Oil Price and Korean Economy

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1 Oil Price and Korean Economy April 17, 2015 Jaerang Lee

2 - Contents - I. Oil Price Outlook II. Effects on Korean Economy III. Conclusion

3 I. Oil Price Outlook Oil prices have lowered to around mid 50 dollars per barrel. OPEC s decision to leave its production target in Nov. triggered the rapid drop in prices. Increase in oil inventory, Strong dollar has contributed. Oil Prices U.S. Oil Inventory 1) Source : Bloomberg Notes : 1) Month-end(3.13 for March) Notes : 1) Excluding Strategic Petroleum Reserve Source : EIA 1

4 I. Oil Price Outlook Oil prices are forecast to rise moderately. Falling U.S. crude oil rig counts, Moderate inventory builds provide support to prices. Supply side factors are dominant. U.S. Rig Count & Crude Oil Production 1) Oil Price Forecasts 1) Note : 1) 3.13 for March Source : EIA Note : 1) Brent Oil, period average Source : EIA, CERA, OEF 2

5 I. Oil Price Outlook High level of uncertainty and risk remain. U.S. Iran Nuclear deal agreed but details under talk. Disputes in Middle East unsolved. IS, Yemen Oil producer countries budget relied heavily on oil revenues, that might cause potential supply disruptions. 3

6 Growth in Korea has been very modest, and BOK forecast is revised downward. Lower oil prices is not showing as much spillovers as expected. Why? (S.A., QOQ, MOM, %) 3/4 4/4 Oct Nov Dec Jan p Feb p Jan~Feb p Retail Sales Facilities Investment Exports(YOY,%) Import(YOY,%) CA(billion U$)

7 Oil price increase in 2000s and regulations on green house gas emission control has increase the demand on energy saving and oil substituting technology. It is required to reduce 30% of green house gas by Alternative energy technology has lowered reliance on oil. Oil Prices 1) and Energy Consumption 2) Energy Source Notes : 1) Dubai Oil Notes : 2) per real GDP Source : Korea Energy Economics Institute, The Bank of Korea, Bloomberg Notes : Ratio of Petroleum consumption = Petroleum Dependence Source : Korea Energy Economics Institute 5

8 Industrial structure gradually has become less-oil consuming. Heavy industry -> IT Manufacture -> Services Ratio of petroleum-guzzling Industries to Gross value added Renewable Energy Production & Supply 1) Source : The bank of Korea Note : 1) compared with total primary energy production Source : Korea Energy Management Corporation 6

9 Oil prices pass through to the limited extent. Gas prices are down at the market, but public transportation fees, electricity, heating fares are regulated. Limited increase under higher oil prices means limited decrease under lower ones. Taxes are lump sum. From July 2014 to March 2015, oil refineries dropped their supply price by 33%, but retail price fell 19%. Gas tax per $: Korea 0.45$, U.S. 0.15$ U.K 0.61$, Germany 0.58$ (Source: OECD) Upside risk in oil prices support floor. 7

10 Uncertainties and risk make consumption and investment decision delayed. Uncertainties in energy market increases volatilities in financial market. If oil prices decline further, oil dependent countries may face tough economic and financial conditions. Korea has almost no financial linkage to oil exporting countries, but about 10% of exports head to them. Low inflation may increase the risk of deflation, leading to uncertainties in the monetary policy. 8

11 Lower oil prices will eventually act as a boost to Korean Economy. Korea has: The 10 th largest oil consumption, and the 5 th largest oil imports in volume. The net oil imports/gdp ratio, 7.6%(2013), the 2 nd highest. Oil Consumption Oil Imports Net Oil Exports Note : Based on 2013 figures Source : EIA Note : Based on 2010 figures Source : EIA Note : Based on 2013 figures Source : UNCTAD, IMF 9

12 Cheaper oil brings benefits to Korean consumers and investors. (Bills saved per GDP, %) U.S.A. China Germany Japan India Korea Singapore Note: Assuming crude oil price decrease from 109$ to 71$ per barrel. Source: Rhodium Group, Wall Street Journal BOK macroeconomic model predicts 10% of international crude oil price decrease lead to 0.1%p increase in growth. 10

13 Boosting effects might not as big as models project. Demand shock explains about 20% of oil price decrease.(imf, Dec.2014) Under 20% demand and 80% of supply shock, 10% decrease in oil price bring less than 0.1%p growth effects.(bok12, BOK macro model) Models are linear, but real world is not. 11

14 III. Conclusion Economic and non economic factors limits the boosting effects of cheaper oil. Lower dependence on petroleum uncertainties and risks in the market Mixed shocks: supply and demand shocks Regulations and taxes Deflation risks are overstated. Inflation expectations are anchored. Core inflation is stable. Oil price drop is not passing through to the larger extent. 12

15 III. Conclusion We may need patience!! Model projects that it takes at least about a year to take a full effect of the oil price shock. 13

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