Low Oil Price Benefits to South Korea

April 11, 2016South Koreaby East Asia Forum

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South Korea's economic engine could be greased by low oil prices.

The global energy situation is changing rapidly. The shale revolution has led to plunging oil prices that have remained around US$30 a barrel since OPEC’s failure to reach a consensus to cut oil production at its November 2014 meeting. This is an astonishing drop from the seemingly endless period of high oil prices of above US$100 a barrel. What do falling oil prices mean for the South Korean economy?

It is difficult to gauge the effects of the recent collapse in oil prices for the South Korean economy. As South Korea imports almost all its crude oil, one might expect that low oil prices have the opposite consequences of an oil price surge. Instead of leading to negative consequences such as inflation, a decline in economic growth and higher unemployment, low oil prices might become a foundation for economic growth — just like during the early-to-mid 1980s.

However, the current low oil prices have arisen in a vastly different global economic situation. During the low oil price period in the 1980s and 1990s, before the 1997–1998 Asian financial crisis, low oil prices supported global economic growth. However, currently, anxiety in the globalised world of financial markets is high, and almost all countries — with the exception of the United States — are experiencing recession. Therefore, unless South Korea adapts its energy policies to changed, dynamic global conditions, plunging oil prices will hinder rather than promote economic growth.

In a time when oil prices are plunging, the primary victims are clearly oil refining and petrochemical industries. These industries garner a bigger profit when oil prices increase. This is because generally the increase in petroleum and petrochemical product prices is bigger than the increase in crude oil price. In addition, there is a premium on the value of pre-purchased crude oil when its price increases. The opposite reasoning can be applied to a period of plunging oil prices.

For South Korea, financial difficulties in the Middle East and the Chinese economic slowdown are particularly harmful. South Korea’s number of contracts with Middle Eastern countries is noticeably decreasing. The delay or cancellation of liquefied natural gas (LNG) projects, stemming from low oil prices, is also directly harming South Korea’s shipbuilding industry, which has been focusing on high-grade LNG vessel contracts and manufacturing.

Current low oil prices are a sign of bad news now rather than a prediction of good news for the future. At the beginning of February, stock prices instantly responded, following the movements in oil prices. This is because the market considers the current oil price to be a barometer of economic trends.

Every day the news is full of reports on low oil prices. Now is the time for both the government and the private sector to adjust nimbly. This requires a flexible internal system that can rapidly adjust to increasingly uncertain external situations. With the international oil price reaching its lowest point in 12 years, it is the right time to secure overseas resources. A delicate financial technique for coping with heightened price volatility is becoming necessary.

South Korea is missing its opportunity due to reduced debt levels of public enterprises and controversy over the Korea National Oil Corporation’s forceful overseas investment during the Lee Myung-bak administration. A single public enterprise, Korea Gas Corporation, is responsible for 90 percent of South Korea’s gas purchase contracts. The gas is supplied at a strictly regulated price to some 30 regionally monopolised city gas companies. The current Park Geun-hye government has been advocating for new energy business, mostly related to smart power technology. However, with regulated fees and barriers to entry, there is little room for such a new market.

Still, there is an urgent need for South Korea’s energy policies to find new direction. The country cannot maintain its regulation of price and market entry within the old policy of ‘secure, government-led, cheap and good quality energy’ under the changed domestic and international circumstances. When the global gas market is favourable to buyers, as it is now, the domestic gas market needs to be more flexible, allowing multiple private enterprises to become purchasers in various forms.

To enjoy the benefits of low oil prices under severe global economic conditions, the government should not block investment in overseas resources. All developed countries, where promising new energy corporations are currently growing, share a liberalised market at their core. To overcome and disperse the risks of a changing global energy market, South Korea desperately needs reform aimed at inducing active private sector participation in the domestic energy market.

Will low oil prices grease the engine of South Korean growth? is republished with permission from East Asia Forum

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