The Many Implications of Cheap Oil in Southeast Asia

Author: Kai Ostwald

Beginning in mid-2014, the price of oil began a precipitous fall from over $110 per barrel to below $50 in January 2015. The standard narrative on the impact of this price decline is familiar: low prices benefit net oil importers while they reduce available revenue for net oil exporters. This truism, however, obscures the many subtler effects that cheap oil and the related decline in prices of other key commodities have on economic and political systems in different regions of the world, including Southeast Asia.

Why should Canada care about these effects? Like many countries, Canada is beginning to take the increasing economic clout of Southeast Asia seriously and has made building stronger economic and political ties with the region a priority. This interest is demonstrated through initiatives like the ASEAN-Canada Plan of Action (signed in 2010), which aims to increase political, economic and socio-cultural cooperation between Canada and ASEAN, and the myriad of other new forms of engagement geared towards increasing trade and investment. Given the importance of the Canada-Southeast Asia relationship, there is a clear need to understand how an abrupt drop in oil prices impacts some of Canada's key partners across the region.

Varied Economic Impacts

The broad economic impact of low oil prices is fairly intuitive for Malaysia and Brunei, the two net oil exporters of Southeast Asia. Malaysia, which funds roughly 30 per cent of its federal expenditures from oil revenue, has been forced to slash its budget mid-year and revise its growth forecast downward and projected deficit upward. This fiscal pain is compounded by the fall in palm oil prices to five-year lows (Malaysia is one of the world's leading exporters of that commodity).

While Brunei has also been negatively impacted, the reserves it has built in recent years provide insulation against the reduced revenue stream, as do its exports of liquefied natural gas, the price of which has not declined as severely as that of oil.

While the net effects on Southeast Asia's remaining countries — all of which are net oil importers — are generally positive, they are far from uniform. Thailand, for example, appears particularly well situated to benefit from low oil prices, both because it relies on oil imports for a large share of its energy needs, and because its sizable manufacturing sector receives a significant boost from low energy prices. Bank of America Merrill Lynch Global Research estimates that every 10 per cent drop in oil prices leads to a roughly 0.45 per cent increase in gross domestic product for the country, one of the greatest impacts across Asia.

This is, however, only half of the picture. Thailand currently holds massive stocks of rice, following the now-ousted Prime Minister Yingluck's program that guaranteed farmers an above-market price for that commodity, much of which went unsold. The value of these stocks has decreased as the market price of rice has fallen alongside that of other commodities. This presents the government with a problem: they are under pressure to recoup at least some of the costs of the subsidies, but selling at current market prices would mean absorbing significant losses. In short, while the low oil prices are indeed a boon to some sectors of Thailand's economy, the accompanying fall in the value of its rice stocks mitigates the positive fiscal impact.

Similarly, the economic impact on Indonesia is far from one-dimensional. The island of Java — home to roughly 80 per cent of Indonesia's manufacturing sector — will see a substantial boost to its economy. But many of the outer lying islands — which rely heavily on commodity exports including coal, rubber, and palm oil — will suffer from the fall in commodity prices. Beyond just lessening the positive impact of low oil on Indonesia's fiscal position, the fall in commodity prices threatens to exacerbate the often-tense relationship between Java and the rest of Indonesia.

Political Unease

The political implications of low oil prices are as profound as the economic ones. Malaysia's dominant Barisan Nasional government has long relied on revenue from the state oil company Petronas to dispense patronage and fund populist programs. With this source of revenue constrained, it finds an important mechanism for securing votes under threat. This puts particular pressure on a government that has seen its public support drop considerably in recent years (it failed to secure even 50 per cent of the popular vote in the 2013 general election).

To be clear, low oil prices are not the primary cause of the many recent illiberal actions by the government (including the re-imprisonment of opposition leader Anwar Ibrahim, the selective usage of the sedition act to repress opposition voices, and the increased prominence of far-right extremist groups like ISMA and Perkasa). With a reduced ability to secure support through patronage, however, the government will be pushed towards other and potentially more divisive measures to maintain its grip on power.

The impact on Indonesian politics is similarly significant. Newly elected President Jokowi (Joko Widodo) entered office last October with a reformist agenda, including a commitment to remove fuel subsidies that consumed 20 per cent of the country's budget in 2014. Despite the remarkable domestic and international attention his victory brought, however, Jokowi found himself in a politically weak position because the powerful legislature was firmly in the hands of his main political adversary, Prabowo Subianto (despite its remarkable symbolic power, the Indonesian presidency is an institutionally weak position). With Probowo's coalition determined to obstruct all elements of the reform agenda — including the test-piece removal of fuel subsidies — Jokowi faced the prospect of becoming powerless at the very onset of his tenure.

Instead, the precipitous fall of oil prices pushed unsubsidized fuel prices below the subsidized prices of only several months earlier, opening a key window that enabled Jokowi to remove all subsidies (except a small fixed subsidy on diesel) on January 1st without significant backlash. Beyond the clear benefits that follow from diverting inefficient fuel subsidy expenditures into more productive areas like infrastructure development, the move brought Jokowi at least some credibility and momentum, and may well have given his presidency a fighting chance.

Thailand's new government has similarly been granted additional maneuvering room due to low oil prices. Much has been written about the coup that overthrew the democratically elected Yingluck government in May 2014, specifically that the new government — led by former general and architect of the coup, Prayuth Chan-ocha — has been unusually repressive and regressive in terms of a commitment to democracy. The political instability and lingering doubts about the ability of the military government to effectively manage the economy rattled the investment community significantly and led to fears of an economic downturn. These fears were manifested in the months following the coup, which saw significant slowdowns in trade, spending, investment, and tourism, as well as annualized growth rates that were amongst the lowest in the region.

Thailand, however, is well situated to benefit from low oil prices and appears to have done so; a revitalized manufacturing sector led the general rebound in economic activity during late 2014 and early 2015. Low oil prices are not the sole factor driving the rebound, but by contributing strongly to it, they have given substantial breathing room to the new government, which almost certainly would have seen resistance against it mount in the face of a sustained economic downturn.

Low oil prices in the Philippines have the potential to impact the relationship between the national government in Manila and the country's restive south, which has considerable commodity wealth and oil reserves, especially near the island of Mindanao and the Sulu archipelago. It has been suggested that those reserves, as with others in the region, would be relatively expensive to exploit due to their deep-water location and vulnerability to typhoons, with the immediate effect that they are not sufficiently profitable at low oil prices to attract investment. Despite the recent political negotiations — currently under threat due to a recent uptick in the conflict — that would see a considerable portion of commodity revenues stay local, Manila does stand to gain from significant investments in the south. There is no question that Manila's primary concerns in the south are security related, but with the prospect of sizable investments at least momentarily reduced, the incentive structure for engagement with the south has changed in a way that is likely to impact the nature of the ongoing negotiations.

A Region-wide Implication: The South China Sea Factor

Like in the Philippines, many of the oil reserves in the South China Sea are either unprofitable or not sufficiently profitable to exploit at low prices. Could this act as a pressure valve to reduce tensions in the disputed waters? It may, if we assume that the conflict is motivated by relatively myopic actors scrambling to secure profitable resources. An alternate reading of the conflict is the one offered by Bill Hayton, who suggests that China in particular is motivated by the value of the oil travelling on the South China Sea, rather than that below the sea; in other words, the conflict can better be understood as a struggle for control of the ever important shipping lanes, rather than as one for resources. Interestingly, the low oil prices will reveal much about the motivations of the South China Sea's key actors, including the Philippines, Vietnam, Indonesia, and China. All eyes should be focused on the decisions made by these governments in the coming months.

Bill Hayton (2014) The South China Sea: The Struggle for Power in Asia. New Haven: Yale University Press

Jomo K.S. and Edmund Terence Gomez (1997) Malaysia's Political Economy: Politics, Patronage, and Profits. New York: Cambridge University Press

The views expressed here are those of the author, and do not necessarily represent the views of the Asia Pacific Foundation of Canada.

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