Lower oil prices could help Korea

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Lower oil prices could help Korea

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The recent drop in crude oil prices is shaking economies and roiling financial markets. But the skipper of the Korean economy sees good sailing ahead and dismissed concerns about it causing deflation.

“There are various analyses about the dropping crude oil price, but for our economy, this is a favorable condition,” Finance Minister Choi Kyung-hwan said at an economy-related ministers’ meeting in Seoul on Wednesday. “We must gather our wisdom to revitalize the economy through an increase of household income and domestic demand and make the decline in oil prices an opportunity.”

According to data from the Korea National Oil Corporation, the price of Dubai crude oil, which accounts for more than 80 percent of the nation’s crude imports, was traded at $48.08 per barrel on Tuesday, the first time since April 28, 2009, that it was traded below $50.

Other benchmark crude oils also dropped. The price of West Texas Intermediate futures dropped $2.11 to hit $47.93 per barrel, which is the lowest since April 21, 2009. The price of Brent crude closed at $51.10 after dropping $2.01 from the previous trading day, which is the lowest since April 30, 2009.

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Choi said oil prices are falling because of supply and dismissed concerns of deflation in the local economy. According to a survey from Bloomberg, the Organization of Petroleum Exporting Countries (OPEC), which supplies about 40 percent of global oil, produced 30.24 million barrels per day last month, which exceeded their target of 30 million barrels. OPEC members, including Saudi Arabia, the world’s top oil producer, already said they have no plans to reduce oil production levels, while the shale gas boom in the United States continues.

“This oil price drop is mainly due to factors in supply, so it’s basically not related with deflation, which comes from a lack of demand,” Choi said.

Choi’s comments were backed up by a joint report presented Tuesday by five state-run think tanks - the Korea Development Institute, Korea Institute for Industrial Economics and Trade, Korea Institute of Finance, Korea Energy Economics Institute, and Korea Institute for International Economic Policy.

The report said Korea’s economic growth and incomes would rise by an additional 0.2 and 0.3 percentage points, respectively, every time global oil prices drop by 10 percent, only if the main reason behind the falling oil prices comes from the supply side.

But it acknowledged that if oil prices are also being affected by the demand side - the sluggish growth of the global economy - then the positive impact on the local economy will be limited.

The report forecast the annual average price for Dubai crude oil for 2015 to be $63 per barrel, down 34.5 percent from $97 in 2014. In that case, Korea’s gross national income will likely increase by an additional 30 trillion won ($27 billion) when 30 billion won in crude oil import costs are saved, the report said.

The institutions provided three possible scenarios for oil prices. In a scenario that the oil price stays in the $60-per-barrel range and the global economy slowly recovers, the report predicted that Korea’s economic growth rate would increase by 0.1 percentage point and the country would have an additional $5.2 billion in its current account surplus. Consumer prices would drop by 0.1 percentage points.

If the oil price drops to $49 per barrel, the positive impact will grow. Korea’s economic growth rate will go up 0.2 percentage points, while the current account surplus will gain an additional $10.2 billion.

“The rise of purchasing power throughout our economy due to oil price drops will contribute to enhancing domestic demand,” the report said. “It will ease the unbalanced situation between domestic demand and exports.”

The report said that a 10 percent drop in oil prices would reduce the country’s production costs by 0.67 percent, with companies in the manufacturing sector expected to see a drop of 1.04 percent.

However, think tanks urged companies to use the production cost cuts to reduce the prices of their products to get the most out of the situation.

The report said that if oil prices drop 10 percent, purchasing power in Korea increases by 10.4 trillion won - but the 9.4 trillion won that goes to companies when the price drops isn’t reflected in prices of non-petrochemical products.

If the decline in the oil price is applied to non-petrochemical products, the report said, there will be a 9.5 trillion won increase in the nation’s purchasing power and 54.8 percent, or 5.2 trillion won, will be returned to households.

“We will try to improve the price structure to make oil price drops reflected in the retail price quickly so that people can actually feel it,” said Finance Minister Choi.

The report also said that lower oil prices will boost the competitiveness of Korean exports as the impact on production costs is twice as large as the impact for competitors in China and Japan. Such cost reductions will lead to an increase of exports from Korea’s manufacturing sector of 0.55 percent.

“Other competitors will also drop prices on their products, but Korea relies more on crude oil imports and will see larger benefits in production cost reductions,” the report said.

However, the report suggested that not all industries will benefit. Profitability in the petrochemical industry will suffer.

“Their production cost will go down, but at the same time, their products’ retail prices will go down,” the report said. “Pressure for managing inventory is also aggravating as buyers are delaying purchases in expectations of additional price drops in the future.”

The report also worried about Korea’s shipbuilding industry, which makes offshore plants for pumping oil from the sea.

“The crude oil price drop will also cut demand from customers to change their ships to be more environmentally friendly,” the report said.

The automobile industry was warned to keep up with changes in demand as there will be more sales of midsize or large sedans instead of environmentally friendly cars like hybrids.

BY joo kyung-don [kjoo@joongang.co.kr]

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