The Impact of Low Oil Prices on China

Like many other Asian countries, China has been affected by recent dramatic changes in global oil prices. In the view of FACTS Global Energy (FGE), the shift occurring in the global oil market is structural, and we have entered an era of lower oil price ranges that is likely to last for years. [1]As such, the impact of low oil prices on China will not end anytime soon. This policy brief assesses the impact of low oil prices on China in several areas, ranging from the economy and the environment to energy security and regional cooperation on market instability.

Economic Impact

The implications of sustained low oil prices may be wide-ranging for the Chinese economy. On the positive side, low oil prices have resulted in the following changes:

• Lower imports of oil in dollar amounts will increase China’s current account surpluses. Using crude oil as an example, in 2014 China imported a total of 6.2 million barrels per day of crude oil at a cost of $228 billion (at an average oil price of around $101 per barrel). Crude oil accounted for 12% of China’s total merchandise imports. For 2015, FGE projects that China is likely to import 6.5 million barrels per day of crude oil. If average Brent crude prices are in the range of $55–$60 per barrel for the year as a whole, total imports will be valued at $130–$142 billion. [2] The share of oil in China’s total merchandise imports is thus forecast to decline to 7%.
• Low oil prices are expected to stimulate growth of China’s GDP. Estimates vary, but the impact appears to be positive. [3]
• This trend should facilitate efforts by the Chinese government to reform the country’s tax and fiscal systems.

A negative implication, however, is that low oil prices have enhanced the fear of deflation. If deflation indeed occurs, the consequences could be grave, considering that China has surplus capacities in many energy-related industrial sectors. [4] Meanwhile, investment in domestic energy supplies, particularly oil and gas production, is likely to be negatively affected by low prices, leading to lower contributions from these sectors to China’s GDP growth.

Impact on Environmental and Energy Security

Low oil prices impose a challenge for the Chinese government to achieve some of its environmental policies and targets. The impact may vary from fuel to fuel.

Natural gas. Following the collapse of oil prices, the Chinese government has been slow in adjusting natural gas prices. During 2014, gas demand growth was already negatively affected due to the increase of government-regulated prices. With lower prices in place for oil, natural gas demand may be further affected. For instance, natural gas competes mainly with diesel and liquefied petroleum gas (LPG), among major oil products. Now that diesel has become cheaper, promoting liquified natural gas (LNG) cars and other gas vehicles has become increasingly difficult. When oil prices were high, LPG could not compete with natural gas for residential use in most places, but now the former’s competitiveness has inched up.

Coal. The bulk of coal consumption—power generation—will not be affected immediately because China has few oil-fired plants. Instead, coal-based chemicals have been affected the most. Coal-to-liquid projects have been hit because of lower prices for gasoline and diesel, though the pressure has been alleviated somewhat due to the fall of coal prices. Coal-to-gas projects will be affected too, followed by other coal-based chemicals.

Renewable energy and biofuels. Renewable energy generally competes with coal, so the immediate impact of lower oil prices is minimal. In the long run, however, it is generally challenging to promote the use of renewable energy if oil prices stay low. Development of China’s biofuels had already been slow because of poor economies of scale. Biofuels now face new challenges with low oil prices.

As far as energy security is concerned, low oil prices present a few challenges to the Chinese government. On the one hand, domestic oil production has been hit hard by low prices. On the other hand, oil imports will be stimulated because it is cheaper to import oil, and lower prices—though muted somewhat by the hike of consumption taxes on gasoline and diesel—have increased demand. As a result, net oil imports will rise and may jeopardize the government’s effort to mitigate dependence on imported energy, particularly oil.

One major advantage of low oil prices in terms of energy security, however, is the opportunity for China to fill up its strategic petroleum reserves (SPR). Indeed, the construction speed of phase-2 SPR sites in China, which had been slow for a couple of years, has accelerated since the second half of 2014.

Policy Implications

Low oil prices provide a rare opportunity for the government to reform its tax and fiscal systems and the oil price regime. The government has already done so by raising consumption taxes on gasoline and diesel three times since November 2014—on November 28 and December 13, 2014, as well as on January 12, 2015. [5]

Low oil prices have also resulted in lower imported LNG prices, not only for China but also for all other Asian buyers as well. Taking this opportunity, the Chinese government completed the final step of its three-step plan for reforming natural gas prices for nonresident use by merging the two price tiers into one. [6] The new regime has been in effect since April 1, 2015.

Prospects for Regional Cooperation on Oil Market Stability

Although oil prices are currently well below $100 per barrel, we have entered a stage with high price volatility. The market plays a key role in determining prices, and oil supply may swing as prices rise and fall. For Asia, regional cooperation to ensure market stability needs to deal with this new challenge of low but volatile oil prices.

For developing countries in Asia, low oil prices provide golden opportunities for governments to reform their price regimes for oil and gas. [7] Much like China, a number of Asian economies, such as India, Indonesia, Thailand, and to a lesser extent Malaysia, have all been in the process of seizing such opportunities. Given that the situation in each country is often different, governments can share their experiences to promote regional cooperation.

Many Asian nations are major oil- and gas-importing countries, and the reduction in oil and gas prices has significantly lowered their energy import bills. Under these circumstances, it is important for developed economies in Asia such as Japan, South Korea, and Taiwan, which benefit from reduced import payments, to consider helping energy-producing countries such as Indonesia, Malaysia, Brunei, Vietnam, Papua New Guinea, and Australia to overcome some of the difficulties related to the reduced revenue for upstream energy production. As such, cooperation between energy-importing economies and energy-producing countries is key to ensuring stable supply during times of highly volatile oil prices.

Endnotes

[1] Ferediun Fesharaki, “The Oil Market and Oil Prices: The Elusive Hope for Equilibrium,” FACTS Global Energy (FGE), Chairman’s Corner, no. 80, March 2015.

[2] Fesharaki, “The Oil Market and Oil Prices.”

[3] J. Ma, “Impact of Lower Oil Prices on the Economy,” Caixin, January 19, 2015, http://opinion.caixin.com/2015-01-19/100775826.html.

[4] R. Li, ed., MStudies of Major Issues for Petroleum and Petrochemical Sectors—Dealing with Surplus Capacities (Beijing: Gold Wall Press, April 2014).

[5] “China Continued to Raise Consumption Taxes on Refined Products with the Third Hike in Seven Weeks,” People Net, January 12, 2015, http://finance.people.com.cn/n/2015/0112/c1004-26370789.html.

[6] K. Wu and W. Huang, “Final Phase of China’s Three-Step Natural Gas Price Reform: What’s Next?” FGE, China Energy Series (Gas), no. 85, March 27, 2015.

[7] Ferediun Fesharaki, “Lower Oil Prices: Will Oil Demand Rebound?” FGE, Chairman’s Corner, no. 76, February 2015.

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Kang Wu is Vice Chairman, Asia, at Facts Global Energy (FGE) and Managing Director of FGE.