China slump would ‘chop oil price in half’

If the Chinese economy has a hard landing, the Middle East's oil producers will be in for a bumpy ride too, says the research house IHS.

China is one of the largest consumers of oil from the Arabian Gulf. Natalie Behring / Bloomberg News

A hard landing for the Chinese economy would crimp growth in the Middle East through a fall in oil prices, new research has found.

IHS, a US-based information and analytics provider, said there was a one in four chance that Chinese growth would fall as low as 3 or 4 per cent a year in the coming three to five years, dragging oil prices down to as low as US$50 per barrel.

“A hard landing in China would mean the Middle East would experience weaker exports, lower tourism and business activity and probably a resurgence of risk aversion by global companies due to this new deterioration of the global economic situation, just at the moment when they thought the situation was finally improving,” said the IHS chief economist, Nariman Behravesh.

IHS is working with its clients, which include multinationals and government-owned companies, on developing a contingency plan for such a scenario.

At the same time, Mr Behravesh said IHS’s “base case” scenario was for Chinese growth to hold near 7.5 per cent, keeping oil prices in the range of US$90 to $100 a barrel.

China is one of the largest consumers of oil from the Arabian Gulf, with about a third of Chinese energy imports coming from the region.

The pace of the Chinese economy has cooled in the past two years, with annual GDP expansion slowing to 7.7 per cent, its lowest level since 1999. But growth in the world’s second largest economy still remains above many other emerging markets and the developed world.

With the economies of China’s largest export markets – the US and the EU – in gradual recovery, the most likely cause of a Chinese hard landing would be the collapse of its shadow banking system after several years of rapid expansion.

“China has quite a significant debt bubble on its hands,” Mr Behravesh said. “In the last seven years, the ratio of total debt to GDP has doubled. It now has debt levels comparable to the US in 2007, that’s very risky.”

If the debt bubble burst, IHS assumes a tightening in credit and a cut in imports. Such a scenario would shave 0.1 percentage points off world GDP this year and 0.5 percentage points both next year and in 2016. Such a slowdown would trim 1 per cent off Saudi Arabia’s growth in 2018, says IHS.

Still, GCC oil producers would be likely to react by cutting back expenditure on output growth, which in turn could help revive oil prices, IHS said.

The Chinese government in March announced its intention to embark on reforms designed to strengthen the financial system and help savers. It said it would remove government limits on the interest rates banks pay on deposits. The low rates have heightened risks by encouraging Chinese families to invest in less stable assets such as property, stocks and wealth management products.

“I think the leadership has embraced lower growth and there has been a steady flow of reforms to gradually bring the shadow banking system under regulation,” said Francisco Quintana, senior economist at Asiya Investments, a Kuwait-based investment company focused on Asia.

Mr Quintana put the chances of a hard landing for China’s economy at 25 per cent, down from 35 or 40 per cent two years ago.

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