Kolkata, India — When a barrel of crude oil touched a historic high of US$147 in July this year, the insatiable demand in Asia, particularly in China and India, bore the brunt of the blame for the notorious spike. Now, as oil prices continue to slide following the global financial crisis that has dented consumer confidence, the same two countries may exacerbate the collapse, say analysts.
According to some global oil research outfits, although falling demand in developed economies like the United States, Europe and Japan have led oil prices to halve since July, an economic meltdown in emerging Asian countries could lead oil prices to touch lows that few would have imagined even a few weeks back. Although at first glance low global oil prices look significantly beneficial for the region, in the long run a particularly sharp decline could have hidden costs not only for Asian economies but for the world.
“Insatiable demand for oil in emerging Asia and in particular in India and China was an important factor in the spike in global oil prices,” said Matthew Mirecki, Asia analyst at Business Monitor International, a London-based research firm on emerging markets. “We believe that the major driver behind lower oil prices has been demand destruction in developed countries – a result of the vast wealth destruction which has been witnessed in the wake of the unfolding financial market crisis. As demand for Asian goods has waned, so has economic growth; thus, demand for oil has moderated accordingly; this has exacerbated the decline in oil prices.”
In a report released last week, BMI projected that the ongoing financial crisis, combined with deteriorating global economic fundamentals and incredible wealth destruction through global asset price deflation, will weigh heavily on commodity markets. That, according to Mirecki, coupled with mounting concerns over decreasing consumption growth in China and India, could lead to a situation where Asia could have a “significant role to play in the collapse of oil prices.”
BMI in its report also said that in view of “a very gloomy global macro outlook,” oil could touch its operating cost of US$50 per barrel over the coming months. Indeed, oil prices slumped by US$2.92 on Thursday on the New York Mercantile Exchange, to touch a 14-month low at US$71.60 as global recession fears took center stage, with global stock markets tanking yet again despite trillions of dollars of bailouts from governments around the world.
Even so, oil may still be the “most richly priced commodity currently,” said a Deutsche Bank commodity report, according to which prices would need to fall to US$35 per barrel in order to represent “cheap” oil.
“The big question is how Asian demand will hold up,” says Jason Feer, the Honk Kong-based bureau chief of Argus Media, which claims to be the world's largest independent energy news and price reporting agency.
“Although most countries in the region are not exclusively export driven, their economies are nonetheless heavily weighted toward exports. Given that in the U.S. and in the Organization for Economic Co-operation and Development countries demand is already dropping, we are already starting to see signs of weakening demand in China and India as problems in their main export markets, like the U.S. and Europe, have had a knock-on effect,” Feer said.
The fact is, unlike many other commodities, “Asia is important for crude oil because its marginal demand is entirely coming from Asia,” said Michael Lewis, global head of commodities research at Deutsche Bank. The bank estimates that in 2009 as much as 360,000 barrels per day of oil will be required by China, which is lower than the 450,000 bpd for the current year. At that rate, “China will be responsible for 80 percent of global crude oil consumption growth,” said Lewis.
Similarly, industry estimates put India’s oil demand at 100,000 bpd in 2008 and predict it to remain unchanged for 2009, even if the country’s gross domestic product were to slip marginally from its current 7.5 percent.
Hoping that Asia and particularly China and India will not falter due to the global meltdown may be optimistic under the current conditions. “What we are seeing is that the Group-3 (United States, Europe and Japan) virus is likely to spread to Asia,” said Lewis. “It will spread because Asia’s export-to-GDP ratio is something like 85 percent. And although the export-to-GDP ratio in China and India is lower at 30 percent, the investment cycle in these countries is pretty much driven by the export cycles, so there are rising demand destruction risks in China and India as well.”
Industrial production in India and China, since peaking around mid-2007, has slowed across the board. India's index for industrial production rose at a dismal 1.3 percent in August 2008 compared to 10.9 percent in August 2007, while in the past three months, Chinese industrial production has shown a decline from approximately 18 percent to 14 percent.
Lower oil prices could benefit Asia significantly, however, at least on the face of things. That is because the region as a whole is a huge net importer of oil with only two of the fifteen biggest economies in the region – Malaysia and Vietnam – exporting more than they imported in 2007.
Consequently, the high oil prices of the past two years have exerted a fair amount of downward pressure on the region’s balance of trade – exports versus imports – due to highly inflated import bills. That downward pressure, in turn, weighed heavily on Asian currencies and intensified the second problem created by soaring energy costs – inflation.
“Lower oil prices will therefore help to ensure a greater degree of price stability in the region, and will consequently help to bolster economic growth as intense pressure on both consumers and industry is relieved,” said Mirecki.
Another reason Asia will be glad to see lower oil prices is that domestic fuel prices across much of the region remain heavily subsidized. “That has been one of the biggest distortions in the oil markets,” said Lewis, “as fuel subsidies in China, India, Malaysia and Indonesia, and in quite a number of other countries, have supported oil demand growth in these countries.”
Besides, owing to subsidies, record-high energy prices have proved to be a significant drain on state coffers of almost all Asian governments. “Weak oil prices, then, are a good opportunity for reforms,” says Feer of Argus, because “falling oil prices can give the Asian governments a chance to wean their economies away from subsidies.”
Nevertheless, prolonged low prices also have hidden costs. Experts say that in the long run, low oil prices discourage investments in oil production and refining, which in turn leads to future price increases when demand catches up. The risk is if the prices fall too low, the oil industry may be left with little money to invest in further production and refining capacities, which could lead later to another cycle of high prices. “So lower oil prices create a risk of higher oil prices in future,” says Feer.
Moreover, artificially low oil prices encourage inefficient energy use among consumers and industries. The Chinese economy for instance requires twice the amount of energy needed in the West to create US$1 of GDP, says Lewis. These asymmetries become more acute if low oil prices persist.
But there may be light at the end of the tunnel. A sharp correction in the oil price could make China and India stockpile crude oil aggressively for their strategic petroleum reserves. According to published numbers, China and India have built reserve capacities of 103 million barrels and 36 million barrels, respectively.
In China, says Lewis, “We estimate SPR filling could amount to 100,000 bpd and that could be a supportive factor.” He added that despite downside price risks to oil in 2009, prices could eventually settle at a fair value between US$90 to US$100 per barrel thereafter.
Source: written by Indrait Basu (UPI Asia.com)
