In a reflection of the nearly unprecedented global economic shutdown amid the coronavirus crisis, the benchmark U.S. oil price hit negative territory last month for the first time in history.
Cheaper oil, in itself, is good for Japan, the world’s third-biggest economy. But economists have said that with manufacturers continuing to curb production and the government still calling on people to telework despite the end of the state of emergency in most prefectures, the benefits of lower oil have been minimal.
Here’s a closer look at the recent oil price plunge and its impact on the economy.
What prompted the recent drop in the price of oil?
A historic decline in global demand, triggered by lockdown measures imposed globally amid the novel coronavirus pandemic — including a near-halt to global air travel — has caused the price of oil to crater.
U.S. light crude oil fell below $20 (about ¥2,150) a barrel in late April, down by around 70 percent from the start of the year, amid concern that U.S. crude stockpiles were likely to reach full capacity.
The International Energy Agency says worldwide containment measures likely pushed down demand by as much as 29 million barrels per day (bpd), about 30 percent of global demand. But the oil cartel OPEC and its allies, including Russia, have agreed to curb supplies by only 9.7 million bpd, leaving the market with excess supplies, pressuring oil prices.
What impact has this had on the Japanese economy?
For Japan, which relies on imports for virtually all of its oil, lower prices are positive for the economy and stimulate economic activity, working similarly to tax cuts, according to Tomomichi Akuta, senior economist at Mitsubishi UFJ Research and Consulting.
“But the negative impact of cheap oil prices is large for Japan, which relies heavily on the manufacturing industry,” Akuta said.
The nation paid ¥7.98 trillion for oil over the course of fiscal 2019, amounting to about 3 million barrels of crude per day at an average price of $67.82 a barrel, according to calculations by The Japan Times based on trade data issued by the Ministry of Economy, Trade and Industry.
If prices hover around $30 per barrel for this business year, which started in April, Japan might theoretically shave off more than ¥1 trillion in annual crude import costs — which could help shrink the goods trade deficit posted in each of the past two years.
Theoretically, that would put downward pressure on the prices of energy and manufactured goods, helping push up consumption and making travel cheaper.
But the benefits of cheaper prices to households and businesses would likely be limited, as oil demand has already fallen more than 10 percent due to requests from the government for people to adopt what it calls a “new lifestyle.” That new lifestyle includes telecommuting, even with the lifting of the state of emergency in 39 prefectures earlier this month, and in three more prefectures in the Kansai region on Thursday.
The state of emergency declaration issued in April has had a devastating impact on the nation’s economy as a whole, shrinking consumption. Japan plummeted into recession in the January-March quarter after gross domestic product shrank by an annualized 3.4 percent, and economists are projecting a contraction of more than 20 percent in the current quarter.
The collapse in oil prices or other commodities has also pushed major trading houses to post more than ¥600 billion in writedowns on their assets in energy, grains and metals in the first quarter, while also curbing new investments amid growing uncertainties due to the global pandemic.
Why did the U.S. oil price hit negative territory and what does a negative price mean?
On April 20, the last trading day for U.S. crude oil futures for May delivery, traders and speculators were desperately trying to offload their remaining positions to avoid owning actual oil. That’s because for every outstanding contract they owned when contracts expire, they would have to take physical delivery of 1,000 barrels at the Cushing, Oklahoma, delivery hub for West Texas Intermediate crude, and pay storage fees.
Amid fears crude storage was nearing its capacity and that much of the remaining capacity had been booked, traders thought they would be better off paying to get rid of unwanted oil. In the end, the May contract expired that day at minus $37.63 a barrel, down $55.90 from the previous closing price. The one-off anomaly, however, did not impact Brent crude, another global benchmark.
Analysts say the chances of seeing oil slip into negative territory again are slim, as the Chicago Mercantile Exchange, which hosts U.S. crude trading, and several brokerages have strengthened steps to curb open positions ahead of monthly contract expirations.
Speculators also have been accelerating efforts to roll over contracts into subsequent months well ahead of the expiry in order to avoid a similar predicament. U.S. crude for the June contract expired on Tuesday without a repeat of the negative price fiasco.
What’s the impact on global oil producers?
Among the grave concerns globally is that current prices are not adequate to sustain most oil producers’ output, as the break-even price for balancing the budgets for major exporters like Saudi Arabia is said to be in the $80 to $90 range or possibly higher, according to Akuta of Mitsubishi UFJ Research and Consulting.
Another concern is heavily-indebted U.S. shale oil producers, some of which have been ramping up pressure on Washington to provide relief funds so they can cover interest payments. The break-even price for U.S. shale oil production is believed to be around $23 to $32 a barrel, Takayuki Nogami, chief economist at Japan Oil, Gas and Metals National Corporation (JOGMEC) said in a report last week.
More than 70 oil and gas operators in the U.S. upstream oil industry could go bankrupt this year if the $30 oil price continues, Rystad Energy projected last month. A default of the American shale industry, one of the biggest issuers of U.S. junk bonds, could send a ripple effect across credit markets. In the long-run, lower oil prices reduce upstream investments and limit supplies, which would then lead to higher oil prices.
“The regulations on the financial industry’s lending and assets have been strengthened after the Lehman crisis, so the impact to major financial institutions should be limited,” Akuta says. “On the other hand, many funds have been lending or underwriting bonds issued by U.S. shale producers, which could raise the risk that they, too, may come under pressure.”
Are we seeing lower prices at the pump?
The average price per liter of gasoline last week inched up by ¥0.7 to ¥125.5 after posting the lowest average price since October 2017 the week before.
Despite lower crude prices, the impact on prices at the pump is seen as limited, analysts say. Petroleum and consumption taxes account for more than half of the price of gas, so it’s unlikely that the average price would fall below ¥110, Akuta says.
What is the outlook for oil?
The collapse of global oil demand likely peaked in April, and the subsequent relative recovery starting in May has been helping push up prices recently, JOGMEC’s Nogami said.
Oil prices have since recovered to above $30, but the IEA has forecast a continuing and prolonged drop in demand. The Institute of Energy Economics, Japan (IEEJ) said Wednesday that fears over a second outbreak of the coronavirus pandemic in 2021 could not be ruled out, and that such a development could cause severe economic damage to most global oil producers.
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