High Oil Prices to Have Devastating Impact on Regional Inflation

Strategic Insights -

Economists and analysts in the Asia-Pacific region are warning of a potentially damaging effect of high oil prices on inflation, which could lead to higher interest rates. The latest rally in oil prices has sparked renewed focus on this issue, with some governments in the region already implementing fuel subsidies to mitigate the impact. However, experts argue that the longer oil prices stay high, the more costly this intervention becomes, forcing other countries to choose between raising interest rates or allowing their currencies to appreciate to offset imported costs.

Key Takeaways:

  • Economists are increasingly highlighting the potentially damaging effect of high oil prices on inflation in the Asia-Pacific region, which is a large net importer of oil.
  • Countries such as Thailand, Indonesia, and India have fuel subsidies in place to dampen the impact of price increases, but these subsidies become increasingly costly the longer oil prices stay high.
  • Other countries may face the difficult choice of raising interest rates or allowing their currencies to appreciate to offset imported costs, with most countries likely to opt for currency appreciation.
  • The supply of oil remains tight due to a lack of investment in exploration and new facilities, with spare capacity among global oil producers falling to less than 1 million barrels per day in September 2022.
  • Analysts predict that oil prices may stay high for the short term, with some estimating an additional $10 to $15 on top of the current price due to a combination of supply shortages, strong global demand, and fears about terrorism.
  • A calculation by the Asian Development Bank suggests that a sustained rise in crude oil prices to $50 from $30 would slow Asia ex-Japan GDP by 1.2 percentage points in the first year, with Thailand being the worst affected with a 4.1 percentage point drop.
  • The impact on margins and profits at the company level could be even more severe, with Morgan Stanley Economist Andy Xie estimating that a $1 increase in oil costs Chinese companies an extra $1.3 billion a year.
  • China's refining industry is under pressure from high oil prices, with Sinopec Zhenhai Refining and Chemical implementing a shift to higher-sulphur content crude to reduce costs, leading to a 10% improvement in its profit margin.
  • Despite expectations of high oil prices, some analysts still see oil producers as too risky due to their vulnerability to a correction, suggesting a position shift towards technology stocks.

Statistics:

  • Spare capacity among global oil producers had fallen to less than 1 million barrels per day in September 2022.
  • Asia ex-Japan GDP would slow by 1.2 percentage points in the first year if crude oil prices sustain at $50.
  • Thailand would be the worst affected with a 4.1 percentage point drop in GDP.
  • China's daily imports of crude oil were about 3.5 million barrels.
  • China's refining industry's profit margin improved by 10% or $0.50 per barrel.
  • Alistair Thompson, Deputy Head of Asia-Pacific ex-Japan Equities at First State Investments, estimated an additional $10 to $15 on top of the current oil price due to supply shortages, strong global demand, and fears about terrorism.

Sources:

  • "Fed chairman Alan Greenspan has argued that the rise in consumer prices has been largely due to oil, which should be regarded as temporary."
  • Nilesh Jasani, Asian Equity Strategist with HSBC
  • Spencer White, Head of Regional Equity Strategy at Merrill Lynch
  • Alistair Thompson, Deputy Head of Asia-Pacific ex-Japan Equities at First State Investments
  • Morgan Stanley Economist Andy Xie
  • Asian Development Bank