World Risk Developments November 2014


Oil — Price slump heralds gains and losses for Australian economy

Lower oil prices will bring a host of positives and negatives to the Australian economy. On the positive side: a boost to the world economy, major trading partners, and to energy-consuming export industries. On the negative: lower prices for coal and gas exporters, meaning lower energy export earnings, and deferred capital spending on new projects.

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Rapid oil price falls will stimulate the global economy — but create winners and losers

Brent oil prices have slid 30% since peaking in June to a four-year low below US$80/bbl (Chart 1). This reflects a strong US dollar, weak global demand and surging US shale output that have outweighed supply disruptions in the Middle East. This month the International Energy Agency (IEA) said ‘downward price pressures could build further in the first half of 2015’. Futures markets suggest prices are not expected to rise above US$90/bbl in the next five years.

Lower oil prices will stimulate the world economy and help spur stalled economic growth. The IMF estimates that a sustained 25% price cut will add about 0.5% to global GDP. But a lower oil price creates both winners and losers.


The winners — Australia’s major trading partners are also net energy importers

The winners are net energy importers. With global oil demand expected to be 94.2m b/d this year, falls in prices from US$115/bbl to US$80/bbl will result in a transfer of US$1.2tn to countries that consume more than they produce. Australia’s eight largest export markets are net energy importers (Chart 2). Take China, the world’s second-largest net oil importer and Australia’s largest trading partner. The Economist estimates that every US$1/bbl drop in the oil price saves the Chinese budget an annual US$2.1b.

Lower prices also support policy efforts to dismantle problematic subsidies. The IEA estimates that the global cost of subsidising fossil fuel consumption is US$550b a year. For instance, while Indonesia will suffer reduced payments for its coal and gas exports, Indonesian fuel subsidies consumed 18% of the central government budget in 2014 — the same as central government capital and social spending combined. But last week, Indonesian President Joko Widodo took advantage of the price fall to increase retail fuel and diesel prices more than 30% — virtually eliminating the subsidies overnight and resulting in substantial public fiscal savings and substantial net income transfers within the economy. In India, lower energy prices will moderate inflation and allow for accommodative monetary policies, likely to boost consumption and investment.

The losers — net energy exporters and those hoping to be

Among important trading partners that stand to lose from lower prices are the net energy exporters, Malaysia and Indonesia. Fortunately these economies are relatively well-diversified, with significant manufacturing and agricultural export sectors that stand to benefit from lower energy input costs. This, along with subsidy reform, will help offset the hits to their budget and balance of payments.

Other OPEC countries with concentrated export bases will not be as well insulated. Oil exporting countries accounting for 45% of global supply require prices in excess of US$90/bbl to finance their 2015 budgets. Weakened fiscal outlooks for Russia and OPEC’s most profligate members will necessitate spending cuts or the financing of dExport Finance Australiaits through accumulated savings or debt. However, the ability to sustain the latter option for a prolonged period varies greatly among OPEC members.

While the US (our fourth largest trading partner) remains a net energy importer, a lower oil price may reduce capital expenditures and slow the ‘shale revolution’ — Barclays estimates that 80% of shale reserves are economic to extract using current technology with Brent around US$85/bbl. Analysts suggest that limiting the viability of US shale production may be the intention of Saudi Arabia — the world’s largest petroleum exporter and traditional swing supplier. In the 1980s Saudi Arabia cut its output by almost 75% in an attempt to sustain prices — but the main benExport Finance Australiaiaries were high cost producers at the expense of OPEC market share.

New hurdle for Australian resources, but a boost for agriculture and manufacturing exporters

Lower oil prices will deliver a setback to Australia’s significant coal and gas exports — Australia is a net energy exporter (Chart 2). The Commonwealth Bank estimates that a 20% fall in oil prices (over one year) will equate to a terms of trade shock of around -0.4% of nominal GDP. This will counteract the gains to industries with high energy consumption — including manufacturing and agriculture — and the boost to consumer spending from lower petrol prices.

A sustained period of low oil prices will exacerbate existing downward price pressure on LNG — from increased US shale exports and cheaper Russian gas arriving in China. Former senior BHP Billiton executive Alberto Calderon suggests that lower prices mean most Australian LNG projects will not return their cost of capital. As a result, future ‘big ticket’ projects may be deferred.

So while a net positive for the global economy and Australia’s biggest export markets, sustained lower oil prices create new hurdles for Australia’s resources exports. Despite this, lower oil prices will stimulate output in Australia’s agriculture and manufacturing sectors — at a time when Australia attempts to achieve a broader based export profile and adjust to life after the mining boom.


China — FTA offers SME opportunities

The landmark China-Australia Free Trade Agreement (ChAFTA) announced last week will assist Australia to broaden its export performance and provide new opportunities to SME exporters, by delivering unprecedented access to China’s burgeoning agricultural and services markets.

Australia’s exports to China have expanded by an average 25% per year over the past decade — it is now by far our most important export market. But surging exports to China have been heavily dominated by resources.

After nearly a decade Australian Prime Minister Tony Abbott and Chinese President Xi Jinping shook hands on a comprehensive free-trade agreement this week. ChAFTA allows for 85% of Australian goods exports to enter China tariff-free upon entry into force, rising to 93% in four years and 95% on full implementation.

ChAFTA completes the government’s ‘trifecta of trade’ with Australia’s three largest export markets. Similar agreements were secured with Japan and South Korea earlier this year. These three North Asian markets collectively accounted for more than half of Australia’s exports last year.

The Chinese market is of unprecedented importance — but gains have been concentrated in resources

Australia sold $102b worth of exports to China last year — more than goods and services exports to its next four largest markets combined (Chart 3). Strong growth in Chinese demand for Australia’s exports is expected to continue given a rapid expansion in China’s middle class — expected to rise by 400 million people over the decade to 2022.

But new Australian exports to China have been dominated by resources. Minerals exports have increased almost 20-fold over the last 10 years, fuelled by China’s rapid industrialisation and urbanisation. Australia’s exports of other goods and services have been more subdued (Chart 4).


FTA to help Australia broaden its strong export performance to agriculture and services

But ChAFTA will boost Australia’s non-resource export competitiveness and promote diversification of exports — an important economic cushion as the mining boom ends. As widely expected, ChAFTA delivered greater access to China’s burgeoning agricultural and services markets in particular.

Australia's agricultural exports to China have almost tripled over the last five years to a record $8.7b. China is now our most important agricultural export market. But there remains significant scope for expansion. ChAFTA will cultivate export opportunities by removing import tariffs on a range of Australia’s agricultural and horticultural products in coming years.

China is also the most important destination for Australian service exports — at around $7b in 2013, China accounted for 12% of total services exported. The government stresses that ChAFTA secures ‘the best ever market access provided to a foreign country by China on services’.

ChAFTA will reinforce export momentum and provide Australia’s exports an advantage over major competitors from the US, Canada and EU. It also counters the advantage enjoyed by competitors from countries like New Zealand and Chile that have already negotiated trade deals with China. China’s imports from New Zealand have grown over 450% since the China-New Zealand FTA entered into force in October 2008. China’s aggregate imports from the world increased only 50% over the same period.

Russia — Economic outlook tests the resolve of policymakers

Russian policymakers appear willing to sacrifice growth by accepting rapid declines in the exchange rate to maintain financial stability. Still, unless oil prices rebound and sanctions are eased, the outlook is for a flat economy, further rouble weakness and rising bankruptcies in 2015.

Russia’s economy has struggled to cope with the ongoing geopolitical tensions and tough western sanctions stemming from the Ukrainian conflict. Now the world’s largest energy exporter has been dealt another blow with oil prices tumbling 30% since June, to US$80/bbl. Oil accounts for 50% of government revenues and 54% of export receipts. Growth is projected to remain flat over the coming years with a modest pickup in the years thereafter.

Sanctions from western countries have cut off Russia’s access to global capital markets and declining oil revenues are weighing on foreign exchange earnings, both hampering Russia’s ability to refinance its short term obligations. The central bank’s recent decision to limit currency intervention should free up its large pool of foreign reserves to finance the country’s external debt obligations (equivalent to 30% of reserves) over the coming year. Standard & Poor’s projections suggest Russia has sufficient cover to meet its external financing needs over the next three years. However, drawing down on reserves leaves the economy vulnerable to further oil price slumps and tighter sanctions.


Lower central bank intervention in currency markets will keep the rouble weak, which in addition to Russia’s self-imposed import ban, will drive up inflation pressures. Weak oil prices will weigh on government revenues, requiring policymakers to lower spending if the government is to remain fiscally sound. This is likely to drag on growth.

Softer growth and higher inflation will be a painful adjustment—with rising unemployment, lower wages and greater bankruptcies testing the resolve of policymakers to save reserves and cut spending to maintain financial stability.

Cassandra Winzenried, Senior Economist

Fred Gibson, Economist

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