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Nov 5, 2014 | 10:00 GMT

9 mins read

Dropping Oil Prices Benefit Major Consumers

The Global Drop in Oil Prices - Part 3

Editor's Note: This is the last installment of a three-part series examining the effects of the recent drop in global oil prices. Part One focuses on the structural changes in the oil market that led to, and could prolong, the price drop. Part Two examines the countries that stand to lose the most from the decrease in global oil prices. Part Three looks at the countries likely to benefit the most.

China

Falling oil prices are a welcome development for China. The Chinese government is struggling with declining home prices, falling real estate-related investment and construction, rising corporate and local government debt pressures, an anemic export sector and rising costs across the board, all of which are affecting economic growth and employment.

Cheaper oil will not reverse China's property sector slowdown, nor will it fully offset the slowdown's effects on Chinese automotive demand, its transportation and logistics sectors, or oil consumption for industry. However, cheaper oil will provide some much-needed relief for Chinese manufacturers and exporters by lowering input costs. It will also help China's logistics industry, a crucial component of the services sector, which Beijing is hoping will absorb much of the employment shed by the housing and infrastructure construction industries in the coming years. Moreover, given that China's transport sector accounts for roughly half of China's total oil products consumption, the falling oil prices will benefit Chinese consumers doubly: Not only will prices for ordinary consumer goods fall (because of lower transport and logistics costs), but prices at the gas pump will be lower, too. This could stem the short-term slowdown in automotive purchases that is likely to result from China's housing construction downturn.

Low oil prices are a mixed bag for China's major state-owned oil companies. On one hand, as the so-called Big Three — PetroChina, China National Offshore Oil Corp. and Sinopec — expand their global exploration and trading operations and complete their transformation from state bureaucracies to full-fledged global energy firms, they will suffer the same negative effects of falling oil prices as their overseas counterparts. At the same time, as PetroChina's recent buying spree on Singapore's crude oil spot market shows, low oil prices enable cheap restocking. During the coming months, Chinese companies will continue to aggressively buy cheap spot market oil, using it to replenish both corporate and government reserves.

The slowdown in China's housing sector and, by extension, the wider economy will continue to drive down Chinese energy demand (and in turn, regional and global prices) for the next 12-18 months. However, rising urbanization levels, the inexorable expansion of consumer car markets and other factors guarantee that China's oil demand has not yet peaked, and Stratfor anticipates that China will become an increasingly dominant force in shaping global oil markets.

Japan

The drop in global oil prices comes in the nick of time for Japan. Later this year, Japanese Prime Minister Shinzo Abe will determine whether to implement a second consumption tax hike in October 2015. Abe has made it clear that his decision hinges in large part on what happens in Japan's economy through the end of November. The tax is significant for Japan's leadership: It symbolizes a commitment to address the country's long-smoldering sovereign debt and fiscal concerns. Failure to implement it would, theoretically, indicate a lack of political will on Abe's part — or worse, a genuine fear by Japan's leadership that raising the tax would send Japan back into recession, thus dispelling the country's short-term dreams of an economic revival.

In this context, low oil prices mean two things for Japan. First, cheaper oil leads to lower industrial input costs. These lower costs appear to have already given Japan's manufacturers and exports a tangible boost in recent weeks. Second, and most significantly for Abe, low oil prices have meant cheaper goods for consumers. This price drop has helped offset the impact of Abe's first sales tax hike — from 5 percent to 8 percent — which was implemented April 1. (The next increase, if implemented, will bring the tax to 10 percent.)

Anything that helps rejuvenate consumer spending is a boon to the Abe administration. Moreover, given Japan's near-total reliance on crude oil and natural gas imports, a drop in the price of both is good for Japanese consumers and for the government's feeble efforts to reverse what has become a chronic and, in recent months, worsening trade deficit. However, lower oil prices are not wholly good news for Japan. While they bring down industrial input costs and consumer goods prices, they simultaneously make it harder for the Bank of Japan to achieve its 2 percent inflation goal, which could undermine Abe's efforts to stimulate domestic consumption by shattering the illusion of ever-falling prices among Japanese consumers. A surprise decision by the Bank of Japan on Oct. 31 to expand its government bond purchases attests to the Abe administration's concern over the impact of falling oil prices on inflation and was explicitly designed to help prop up the inflation rate. But at least in the very near term, with the consumption tax decision in the balance, the Abe administration will greet lower oil prices, and their effect on consumer spending habits, happily.

Southeast Asia

Downside risks in major economies, particularly China, and the withdrawal of quantitative easing in the United States are renewing worries about the health of emerging markets in Southeast Asia. Yet a sustained period of lower oil prices should provide a cushion for most countries in the region, depending on their economic structure and energy consumption patterns.

In the past decade, Southeast Asia's rapid economic growth and increasing energy consumption has led to more reliance on oil imports, exposing the region's economies to high financial costs and external fluctuations. At the head of the pack is Thailand, which imports 60 percent of its total petroleum needs and 85 percent of its crude consumption, primarily for the country's transport and industrial sectors. Thailand's economy is still paralyzed by weakening exports and a yearlong political impasse, and an unsettled constitutional crisis has contributed to lingering political uncertainty in Bangkok. Nevertheless, low global oil prices could give the newly established military government the resources needed to spur economic growth. Other net oil importers, including Indonesia, the Philippines and Singapore, could feel similar effects, although state-owned energy firms in the region's net exporters, such as Malaysia and Vietnam, could lose some income.

Moreover, high global oil prices in recent years forced several net importing nations to expand their fuel subsidies for the sake of social stability. These subsidies widened fiscal deficits in countries including Indonesia, Malaysia and Thailand, where fuel subsidy spending accounts for 25, 11 and 7 percent of total government revenues, respectively. For years, Indonesia has struggled to achieve its economic and infrastructure development goals amid steadily declining domestic oil output, an increasing reliance on crude and refined oil product imports, and rising oil import prices that simultaneously burdened the government's fuel subsidies program and made it more necessary. A drop in oil prices may lower Jakarta's oil export revenues (roughly 5 percent of the country's total export revenues), but it provides a crucial opportunity for newly elected Indonesian President Joko "Jokowi" Widodo to begin dialing back the subsidies that hamstrung his predecessors. Cutting subsidies will be a top priority for Jokowi in 2015, and low global oil prices could be just what he needs to muster the popular and political support to do it. Likewise, Thailand, Malaysia and Vietnam are drafting plans to cut back subsidies.

United States

Despite being one of the world's three dominant oil producers, along with Russia and Saudi Arabia, the United States is an oil-consuming juggernaut, which means that low oil prices are undoubtedly a benefit for the U.S. economy. The U.S. oil and gas revolution that caused oil production to increase from 5.5 million barrels per day (bpd) in mid-2011 to nearly 9 million bpd is adding to the overall health of the economy.

Rising U.S. oil production has happened so quickly that West Texas Intermediate, the U.S. oil benchmark, has traded at a discount to international oil prices for much of the past two or three years. Concurrently expanding U.S. natural gas production has resulted in domestic natural gas prices that are far below international gas prices — about half of those in Europe and one-third of those in Asia. This has translated to low electricity costs and will eventually shrink the U.S. energy trade balance further as the country becomes a liquefied natural gas exporter in 2016.

Energy costs will remain structurally lower for the United States than for its competitors, further strengthening the country's comparative advantage in the manufacturing, industrial and refining sectors. These circumstances will continue underpinning a U.S. manufacturing renaissance (even China has begun setting up shop for textile manufacturing in the southern United States) and will continue fueling the steady U.S. recovery from the global financial crisis, even as the Chinese and European economies continue to struggle.

Low oil prices could undermine some of the benefits the United States enjoys relative to the rest of the world, but right now the United States has the best of both worlds: falling energy costs that remain lower than the competitors' costs and rising domestic energy production that has not been deterred by low oil and gas prices. There is much debate surrounding how far oil prices can fall before shale oil production is deterred, particularly since the break-even point for shale oil varies considerably from basin to basin. If prices remain above $80 per barrel, then a significant production slowdown is not likely. However, if prices fall into the realm of $70 per barrel, some marginal prospects will lose their appeal. Moreover, if prices dip below $70 per barrel, then greater U.S. oil production will become less attractive.

With all of that considered, U.S. shale production costs have fallen dramatically over the last few years and will continue falling, especially if a surplus develops in ancillary markets and production efficiency continues to rise. Regardless, at the current price of oil, the United States is at a point where energy prices are above the break-even point for domestic production but low enough to benefit domestic consumers. For an industrialized economy where the backbone remains industry, services and manufacturing, this is an ideal situation. 

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