014. As lower oil prices slows down economic activity in gulf, source of remittances would also get adversely hit.

Indonesia and Malaysia has already taken advantage of fall in prices to reduce its subsidies on fuel freeing the much needed capital to invest in infrastructure projects and welfare schemes. It has also provided a ripe opportunity to deregulate prices and initiate further fuel pricing reforms.

Some other beneficiaries would be South Korea, Thailand, Taiwan and other oil importing nations. Thailand stands to benefit the most from the plunge in oil prices as it has much higher dependence on road transportation than rail and the proportion of oil in its energy consumption basket is rather high.

The recent fall in oil prices may be dramatic but they are not random. The underlying cause behind these movements in prices is an unprecedented surge in non-conventional oil production against decreasing global growth expectations. Fall in oil prices will come as a boon for most of the Asian economies but their response will determine who will be the biggest beneficiary. Volatility in commodity prices may spur oil rich nations to diversify their economies and insulate themselves from future supply shocks whereas lower oil prices may help in improving the productivity potential of the overall global economy.

References: 

* wall street journal

* financial times

* economic times

* vox.com

* Deutsche bank