Oil influence for Europe toward China trade
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Executive summery
One of the most imported fundamentals in the global trade is based on the oil prices, when we look at the oil prices during the first oil crises at the beginning of 2001 we can indicate that this has led to higher transport cost of goods. Since there is a direct link between Transport cost and foreign trade , increasing oil prices result in lower export figures.
The main question of this report is; Do oil prices have a significant influence on European Union import from China and what are the consequences in balance between the EU and China?
The global oil crisis with increasing prices was just recovering at the moment the economic crisis started as a result the oil prices started to decrease. Ahead of this economic crisis the growing global demand of oil has increased the prices and boosted by emerging countries such as China has lead on July 3rd 2008 to a peak of 143.95 dollar a barrel the highest price ever recorded.
The high prices have a great effect on trade between countries especially China to EU and USA. Because transport cost increased and the demand decreased in addition the credit crises had a major influence on this. The oil prices has dropped on December 26th 2008 to 33,73 dollar a barrel. When we look to the current situation is around 75 dollar.
China has become one of the largest manufacturing country in the world due their comparative advantages therefore European companies have outsourced their production to China. The produced goods need to be shipped back to Europe. The (sky) high oil prices during the crisis have forced shipping lines to adjust their fleet by reducing speed and volume of their transportation between Europe-China. Finally the increase of this prices were also effecting negative the prices of consumer products.
The high oil prices effect the transport and production cost and this will result in less European goods being exported. However China has always supported competitive manufacturing and stimulate their export that led to lower transport cost. In addition the currency policy of China keeps Chinese goods artificially cheaper.
Introduction of the assignment
This assignment has been issued by Jennifer Swint and is the resit of the resit alternative replacement assignment of the course of Asia trade and business economics in term 7.
For this assignment I have chosen to focus on China, because China is today the second largest economic in the world. Therefore, it is in my opinion interesting to research, whether trade and economic growth between Europe and China would be affected by the increasing oil prices. Chinas economy is developed as an strongly based to the export of mainly low value goods. The issue is: will this economic structure remain the same, when production and transport costs increase due to the rising oil prices and current economic crisis.
The rising oil prices have lead to higher freight rate and oil charges in transport costs, which become a larger component of transaction costs. This can affect the European and China trade. However production costs are also determined by factors, like trade volumes, geography, administrative processes and infrastructure. Higher oil price could affect globalization process and that can change global trade.
Every time when I drive my car towards a petrol station Im interesting to see what the current prices of petrol is. When I know that the oil prices will drop than I wait (when possible) to fill up my car. This is off course a small effect that I experience and this give me the motivation to study the larger effect of trade between China and Europe When oil prices and transport cost. change, what is the effect on trade.
This report will give an indication of my findings. Out of personal interest I watch the movie The Tank Man this documentary is all about the protest at Tiananmen Square in 1989 and about the politics situation of China. Also I would like to Thank Martijn Turkenburg with his advice and input to help me to make this assignment.
Information about China
To have an better overview of China I give in this assignment the important and basic facts about China, to fully understand the history of China you can see why the government of China has chosen their pads. In line of the subject of Asia trade en business economics I give hereby a general overview of China:
Summary
China is known for centuries as a leading civilization in art and sciences. In these practices the Chinese were far ahead of other countries like Great Britain, USA and Europe. Their invention of paper and printing and also the compass was at least 100 years ahead of any other nation . China is the third largest country in world after Canada and Russia and currently China has a population of around 1.34 billion people.
After the loss of China following the Opium War, to great Brittan in 1884 and later the Japanese invasion, the country was beset by civil unrest, military defeats, and foreign occupation. After World War II times changed and on 1st October 1949 the People's Republic of China was established by the Communists under Mao Zedong.
In late 1970 China started their economic reform, this resulted in a rapid economic growth with continuous experimentation and the multi staged market reform. Nowadays China is still the most wealthy by changing economy country in the world, Chinese believe that their economic will be booming and continue to be in the coming centuries.
Independence & Demographics
A quarter century ago Chinese Premier Deng Xiaoping has declared his goal to get rich is glorious. due to the large population of workers China has a great advantage and is cashing in now.
For centuries China has been the most populous country of the world. In 1953 the Chinese population reached 582 million. Currently the Chinese population grew to 1.3 billion people. The means that one in five people worldwide is Chinese. These demographic enable China to have a rapid economic expansion. Employment in China is now over 800 million people this is double that of the United States and the European Union combined. In 2009 China is forecasting to overtake the United states as the current largest manufacturer of the world.
The population of china will continue growing for at least another twenty years, and will have an peak at about 1.5 billion citizens around the year 2035. With fertility rates of 1.7 children per woman, China is now below the replacement level of 2.1 children.
The United Nations has estimate that China large workforce will be shrinking from the year 2015. The slowdown will be felt later is the opinion of others, because of the millions of migrants are still moving to the cities. Some hope, that there will be an offset of better educated workers. However the United Nations has estimate that by 2050 a third of the population of China will be over 60, that is three times the current population, this will result is enormous pressure on the economy and social system.
The challenge for China will be to make a good balance between growth in population, education and economy.
Economy
For the past 30 years China economy have been changed rapidly from a centrally planned system that has been in that past closed for international trade to a modern new market-oriented economy that allow a fast growing private sector and therefore they are now a major player in the global economy.
China needs to search and develop energy production capacity from sources other than coal and oil alone, they need to focus on nuclear energy development. In 2009 started the downturn of the global economic it reduced foreign demand for exports for the first time in many years. The government vowed to continue reforming the economy and emphasized the need to increase domestic consumption in order to make China less dependent on foreign exports for GDP growth in the future.
China GDP Growth Rate
The annual Gross Domestic Product in China was in the last quarter of 2009 10.701%. According to the world bank the Gross Domestic Product of China is 4326 billion dollars or 6.989% of the total world economy. China's economy is since 2008 the second largest economy in the world after United States. This success is the result of the numerous changes in the past 30 years, the economy has changed from a central planned system that does not allow much to non international trade to a modern market oriented economy, this allow a more rapid growth of the private sector.
China Industrial Production
During the last several months is the Industrial Production in China expanded to 18.514%. the Industrial production measures the changes in output from the industrial sector in compared to the economy, this includes utilities and manufacturing of products. For economic forecasting the Industrial Production is an important indicator. This is also used to measure inflation pressures of the top levels of industrials production and sometimes used to change prices to balance the economy.
China Gross Domestic Product (GDP)
By the figures of the World Bank Chinas Gross Domestic Product is worth 6.987% of the world economy. Chinas Gross Domestic Product (GDP) expanded at an annual rate of 10.701 percent over the last quarter. Since 2008 the Chinese economy is the third largest in the world after the United States and Russia. In the last 30 years the economy in China has rapidly changed from a centrally planned system that was nearly closed to international trade to a more market oriented that allow a rapidly growing of the private sector. A major component supporting China's rapid economic growth has been exports growth.
Politics
On October 1, 1949 Mao Zedong claimed the founding of the People's Republic of China. with his new government he take control of the country and people that have suffered by two generations of war, social conflict and the high inflation of the economy. Change for a new politics and economic was in order to change China. Mao Zedong party quickly established a new government based on Soviet union example.
Moa broke with the Soviet model in 1958 and he announced that the government needed to focus on a new economy program called the Great Leap Forward which was designed to focus more on industrial and agricultural production. Small backyard factories developed quite rapidly in to large production factories. However due to over production products became unsellable the poor planning of the overall Great Leap Forward to get the economy in balance has resulted later in a more stable economy and production but this was not before 1960.
When Moa announced that they were breaking with the Soviet model in 1958, the relationship between them deteriorated sharply. In August 1960 the Soviet union began to withdraw all their personal from China. Also Soviet restricted sharing their information about science and technology development.
In 1989 there was high inflation and the economic growth stayed out. After the death of Hu Yaobang on 15 April 1989, the lack of improvement resulted in large scale protest started by the (high educated) students followed rapidly by other parts of the community soon after the students started their protest intellectuals, medical personal and journalist joined the protests. In Beijing the students and other citizens gathered at the Tiananmen square first off all the mourn of Hu Yaobang death but also to protest against all who would prefer a slow reform. The government was not pleased with this situation their efforts to end/ contain them failed and the protest grew not only in Beijing but also in other cities like Shanghai and Guangzhou. On 20 may 1989 Martial law was declared this did not had any effect until begin of July. The government ordered military force the stop the protest and the military force unit started late 3rd July and the early morning of 4th of July to clear the square and clear all the students from the streets of Beijing.
After the protest the gap between the people of China and the government was huge. The government realized that there was need for changes, despite the slow reform a new plan was issued by Deng Xiaopings after his dramatic visit in 1992 to the southern of China. After that visit the started to renew politics to push for an more open market orientated economy, Deng realized to give something back after the protest to the citizens is wealth something that the communist party have always banned to control the country strict. Later in the year at the 14th party congress the leaders official sanctioned this new market oriented economy.
In the party Deng and his supporters argued that the economy needed to change to increase living standards this should for them be the only focus China need to undergo, China needed to change after the protest and the best way is give something back. Even capitalist measures were adopted and that is for China radical because they have always been very protected by the government.
After the government finally committed to reform the economy and allowed an open market and foreign business. China desire to reform their state industry was the main government priority, the main goal was to achieving a large scale privatization of the non profitable state owned companies. Also the new leadership has limited the government influence and bureaucracy. After the open market the international business really grew to the second largest economy it is today.
Oil crisis and economic issues
Summary
In national and global economy crude oil is one of the most important fundamental component to measure the economy. Because it one of the most imported energy source we know. Oil can be used to generate electricity also it is a raw material for numerous products like plastic. When crude oil is refined to a more synthetic one you can also use it for petrol of a car, plane or boat. Because the (crude) oil is a imported factor to many products we use has, it is a fundamental function in our economy. The oil price has an direct impact to the manufacturing sector and transport sector because production and transport costs have a indirectly influences on product prices. The oil price have an effect on inflation and have a big impact on stock prices , car sales, exchange rates and many other things. Rising oil prices and economic growth have a high correlation , but in reality the adjustment of economic growth has some time lag after an oil price change.
The oil crisis of 2008
In previous century there have been two oil crises that were affected by high oil prices which deteriorated the global economy. The first oil crisis in 1973 was the first that influenced the whole global economy. Arabic oil exporting countries cut oil supply as a politic action against western countries. Oil prices increased with 70%, while oil production reduced with 5% every month. After a half year oil prices increased. Increasing oil prices had a big impact on the global economy, which ultimately lead to stagflation. The second oil crisis was in 1979, when crude oil price increased exponentially due to the huge conflict between Iran and Iraq. between November 1978 and June 1979 Iran had limited the oil export to only 2 to 2,5 million barrels per day. The production in 1980 of the global oil production was even 10% lower than in 1979. These events caused oil prices to rise from $14 in 1978 to $35 in 1981. After 26 years, Iran production is still only two-third of their previous level. Iraq oil production remains about 1,5 million barrels under its peak before the Iraq - Iran war. The cause of both oil crises is the result of political, bureaucratic and business that gains from the government limitations on oil market.
The current oil crisis is differs from the previous two oil crises from the 20th century. The origin of the oil crisis in 2008/9 is not just caused by political confrontation in Middle East, but from a broader economical global context where emerging countries also play an important role. Moreover, EU import of cheap Chinese goods limited inflation pressure.
Recently, there have been new reports about the Peak oil in the future. The combination of expected oil production and larger global demand by emerging countries resulted in a higher oil price during the recent oil crisis in 2008. Between the beginning of 2003 and mid 2008, oil prices in dollars increased by 320%. Beginning 2008 oil value measured by the exchange rate passed the 100 dollar this was caused by low supply growth in combination with a tight spare capacity. It is interesting to compare to the oil price in the year 1998 when it was just 11 dollar, in Unit 2008 the record oil price was in April 1980 102,81 dollar adjusted by inflation. The reverse and peaked at the record high of 143,95 dollar on July 3rd 2008, see overview of the oil price of the last 20 year in figure next page.
Europe Brent Crude Oil daily Spot Price FOB (dollar per barrel)
Source:
Own elaboration based on US Energy Information Administration data (2009)
Oil price increase
Many factors caused the increase of the oil prices the 2008 changed the prices suddenly to a new oil crisis period.
The main driver is the fastest growth of world economy and trade in decades. This economic expansion leads to a substantial increase in oil demand. The economic prosperity is proportional with energy consumption. Higher traffic volumes and particularly road traffic volumes are strongly coupled to GDP. Global oil demand by emerging countries. Dynamic economic growth of emerging countries pushed their appetite for oil, which resulted in larger global oil demand. The increase of an higher word demand is related to China by 1/4 in 1995-2004 and even 1/3 in 2004 China expected share in world oil demand increased from 7% in 2005 to 12% in 2025.
The high demand oil is according to a few analysts mainly the result of speculative investors who used crude oil as an investment for the weaker dollar. when banks and hedge funds treat oil as assets. Moreover, speculators gamble on oil exhaustion combined with larger global demand in the near future.
The consequences of high oil prices have deep impact on the global economy The higher fuel price generate a large problem for the whole transport sector the most direct effect is on the aviation sector who suffers one of the most under the high kerosene prices to run their fleet, everyone is aware of the effect on plane tickets. Prices have increased as never before. Also higher bunker price in the maritime transport leads to higher freight rate. Higher transport costs eventually passed to the end consumers. However, increasing transport costs forced transport companies to higher efficiency.
High oil costs have forced users to change their usual oil consumption. Governments and manufacturers have more financial incentives to invest in alternative energy sources to reduce oil dependency. Investments in sustainable energy or energy efficient technology are more profitable.
Oil price decrease
Many studies are forecasting the future oil prices will increase to over 200 dollar only those studies did not include the decline of the oil price in late 2008. The main reason for the decrease of the oil prices was the current credit crisis, which started with the financial crisis in the USA. The collapse of Lehmann Brothers on 15th September 2008 caused a domino effect on the rest of the financial world.
The forecast of the world economic growth for 2009 by the World Bank was very poor figures. The global GDP growth has dropped from 2.5% in 2008 to 0.9% in 2009. However world trade will contract by 2.1% in 2009 which imply the first reduction since 1982. All countries expect lower exports, which resulted in rapid slowdown of global demand. These forecasts caused the big decline in demand for oil, which resulted in the plunging oil prices with 76,6%. The falling oil prices and (food prices) imply the end of the most significant commodity price boom in decades.
The oil price has reached its peak on 3 July 2008 at 143,95 dollar see figure below. Just after the bankruptcy of Lehmann Brothers oil price was 102,51 dollar. When global credit crisis started the oil prices dropped to the lowest point of 33,73 dollar on 26 December 2008. Oil exporting countries did cut their oil production to avoid oversupply the international market. However the attempt of OPEC and Russia cutting the oil supply to prevent falling oil prices, it further declined.
Oil price development January 2007- November 2009
Source:
Own elaboration based on US Energy Information Administration data (2009)
While developed economies like Europe and USA still suffer from the credit crises, Asian emerging economies already generate positive GDP growth rates. Chinas expected domestic demand growth of 8,43% in 2010, has positive influence on other countries, which supply products and raw materials to China. The economy of China has a better than expected global economic growth. That has driven the oil price gradually from the lowest point of 33,73 dollar last year to around 75 dollar begin November 2009. The weak dollar keeps the oil price high despite a slump in American consumption and constructs cheaper oil for investors holding the stronger euro. It looks as though the whole oil crisis cycle tend to resume, where higher demand from China partly boost the oil price.
Conclusion
In 2008 the oil crisis differs with previous oil crises, because the previous oil crisis was mainly caused by higher global demand, particularly by emerging countries. Oil consequences are limited compared with previous oil crises, since many developed countries have established economic structure to resist higher oil prices. Inflation can be controlled by monetary policy. In China GDP has become more vulnerable for high oil prices than Europe, however the European imported Chinese manufactured goods still increase.
European and also a lot of American enterprises have outsource their manufacturing activities to China due to low production costs, growing effect and growing on domestic market. In periods of high oil prices fuel costs shipping lines will be very flexible to in a significant way to manage the costs better. One of the most common measure is the reaction to a lower vessel speed. Additionally, shipping lines and oil related surcharges on growing freight rates to compensate higher fuel prices, which results in higher transport costs. However freight rate (small part of transport costs) is determined by more factors such as port handling charges etc. Reverse in European off shoring to China is not profitable, if transport costs reductions cannot off set Chinas lower production costs. Chinese manufactured goods better export performance, while oil prices increase is the result of Chinas capability to use more cheap labour in production. On its turn, higher Chinese export leads to higher oil demand and therefore to an higher oil price.
Europe import growth in 2000 to 2009 from China is higher than the export growth of Europe to China trade, this have lead to a growing Europe - China trade deficit, particularly in manufactured goods. Europe average imported manufactured goods is 95,9% of total goods. The export figures are much lower. During high oil prices period Europe imported goods from China is in value still increasing, while in quantity are declining. Europe import has also in value increase due to Chinas shift to more high tech production which has a less effect on higher freight rates and transport costs. The strong euro against dollar and Yuan has also an influence of the rising oil price what on course also a influence on transport costs overall witch make Chinese goods export relative cheaper for European importers enterprises. This also restrains European export to China, which result into a growing European trade deficit.
The oil price has a neutral correlation with European imported of Chinese goods. The higher oil prices have lead to higher transport costs. You should expect a decrease of European import of Chinese goods, but Chinese goods have due Chinas unique competitiveness advantage in export a unique position and effect on the further oil demand has at this point an less impact than expected. The shipping lines reaction to reduced vessel speed leads to downward pressure on total transport costs. Chinas Yuan keeps Chinese imported goods artificially cheaper than in Europe or America. Without these two measures European import could decline. Therefore the oil price increase does not affect the European -China trade. European trade deficit with China still grows, because Europe export growth is lower than Europe import growth from China.
The expected oil influence for Europe toward China trade in the future depends on the development of profitable oil substitutes. Western investment in alternative energy sources, while investment in China increases. China shift to a more high tech and green product manufacturing will increase Chinas future in manufacturing product due to export value, which is less sensitive for higher transport costs. European export growth to China will remain always lower than import growth. When European firms are still relocating their manufacturing production to China to gain more profit and in this growing consumer market it will work for several years more. When China will be more active in the global supply chain, then it will result in some downward pressure on Asia to European freight cost. Freight rates and maritime transport costs up to 2020, will remain rather low due to expected modest oil price increase to 100 US dollar a barrel and the contemporary oversupply in vessel capacity.
References
Books:
Alexandra Harney The China Price (2009)
Harvard Business School Harvard Business Review on Doing Business in China (2004)
Ashgate Gower Revival of Private Enterprise in China, The. The Chinese Trade and Industry Series.(2008)
Susan L. Shirk How China's Internal Politics Could Derail Its Peaceful Rise (2007)
OPEC Long-term strategy (2005)
Internet:
Trading economics tradingeconomics.com
Central Intelligence Agency cia.gov
Allianz Group knowledge.allianz.com/
Countries (OAPEC): www.oapecorg.org
World Energy Council: worldenergy.org
World Trade Organization: wto.org
