Tue, Mar 17, 2015 - Page 8 News List

Implications of crude price plunge

By Darson Chiu 邱達生

West Texas Intermediate (WTI) crude oil cost US$106.07 per barrel on average in June last year. However, it reached US$49.56 in February, indicating a price plummet of 53 percent over eight months. Such tumbling oil prices are not unprecedented: When WTI crude dropped from US$133.93 in June 2008 to US$39.16 per barrel in February 2009, it lost as much as 70 percent of its value.

The previous major oil price fall was caused by the most recent global financial crisis; nobody has been trying to debate that. After all, the underlying principle was self-explanatory. On the contrary, the ongoing price dip was triggered by multiple reasons, and the world is still paying great attention to its development.

In economics theory, price is decided by demand and supply. To apprehend the trend of crude prices, observers must analyze the propositions of both the demand and supply sides.

Furthermore, all commodities are priced in US dollars — meaning the fluctuation of the greenback also has a significant role in determining crude oil prices.

Weaker world demand is a major reason behind the tremendous fall of crude oil prices. A review of the economic performance of global major economies from the first quarter of last year until now shows that the US has been the only economy enjoying a solid recovery, despite an enduring US west coast labor strike paralyzing 29 ports.

FISCAL STIMULUS

Considering weaker demand, China has to be put under the spotlight. China’s economic growth target for last year was set in March last year as 7.5 percent; it turned out that the actual growth rate was 0.1 percentage point short of the mark. In addition to the failure of fulfilling its annual goal, a 7.4 percent GDP growth rate signaled a new low for the second-largest economy in the world since 24 years ago.

Structural reform conducted by Beijing is hurting China’s internal demand growth, whereas its external growth has no choice but to rely on input substitution policy.

Besides China’s role, Europe and Japan play supporting roles in weaker demand. Europe and Japan have long-lasting debt issues to address; imposing expansionary fiscal stimulus is no longer among their options. Both of them are still fighting deflation with extremely slack monetary measures.

The Bank of Japan introduced its quantitative and qualitative monetary easing in April 2013, aimed at overcoming years of deflation and anchoring 2 percent inflation in just about two years from then. The European Central Bank (ECB) began its European-style quantitative easing in March by purchasing 60 billion euros (US$63.2 billion) of debt per month.

The ongoing easing by Japan and fresh easing by the ECB have strongly suggested that growth in these two economies remained tepid, and monetary operations were the obliged methods, due to the fiscal crisis. Ironically, the collapse of crude oil prices has further hobbled their efforts to cope with deflation.

In addition to weak demand, oversupply has played a critical role in driving down crude oil prices.

The introduction of shale oil fracking technology — widely recognized as an oil production revolution — helped shift out the supply curve. The technological advance has dramatically increased the supply of oil coming from the US.

Nevertheless, global oil prices are not simply decided by supply and demand equations, and the oil market is not in the slightest an example of perfect competition.

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