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Will plunging oil lead to overall boost in global economy by delivering windfall to consumers, manufacturers

Will plunging oil lead to overall boost in global economy by delivering windfall to consumers, manufacturers

29-Dec-14

The year 2014 saw a sudden crash in oil, naphtha and polymer prices in Q4 -Benchmark Brent crude oil has fallen from a peak of US$114/barrel in June 2014 to hover at levels around US$60/barrel for most of December. Oil prices plummeted to a four-year low after OPEC opted to keep its production ceiling unchanged on November 27, amid increasing supplies from USA. Led by Saudi Arabia, OPEC is signalling that if oil production levels need to be cut, other exporters who are non-OPEC members wil also have to cut their production. Currently, the oil producers have two options- cut production and therefore lose revenue and market share, or let the price fall in anticipation that a higher cost of production will eventually lead to a drop in supply. Falling energy prices are hurting major oil exporters such as Iraq, Algeria and Nigeria that rely heavily on petroleum revenues. It is particularly bad news for countries such as Russia, Venezuela and Iran already facing deep economic problems. Though the decision has had profound effects on the global economy, analysts say, not all of them will be negative. Many experts opine that the fall in prices was well overdue. Historically, sharp drops in oil prices tend to be associated with recessions as energy demand collapses. This time a range of supply-boosting factors is causing the shift- from advanced drilling techniques to a revival in Libyan oil supply and a bid by some Middle Eastern producers to price competitors out of the market. Since May, nearly 700,000 bpd of unplanned OPEC production have come back online, largely in Libya. New technology and tightening regulations, particularly in USA, have also boosted fuel efficiency. IMF attributes roughly 80% of the fall in oil prices to supply-side causes and only 20% to declining demand from slowing growth. Part of the boost comes from lower transportation and manufacturing costs, particularly for energy-intensive industries such as airlines and steelmaking. Economic growth for USA, Europe and Japan among others, is being re-forecast, as experts bet that plunging oil prices will lead to an overall boost in the global economy by delivering a windfall to consumers and manufacturers, as per Wall Street Journal. Officials at the International Monetary Fund, US Federal Reserve and European Central Bank have recently shrugged off concerns that the tumbling cost of crude signals a global slowdown. Instead, they project cheaper oil will be a shot in the arm for the world economy overall, especially countries with high energy tabs. This "supply shock� could end up helping the US; as it is more likely to increase GDP than see a reduction. For major oil importers. China, Japan, Germany, India, South Korea, Italy, France and a number of other countries spend a much higher percentage of GDP on crude purchases than the US does, this price plunge could add nearly a percentage point of GDP to their economies. Japan, which spent around 3.6% of its GDP to pay for its oil imports in June, is one of the biggest beneficiaries, and will see the price plunge cut its crude bill by nearly 1.2% of GDP.
The success of US producers using hydraulic fracturing and horizontal drilling technologies could come back to bite the fracking industry and other drillers in America. If low oil prices continue for some time, rigs in the US may start to lay down. This will impact not just the direct revenue, but also consumer spending and jobs. Plans for new drilling will be likely put on hold. The companies to be affected will vary greatly on the efficiency of the producer and their location, as well as the field productivity. Location makes a difference because the regulatory environment currently makes it more expensive to develop rigs on federal or tribal lands. There is a point at which the lower commodity price combined with the increased regulatory cost will put new wells out of business. Companies have put on hold plans for all of next year's growth, and are evaluating what was done this year and how much can be cut back from that level. It is relatively cheap to pump oil out of places like Saudi Arabia and Kuwait, but more expensive to extract oil from shale formations in places like Texas and North Dakota. So as the price of oil keeps falling, some US producers may become unprofitable and go out of business. And the price of oil will stabilize. It seems that OPEC is trying to put the US producers out of business. These producers have been successful in increasing production by over 80% since 2008 and reduced imports below 30%. Most US producers will survive in the long term, though not without cutting back. If oil stays around US$60 per barrel, some US companies will cancel or scale back shale drilling, or reduce costs and keep drilling. This makes it very hard to predict where global oil prices will bottom out. Oil-producing states like Texas and North Dakota are likely to see a drop in revenues and economic activity, while Alaska's state budget will be severely pressured. Most major OPEC members cannot allow prices to remain this low forever. They also need to maintain oil prices at certain level as their revenue is committed to development projects. Also, many major oil producers are embroiled in domestic and international political crises, and political analysts are watching closely to see how these countries react as revenues continue to decline.

Impact Of Low Oil
On Petrochemicals
Approximately 5% of the world's oil production is used to make plastics. Lower crude prices have exacerbated the bearish sentiment in global chemical markets in 2014 with the impact most notable in Asia. Spot petrochemical prices on Asia markets reacted almost immediately to the falling price of crude and that of the primary feedstock naphtha from after mid-year, as per ICIS. Approximately 55% of global ethylene production is based on naphtha and heavier liquids. Cracking of ethane, other natural gas liquids (NGLs) and liquefied petroleum gas (LPG) is becoming more prevalent. Each of these is impacted directly by movements in oil price. Chemicals demand growth is expected to slow this year to around 4% from earlier higher estimates as global economic and industrial growth diminishes. Forecasts of future growth have been lowered by some because of the difficult global economic outlook. The plastic industry is well positioned to capitalize on the situation. Falling oil prices will also boost demand due to the increasing disposable income at the customer level. Cheaper oil means lower gasoline prices. This, along with an improving employment scenario, will lead to a positive turn in consumer spending patterns and consequently, plastics demand. Companies engaged in plastics are among the biggest beneficiaries of falling crude prices, being derivatives of crude oil polymers. Lower oil prices would lower the transportation costs for the industry.
On Naphtha
Open-spec naphtha has dived to more than three-year low level as crude hovers around US$60. Naphtha is Asia is expected to be weak at least in H1-2015 amid a global glut in oil supplies and bearish demand, and increasing naphtha supply from the US, Europe and Middle East. Falling crude oil has propped up refinery margins. Rising refinery runs in the US and higher operating rates at the European refineries have pushed up supply availability of naphtha for exports to Asia. Meanwhile, the downstream petrochemical segment is seen lacklustre on account of weak demand in China. Plunging naphtha is leading to expectations of big drops in January ethylene and propylene contracts. Supply and demand are now playing a role in expectations for early 2015 pricing, however, rather than simply upstream movements, although this is more pertinent in the PE market than for PP. Most players expect prices to fall in January, but almost all expect producers� margins to improve again.
On Polyolefins
PP prices remained stable through Q1-2014, after which prices rose in orderly fashion on propylene shortages, but largely in line with upstream propylene movements, as per ICIS. A lack of imports, increased exports and better-than-expected demand at the end of the year. However, by December volumes have tailed off, and while product availability is not long, it is no longer tight. PE price movements were similar- with gentle price movements, usually in line with manageable upstream ethylene monomer price changes, amid high price of crude oil and naphtha moving within a relatively limited price band.

 

 

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