Should we be worried by the falling price of crude oil? – A strategic discussion
December 1, 2014
So last week, the Saudis decided not to tighten the spigot and allowed production to go on as planned. This saw the price of crude oil tumble to a 4.5 year low of US$66.36 before settling above US$72. Many people saw this as a sign of the slowdown in the Asian economy, as China the largest net importer of oil, cuts down on demand. On the flipside of the things, the falling price will see pump prices go down, electricity tariffs drop, transportation prices fall, and an overall drop in the price of imported goods! It must be good news for us consumers! Or is it? In this article, we assess the impact of the falling price of crude and answer the question, “Should we be worried by the falling price of crude?”
Visible impact of the falling price of crude
As mentioned, the immediate impact of the falling price of crude can be seen at the petrol pumps. The falling pump price immediately makes the cost per trip less. This has a huge knock-on effect on the supply chain. Delivery costs will fall, thereby making the total cost of consumer goods cheaper, keeping all other things equal. As an importer of goods, Singapore’s inflation rate will fall with the fall in the price of crude.
Other services will also be cheaper. Electricity tariffs will fall and with it, the cost of production as well. Retail operators will revel in the increase in margins due to the fall in utility rates. It will allow them to stay open longer, and with that, benefit from the increased business activities, which is especially helpful in the year-end Christmas season.
Airlines can also breathe a little easier. With fuel making up the largest expense for any airlines, the huge drop in fuel prices will allow some airlines to move from the red into the black; with no change in operations. While this may prompt travellers to expect ticket prices to fall in tandem, this might not happen in equal proportion to the fall in prices because airlines will want to take this opportunity to boost their coffers, which may have been ravaged over the last 4 years. But that should still bring good cheer to travellers. At least they can expect a sunnier disposition from the cabin crew, what with a better bonus that they can expect from this.
The negative impact
Obviously, the falling price of oil directly impacts oil producers. With a drastic drop in revenue, some producers will find it difficult to fund capital expenditure (capex). They might have to delay much-needed equipment upgrades simply because the money has evaporated. This keeps operational expenditure (opex) high, thereby reducing margins for these companies even more. This has a knock on effect on all supporting industries who rely on the producers to make money. So if the producers’ margins are crimped, support companies will also see their margins crimped. And with that, the impact on salaries will be felt as companies look to rein in costs. Some companies, especially those in the US drilling for shale oil, and who have costed their operations and obtained credit terms based on a certain crude oil price, may suddenly find their credit lines pulled by their creditors, forcing these companies to fold. This has secondary effects on the market, of course; the impact of which will be felt in the housing, equities and bond markets.
There are also other impacts to the economy. Countries that rely heavily on oil and gas, like Brunei and to some extent, Malaysia, will see government coffers being negatively impacted. This will of course affect social expenditure, and some of the initiatives might have to be pulled back because of this. Singapore, having a more diverse portfolio, will not be as badly affected by the falling price of crude; in fact, as a hub for refining crude oil, there may even be an uptick in revenue as volume increases.
Of course, stock price of companies that deal with oil and gas production will also be affected. For example, oilrig manufacturers like Sembcorp Marine may see orders being cancelled. The thought of such events would send share price down, as can already be seen. Market players can use this to short such counters, thereby causing a downward pressure of share prices. If there is a contagion of such effects on more share counters (something that is NOT expected), there may be even more negative effects of the fall in crude prices.
So, should we be worried?
Not for most of us in Singapore. There may be a more positive impact by the falling oil price in the overall economy. Imports may cost less over time, operating costs may fall for many companies, other companies like airlines may also be able to bounce back. There will be pockets of companies being negatively affected by it, but due to the diversity of Singapore’s economy, we will not come off badly by it. However, there may be impacts to other countries that rely on high oil price; and that may still affect us.