In Asia who Benefits and Loses the most from Falling Oil Prices?

Posted in Finance Articles, Total Reads: 834 , Published on 02 June 2015
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Over the past few months we have seen one of the steepest falls in the price of oil. Oil prices have fallen over 40% in the last few months and this steep fall has caused chaos in the global economy. Economists are left clueless as to whether this cheap oil is for the betterment of the global economy or will this cheap oil add to or decrease unemployment, or complicate the global effort to "defeat" deflation.


Most of Asia seems well-positioned for this cheap oil given that most economies in Asia are importers of energy, the correction in commodity prices bodes well for the region’s current account and inflation outlook. But before we jump to the conclusion that low prices are a boon for all, let us look into who benefits and who loses the most from this decline in oil price.



Background:

Let us first look into the macroeconomic and political impact of low oil prices and then we shall look into country specific impact taking the three major economies of the emerging Asia.


With a fall in the price of oil there arises an opportunity for reform. In countries where fuel is sold below market rates, authorities can take advantage of the drop in the international oil price to remove costly fuel subsidy without having to suffer a spike in domestic fuel prices. Some examples of countries that have slashed fuel subsidies are India, Indonesia and Malaysia. The resources that would be tied down to provide for these subsidies can be freed and reallocated to more productive areas such as education, public healthcare and infrastructure.


For countries that are oil exporters, it is possible to mitigate this short term loss in revenue into a long-term gain. With commodity prices low the exchange rate depreciates and this fares well for the manufacturing sector which needs a depreciated currency to make exports competitive.


There are winners and losers in every geo-political event and we shall look into who exactly are the big winners and losers in Asia from this steep fall in oil price.


Impact on China:

The effect on China is mostly beneficial. China is the world’s largest net importer of oil with nearly 60% of its domestic supply met by imports. So lower the oil falls the better it is for China. China is in a period of slowing growth, its engines of double digit growth have slowed down and now growth is at a moderate 7.5%-7.7% (China has averaged 10% average growth over the past two decades). Thus low energy prices not only help jump start the stalling manufacturing sector in the present but China can also buy more oil than it needs now and warehouse it for times when the price of oil rises again. That translates into enormous savings for China in foreign exchange. China is looking to save as much as $30 billion by the end of the year if prices continue this way.


However there are losers to every game and in the case of China they are its national oil companies which are under a ton of debt. China’s national oil companies are already struggling under the pressure of Beijing’s desire to substantially boost domestic energy output. In recent years China has embarked on a major program to extract its own shale gas reserves setting a target of producing 60-billion to 100-billion cubic metres of shale gas per year by 2020 (in perspective the entire Canadian industry produces 142-billion a year), and spent heavily to accomplish that goal. Estimates suggest that Government owned oil companies Sinopec and CNPC lost $1-billion pursuing shale gas last year, and China set a national subsidy of roughly $1.83 per thousand cubic feet.


Impact on India:

Agriculture still forms an important part of the economy for low income countries. Agriculture is more energy intensive than even manufacturing because energy is the main input into fertilisers, and in many countries farmers use huge amounts of electricity to pump water from aquifers far below, or depleted rivers far away. Therefore growth in such countries is very sensitive to energy prices. For example India which is home to about a third of the world’s population living on under $1.25 a day. Cheaper oil is a threefold boon. As in the case of China imports are cheaper and the fiscal burden is reduced. Exports are not witnessing across-the-board price declines since they are diverse (everything from textile to computing services). Cheaper energy also moderates inflation, which has already fallen from over 10% in early 2013 to 6.5% bringing it in the central banks targeted range. The lower inflation figures should boost investor sentiment leading to inflow of capital.


Cheaper oil also cuts India’s budget deficit, now 4.5% of GDP, by reducing fuel and fertiliser subsidies. These fertilizer subsidies along with food subsidies total 2.5 trillion rupees ($41 billion) in the year ending March 2015—14% of public spending and 2.5% of GDP. The government in the past controlled the price of diesel and compensated sellers for their losses. But now for the first time in years the sellers are making a profit. As was the case in China, cheaper oil reduces the pain of cutting subsidies—and on October 19th Narendra Modi, India’s new prime minister, said that he would finally end diesel subsidies, free diesel prices and raise natural-gas prices.


Impact on Indonesia:

The fall in oil price has brought mixed blessings for Indonesia. On one hand low oil prices would shrink burdensome fuel subsidies, but on the other hand an oil price of below US$60/barrel would not be economical as the loss in state revenue from the oil sector might exceed the economic benefits. Despite being a net importer, Indonesia exports some of its oil abroad but the oil extraction process in Indonesia is not viable at prices below $60/barrel. According to a figure by US Energy Information and Administration, Indonesia exported 455000 barrels per day last year. With the fall in prices there has been an accompanying fall in investments into oil and gas exploration industry. Companies working on oil and gas blocks in Indonesia are cutting back on investment next year. This has hurt the state revenue collection.


Impact on Japan:

Japan imports almost all of its oil and is the third largest oil importer in the world. Low oil prices have reduced the cost of inputs which has helped the manufacturers’ lower prices, in turn lifting wages and the economy. The consistently low prices can frustrate the government to lift the economy out of deflation through aggressive monetary easing. Japanese core inflation last month fell to 0.9 per cent, a 13-month low. A further erosion in inflation from lower oil prices will raise expectations that the Bank of Japan will once again beef up its stimulus efforts.


That would lead to a steeper depreciation in the yen, which in turn could mitigate the positive impact of falling oil prices on the purchasing power of Japanese households.


Conclusion:

We can sum up by saying that low oil prices do more good than harm. Some studies suggest that a $10 fall in the price of oil transfers the equivalent of 0.5 percent of world GDP from oil producers to oil consumers. This has a knock off effect on consumption as consumers spend more of their income on other goods and services. Low oil prices act like a tax cut increasing disposable income. Those to suffer include producers and some governments, whereas the global economy is set to benefit from the equivalent of a huge program of quantitative easing.


This article has been authored by Akshay Mall from XLRI




References:

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