Oil Price Effect on International Trade

Oil prices fluctuate violently in these few days due to the US-Iran tensions. The WTI oil price fluctuates between USD60–63 per barrel in the past 2 days. If you take a longer horizon to view the fluctuations, the volatility is even more frightening.

The recent peak was USD135.36 in June 2008 as shown in Figure 1. It surged up 151% from Jan 2007. But it plummeted dramatically to USD34.93 in Feb 2009, i.e. a 74% fall! Then it rose back to above USD100 and leveled off for almost 5 years and then it abruptly plummeted to the recent bottom at USD30.10 in Jan 2016.

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Figure 1 Oil (WTI) Price Fluctuations 2007–2020. Source: Markets Insider https://markets.businessinsider.com/commodities/oil-price?type=wti

Oil price affects almost every aspect of our lives, as it is still the dominant energy source. The transport industry receives the most direct impacts. Airlines and Bus Companies had asked for fare increases, and especially in cities like Hong Kong where almost all products are imported. Once oil prices go up, all prices will go up. That is the story told by Jeff Rubin (2009) that “why your world is about to get a whole lot smaller”, because when transportation cost is too expensive, people would normally switch to local products or products produced from shorter distances.

However, with hindsight, Rubin’s (2009) prediction is proved to be fatally wrong. He could not foresee the abrupt plummet of the oil price since 2014. It allows a bigger world for trading again.

With such a roller coaster oil price pattern, even if you have hedged the price upsurge, you may make a big loss. There was an airline in Hong Kong that had hedged heavily against oil price increase so as to prevent making a loss in the airline operation, unfortunately, it caused the company a heavy loss in the wake of the sharp fall of oil prices in 2016.

How does oil price change affect our living costs? Since oil consumption is almost inevitable in every aspect of life, from transportation to food production, its price change would impose a severe impact on our living cost. What we can do is to cut our consumption quantities, especially products from countries far away from us.

In other words, it is plausible to expect that when oil price increases, international trade quantity would decrease. Figure 2 shows the Baltic Dry Index which reflects partly the international trade situations. Its pattern in the past decade seems to match with this hypothesis. When the oil price in the early 2000s was high, the Baltic Dry Index fell until 2016, then went up. Coincidentally, the recent lowest oil price point was in 2016, which allows international trade to grow again. But it also seems to have a lagging pattern in the index.

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Figure 2 Baltic Dry Index. Source: Trading Economics https://tradingeconomics.com/commodity/baltic

However, Deb et al. (2019) provide some interesting evidence of the relationship between petroleum price and its volume imported to Mainland China. It indicates that the imported volume is not quite elastic to the price, probably reflecting that it is difficult to adjust its consumption.

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Figure 3 Petroleum Import Growth in Volume and Price to Mainland China. Source: Deb et al. (2019)

Figure 3 shows that the fluctuation of petroleum price from 2014M12 to 2018M12 ranged from -0.5% to +0.5%, the imported volume of petroleum seems to have a slightly negative relationship with the price change. The inelasticity of petroleum consumption may be inferred by the fact that “The price increase accounted for close to 80 percent of the increase in petroleum imports” (Deb et al., 2019). Then, we probably have to cut other consumptions so as to retain more or less the same consumption of petroleum. It will anyway affect global trade.

References

Deb, Pragyan, Gjonbalaj, A. and Hannan, Ahmed (2019) The Drivers, Implications and Outlook for China’s Shrinking Current Account Surplus, IMF Nov.

Rubin, J. (2009) Why Your World is About to Get a Whole Lot Smaller, London: Virgin Books.

Written by

ecyY is the Founder of Real Estate Development and Building Research & Information Centre REDBRIC

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