Future tab for today’s oil prices?

Florence Chong's picture

LOWER oil prices could be a passing phenomenon. As more energy projects are stalled or mothballed, what price will future consumers be asked to pay? 

WHILE the global economy is enjoying a growth kicker from the dramatic fall in oil prices, there is a need to ponder whether there is a future cost looming on the horizon.
Is the present low crude oil price a short-term adjustment — or a structural change of sorts? This is just one of the questions the world confronts as it moves into a New Year.
With China coming off  double-digit growth and spectacularly high levels of investment, some believe China’s seemingly insatiable demand for crude oil might not grow at the furious rate of the past decade. Chinese investment is now estimated at 40 per cent below its peak.
If one follows this line of thinking, it is plausible that global demand for oil will moderate from here on in,and that this will, in turn, be reflected in the price.
Speaking to the Canadian newspaper, The Globe & Mail, recently, leading China specialist Andy Xie said China’s massive investment overhang in China, valued at more than US$6 trillion, will dramatically affect its energy demand growth, and will, as a result, rein in oil prices for a long time to come.
“China’s energy demand, the only source (of oil price growth) for a decade, has fallen sharply,” he said, adding that global oil demand in the past decade has been entirely driven by China. The Paris-based International Energy (IEA) has long credited demand from rapidly developing economies led by China for strong growth in crude oil requirements around the world.
Xie said that, for many years, China alone was responsible for 50 per cent of annual world growth in oil demand. And, given that China has now developed most of its infrastructure, and that investment has tapered off, the global oil price “will be range-bound between US$60 and US$80”. “There’s not another cycle coming,” he noted sagely.
China imports roughly 60 per cent of its daily consumption of 10-million barrels.
Lower oil prices, together with a sharply lower cost of iron ore and other raw materials, have already translated into lower input costs for Chinese manufacturers. Some observers have begun to refer to this as
‘factory-gate deflation’.
China’s producer-price index dropped 2.7 per cent in November from a year earlier, recording a record 33rd-straight decline. It was the biggest fall since June 2013. Consumer prices in November rose by 1.4 per cent, compared with 1.6 per cent in October.
Some economists believe the lower price of Chinese exports will add to disinflation pressures across the world.
China has entered a rapid dis-inflation process, and faces the risk of deflation, according to Liu Ligang, Chief Greater
China economist at ANZ Bank in Hong Kong.
And Lu Ting, Bank of America’s Head of Greater China economics in Hong Kong, has been quoted as saying that the major driver of the recent decline in headline inflation readings is the slump of global oil and other major commodity prices.
As the largest oil importer in the world, China is the major beneficiary of the collapse in oil prices. It is estimated that, at the current price, China can save up to US$30 billion a year. Chinese data shows that China spent nearly US$220 billion on imported crude oil in 2013.
Bank of America Merrill Lynch estimates that, for every 10 per cent fall in the price of oil, China’s GDP growth will be boosted by around 0.15 per cent. With a fall of more than 40 per cent in oil prices during 2014, this would give China’s national economy a 0.6 per cent lift from cheaper oil.
The IMF estimates a positive impact of 0.8 per cent in advanced economies.
Oil prices hit $US115 a barrel in June and were trading at US$53.61 at the time of writing. But looking beyond the immediate economic benefit, there must be concern.
Abundance of supply today is the result of strong investment in recent years to capitalise on rising oil prices. A combination of the
impact of the shale oil revolution in the US and an OPEC decision to resist production cutbacks — to bolster prices — lies at the root of the price collapse. Oil companies and prospective producers have now started to scale back investment for future production. This is widely evident ­— in shale oil in the US and in energy projects in Australia, as examples. At current price levels, more marginal and high-risk projects are no longer viable. And as more projects are stalled or mothballed, future energy sources which are needed could be deferred.
The last oil price shock, in 2005, came as a result of many years of low investment.
The fine balance of supply and demand then was torpedoed by Hurricane Katrina, which hit the East Coast of the United States in 2005, leading to a price spiral, with crude briefly reaching US$70 a barrel. It was the end for years of stable oil prices.
The Katrina experience highlighted the fragility of global oil supply. Demand from booming Asian economies was not fully appreciated at the time, and, discouraged by a long period of weak oil prices. (see ATI October 2005), investment in energy projects failed to keep up with expected growth in demand.
The upshot was nearly a decade of soaring oil prices.

* Florence Chong is Editor of ATI Magazine