Cheap oil alone cannot grease the economy

Cheap oil alone cannot grease the economy

Crude oil prices have more than halved since July, with a dramatic drop towards the end of 2014 as the Organisation of the Petroleum Exporting Countries (Opec) refused to curb output. The Thai equity market tumbled because energy stocks contribute as much as 20% to the SET Index market capitalisation. But most other sectors remained flat and there are a few sectors like consumer and transportation stocks that actually emerged as winners.

A petrol station worker refuels a car as oil prices continue to tumble. Pattarachai Preechapanich

Taking a hint from the stock market, one has to wonder what this cheap oil environment means for Thailand's economic recovery.

Indeed, Thailand as a net oil-importing nation should benefit from cheap oil. It should help improve private consumption as more money is left in consumers' pockets from lower fuel bills.

Firms should also enjoy savings from low oil prices, especially those in highly oil-dependent sectors like airlines and logistics.

However, cheap oil can have a material impact on income. Prices of many commodities, agricultural and industrial, usually fall in tandem with oil prices and lower farmers' and firms' revenues. Trading with oil-exporting nations like the Middle East is likely to take a hit because the bloc is hurting from the plunge in oil prices. And how much is our tourism industry relying on tourists from Russia who saw their rubles devalued by half on the back of the country's loss in oil revenue?

So what, then, is the net effect of cheap oil on the Thai economy? To answer this question we must look at the effects piece by piece.

Let's start with consumption. And it's a tale of two economies.

One is the urban, non-farming economy. Cheaper retail fuel prices will mostly benefit those living and working in non-farming areas, especially cities like Bangkok. Cost saving is relatively high for this consumer group. Not only is it because of the heavier gasoline expenditure in the city, but it is also because of the structurally steeper drop in prices of benzene and gasohol than that of diesel which is more widely used in rural areas.

Incomes of the urban population appear to be unrelated to the drop in oil prices, unless you work in an oil company and may see your remuneration affected. The loss of wealth from the equity market may be at play for those in the upper-middle and high-income brackets; it should nevertheless have little impact on their spending patterns.

Thus, city dwellers will enjoy a net-positive impact from falling oil prices. Their higher spending power from lower gasoline expenditure should translate into an increase in consumption. As this non-farming economy accounts for roughly 60% of the population, one would think that this tips the scale towards a clear plus for the entire economy.

But this deserves careful consideration, because 40% of the country — the rural economy — has been hard done-by after the oil price drop.

For the rural population, the logistics cost saving from diesel usage is small, while the negative impact of low oil prices on the income from crops is tangible. To a certain extent, agricultural commodities suffer the same negative sentiment directed towards all types of globally traded commodities amid crude oil's recent dramatic fall.

But more importantly, the low oil price hurts global demand for biofuels like ethanol and biodiesel. This environment has already pushed the Brazilian sugarcane industry, which is the largest ethanol producer, to switch to producing sugar instead. The increased sugar supply has since put downward pressure on its market price. A similar situation is developing for palm oil and cassava, both of which are used in biofuel production. Thai farmers of these crops will also be forced to sell for less.

We should also be concerned about the price of para rubber. The price of its substitute, synthetic rubber, which is made from a by-product of oil, has plummeted together with oil, closing the gap between the price of synthetic rubber and that of para rubber. This hinders any attempt by the government and the rubber growers to raise the value of para rubber from its five-year low.

With such an adverse impact on the rural economy as a result of low oil prices, the nationwide implications on private consumption would be slightly positive at best. Any uptick is likely to be concentrated in urban areas. Instead, what the oil price drop has done is further expose the differences between the two economies of Thailand.

What about our export growth? This time, it's a tale of two products.

On the one hand, we have exports of commodities. They account for about 15% of total exports, and this year they will be materially affected by the universal drop in commodities prices to varying degrees.

The other 85% are exports of non-commodities, such as automotive, electronics, fruit and seafood. We do not expect the prices of these products to grow amid global deflationary pressure. But they should find improving demand from our key trade partners like the US, Europe, China and Japan on the back of better fiscal positions from cheaper oil imports. Still, export products targeting the Middle East — the light truck segment which normally sells 20% of its production to these oil-rich countries — could be facing a substantial decline in demand.

A respectable growth in export volume of 3-4% is likely, and higher if demand from the Middle East prevails. In dollar terms, however, the loss in prices of commodities, especially para rubber, sugar and petroleum products, will weigh on our total export value, dampening growth prospects to lower than 1%.

The last piece of the puzzle is tourism. We remain highly positive on tourism growth this year owing mainly to the return of Chinese travellers. The sharp drop in oil prices is just a bump in the road; it entails a large decline in the number of Russian tourists who normally account for just 6% of international tourists. This is due to Russia's economic contraction on the back of the plunge in oil revenue. The consequent depreciation of the Russian ruble also makes outbound travelling more costly.

Of course, it is more than just a bump for well-known tourist spots for Russians, especially Pattaya. Russians account for a quarter of international tourists in Pattaya and local hotels are already bracing themselves for a 40-50% drop in Russian visitors. The fact that Russians tend to spend more and stay longer than an average tourist does not bode well.

All in all, the plummeting oil prices are doing very little to our economy, on a net basis. Our economic dependence on commodities more than offsets the prospect of higher spending power from fuel-cost savings. Exports of non-commodities products look promising, but even so, they are still contingent on how much low oil prices can help to generate additional demand.

But what if oil prices stay low, perhaps at $40 (1,300 baht) per barrel, for a few more years? There may be some structural changes coming our way.

For example, we could face stiffer competition in Asian sugar markets. Low-cost Brazilian sugar will become more competitive when shipping costs no longer dominate negotiations. Brazil has already penetrated the Indonesian market in a big way.

Another potential loser is the auto industry. The low oil price environment is likely to shift car purchase sentiment towards bigger and less fuel-efficient vehicles, as opposed to smaller passenger cars. The response has been quick in North America where light truck and SUV sales were much stronger than smaller cars in 2014. If the same is true for Thai consumers, the shift in preference away from eco-cars towards bigger sedans may result in the delay of the eco-car phase II investment in Thailand.

Regardless of the oil price trajectory, Thailand certainly needs a serious positive shock to get Thais to spend and corporates to invest to resuscitate our ailing economy.

By the look of things, cheap oil will not do the trick.


Sutapa Amornvivat, PhD is Chief Economist and First Executive Vice President at the Economic Intelligence Centre, Siam Commercial Bank. She has international work experience at the IMF, ING Group and Booz, Allen, Hamilton. She received a BA from Harvard and a PhD from MIT. eic@scb.co.th | EIC Online: www.scbeic.com

Sutapa Amornvivat

CEO of SCB ABACUS

Sutapa Amornvivat, PhD, is CEO of SCB ABACUS, an advanced data analytics company under Siam Commercial Bank, where she previously headed the Economic Intelligence Center and the Risk Analytics Division. She received a BA from Harvard and a PhD from MIT. Email: SCBabacus@scb.co.th

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