Drop in oil prices not the pits

Decline puts pressure on manufacturers to create more oil reserves, accelerate economic restructuring

The decline in crude oil prices globally is expected to have more positive than negative effects on China's overall economy.

The price of global crude oil fell from above $110 per barrel in early July of last year to below $50 by the beginning of 2015.

From a supply perspective, geopolitical conflicts have not caused disruptions to the crude oil supply chain. As oil prices fell, member countries from the Organization of Petroleum Exporting Countries did not reduce their crude oil production in an attempt to restrain the growth of the US shale gas industry.

After the US Federal Reserve ended its quantitative easing policy late last year, with the expectation that the move would raise interest rates this year, global crude oil prices dropped based on the expectation that the dollar would be stronger in the future.

Other elements that have played a role in the fall in prices include speculators who were bearish about crude oil markets and the moves by member countries of the North Atlantic Treaty Organization to crack down on Russia's export revenues and financial strength in the wake of the Ukraine crisis.

But China's economy has been and will continue to be influenced by the slump in oil prices from different aspects. China is a net importer of crude oil and the world's second-largest importer of oil - imported oil accounts for more than 50 percent of the country's oil consumption. The drop in prices will help to lower the cost of oil imports, creating more favorable trade conditions.

As costs trend downward, it creates a widening trade surplus, which in turn will make net exports a stronger contributor to the nation's economic growth. In the third quarter of 2014, net exports contributed about one-third of GDP growth.

For China's manufacturers, their profit margins are expected to improve following the plunge in oil prices. Since manufacturers import most of their raw energy materials, the fall in oil prices will help their bottom line, especially at a time of overcapacity in sluggish domestic and overseas markets. But while the decline in prices works in favor of certain manufacturers, it also financially burdens oil production companies and refineries in China.

Another likelihood from the drop in prices is that Chinese governments and enterprises will build more strategic oil reserves. Indeed, the central government has reportedly intensified its efforts in building oil reserves in recent years. And as Russia's economy struggles through its slump, the nation will be highly motivated to increase oil and gas exports to China. If the Chinese government can seize on the opportunity to secure more mid- or long-term oil and gas contracts with Russia, it will help to ensure China's future oil and gas security at a lower cost.

China imported 308.38 million metric tons of crude oil last year, up 9.46 percent year-on-year, according to the General Administration of Customs. In December, China's imports of crude oil reached 30.37 million tons, a record high. The imports climbed by 4.96 million tons, a 13.4 percent jump year-on-year.

The percentage of imported crude in the overall oil stockpiles has grown from 36.7 percent in 2005 to 57.4 percent in 2013, according to the CNPC Economics and Technology Research Institute.

Although falling oil prices have had negative effects on some domestic oil producers - through a decline in sales, a tension in capital chains and a growing risk of bankruptcy - it has also provided a new opportunity for these enterprises to invest overseas.?

These negative effects will force Chinese oil and gas enterprises into overseas acquisitions and mergers, most of which could come at inexpensive prices. If these companies could achieve more oil stockpiles and conduct effective foreign direct investment at a lower cost, China's economy will perform more actively if oil prices go back up.

But the biggest shadows cast on China's economy by the oil price slump are the intensified deflation pressures and the negative effects on China's exports.

In January, inflation at the consumer level fell to a five-year low of 0.8 percent, while the year-on-year Producer Price Index growth has recorded negative growth for 35 months straight, which indicates a growing deflation pressure.

Since the Import Price Index will affect PPI and the CPI, the drop in oil prices will accelerate the decline of the year-on-year growth of both PPI and CPI. In order to ease the pressure on deflation, it's expected that the People's Bank of China, the country's central bank, is going to implement more active monetary policies, such as cutting the reserve requirement ratio and interest rates.

Global oil producers will suffer significant losses in export revenue and economic growth, which could create a negative impact on China's exports. Thus far, the main exporters of bulk commodities, such as Brazil, Russia and South Africa, are undergoing economic instability and uncertainty. Once these countries' economic growth slows down or even takes a further downturn, China's exports to these countries will naturally experience a significant decline.

Main oil exporters around the world might also resort to measures such as trade protectionism and a devaluation in home currency that would surely affect China's export growth.

This year, Chinese government should strengthen its economic restructuring campaign, especially in accelerating market reforms and changes to the yuan exchange rate mechanism. The government should also try to stabilize economic growth, which stands at around 7 percent, in every possible way to create an agreeable environment for economic structural adjustments.

The author is senior research fellow and head of Department of International Investment, Institute of World Economics and Politics, Chinese Academy of Social Sciences. The views do not necessarily reflect those of China Daily.