NAB: Here's why the crude oil collapse won't ruin Australia's economy

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The sliding oil price, along with renewed concerns over the strength of the Chinese economy has been at the forefront of investors minds so far in 2016.

Session after session it seems to hit a fresh multi-decade low, further increasing nerves among investors.

Be it a forward indicator for global economic growth, a sign that high-yielding credit markets may come under renewed selling pressure, or another bearish development, many are on edge, including in Australia.

While investors continue to fret, Alan Oster, chief economist at the NAB, suggests that the net implications from the slumping oil prices on Australia’s economy, while multifaceted, are currently seen as neutral.

He explains.

On Australia the outcomes are complicated – but are probably net positive to growth and will result in lower inflation. The latter might also increase the risk of further help via rate cuts. But lower oil prices will be especially punishing on LNG profits – via the link between long term LNG contracts and oil prices. And, via that mechanism, it will provide further substantial headwinds to government revenues.

For consumers, Oster suggests the lower oil price will deliver a boost for households should it be passed on by full, a big “if” considering the margin expansion seen between wholesale gasoline prices and Australian retail petrol prices in recent weeks.

The chart below shows that despite recent sharp decline in the Tapis oil wholesale gasoline prices, the average Australian petrol price has remained sticky around the 120c/litre level of late.

“From the consumer’s perspective a fall to USD 30 per barrel (from USD 50) fully passed through (and not offset by lower currency and/or wider margins) should see petrol fall from around 120c per litre to say 98c,” says Oster.

“Our internal models would suggest a net gain to consumption of around 0.4% per annum (or around ¼ point to GDP). It would also see lower headline CPI increases of around 0.6% per annum but much lower core inflation readings – reflecting lower feed through indirect effects on production costs and some improved activity impacts.

For businesses outside the energy sector, the falling crude price will also help to boost profitability, including in some parts of the mining sector such as iron ore miners whose cost of production is heavily influenced by transportation costs.

Although Oster admits that recent volatility on global equity markets will have lowered consumer confidence and household wealth, he believes at current levels “these impacts will be significantly outweighed by the direct effects on consumer and most businesses cash flows”.

While those are the net beneficiaries in his opinion, not every part of the Australian economy will benefit from the lower crude price, including the Federal government.

On the other hand, its impact on the profitability of the massive ramp up in LNG exports would be even more withering. Remember most of long term LNG contracts were locked in at around USD 80 or above. Even allowing for AUD depreciation current oil prices imply a LNG effective price of around AUD 5-6 per GJ –less than half the implied price of recent years. In short, very very poor profitability and little chance of much tax revenue increases for the Government from what will be Australia’s second largest mining export. Also more generally the MYEFO had a forecast oil price of USD 40 per barrel – so this implies a weaker indirect tax take.

Oster notes that while there’s plenty of uncertainty surrounding the impact of lower energy prices on Australia, he does not believe that it will lead to a sharp slowdown, or worse, for the economy.

“While by necessity there are many ifs and buts in the analysis – but that also applies to analysis of recent bearishness in markets and especially some ultra-bearish commentators,” he wrote.

“A more reasonable assessment in my view is, if anything, at least balanced for Australia. Certainly we are not in the camp that we are “all ruined”.

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