Oil Prices: Why they are falling and its impact on World Economy and India

What Crude Oil is?• Crude oil is a naturally-occurring substance found in certain

rock formations in the earth.• It is a dark, sticky liquid classified as a hydrocarbon. This

means, it is a compound containing mainly carbon and hydrogen.

• Crude oil is highly flammable and can be burned to create energy.

• Petroleum= Petra (Rock) + Oleum (Oil) (Latin)

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Introduction• Crude Oil, often called “black gold” is naturally occurring, unrefined

petroleum product composed of hydrocarbon deposits.

• Trade of crude oil across the globe is one the major factors in determining the G.D.P and financial policies of various countries across the globe.

• It is refined to produce usable products such as gasoline, diesel and various forms of petrochemicals.

• 80% of international crude oil is transported through waterways in supertankers.

• Majority of oil reserves is in middle east of the world.

Recent overview of crude oil

• Oil prices fell sharply in the second half of 2014.

• Four-year period of stability around $105 per barrel.

• From June 2014, the global oil prices started a trend of downward shift.

• From $115 per barrel it touched a low of $30 per barrel in Feb 2016.

• This decline being the largest since the 2008 decline when prices fell from a whooping $145.85 per barrel to $32 per barrel.

Crude Oil Price Trend

West Texas Intermediate (WTI) crude oil is of very high quality and is at refining a larger portion of gasoline. Its API gravity is 39.6 degrees, which makes it a "light" crude oil, and it contains only about 0.24 percent of sulphur (making a "sweet" crude oil). 

West Texas Intermediate (WTI) & Brent Blend

Brent Blend is actually a combination of crude oil from fifteen different oil fields located in the North Sea. It is still a "light" crude oil, but not quite as "light" as WTI, and it contains about 0.37 percent of sulphur (making it a "sweet" crude oil, but again slightly less "sweet" than WTI). 

West Texas Intermediate (WTI) & Brent Blend

Increased Global SupplyGlobal supply of oil has surpassed the global demand,

which has resulted in the fall of prices.

Why are Oil Prices Dropping?

US Oil BoomOil Production in the US has increased as Shale oil production has gone up to 4 million barrels per day. As such, US import of oil from

OPEC has reduced by half.

Tepid Asian DemandCountries in Asia are reducing oil subsidies, as a result of which oil demand has fallen, which in turn has resulted in

increased oil prices, thereby, reducing demand.

Crude Oil - Demand v/s Supply

Negative European Economic OutlookA slowdown is expected in Eurozone economies in 2015. The growth forecast has been cut down by IMF to 0.8% in

2014 and 1.3% in 2015.

Why are Oil Prices Dropping?

Strengthening US DollarDollar getting stronger makes oil more expensive to buy

in countries outside the US. That, in turn, weakens worldwide demand and further puts downward pressure

on oil prices.

Increased output from LibyaBecause of the civil war in Libya, oil production had decreased to

150,000 – 250,000 barrels per day. It now produces 1 million barrels a day, which may go up to 1.2 million barrels a day by next year.

OPEC InfightingThere is a rivalry among OPEC members,

who are trying to lower prices to maintain their market share.

Why are Oil Prices Dropping?

On November 27 2014, a big meeting was held by the Cartel, and countries, like Venezuela and Iran, proposed

that the Cartel (mainly Saudi Arabia) decreases oil production in order to maintain stability in the oil prices.

1

Just to ensure it maintains its market share, Saudi Arabia, the world's largest oil producer, did not agree to

reducing oil production and was willing to let prices plummet.

2

OPEC's surprising response: Let prices keep falling

Oil Exporting Countries

RussiaSaudi ArabiaIranU.s.aVenezuela

Russian budget heavily relies on its

oil income

More than half of its budget revenues

come from selling Oil and Gas

The Russian economy may go into

Recession if oil prices keep falling

Effect of falling oil prices on Russia

Saudi Arabia is the world's second largest crude producer after Russia.

It oil stays at around $60 per barrel next year, the government will run a

deficit equal to 14% of GDP.

If low oil prices persist, Saudi Arabia may have to cut back on some of the

social programs.

Effect of falling oil prices on Saudi Arabia

High oil prices are one of the major factors affecting the Iranian economy.

Severe economic problems may result if oil prices keep falling.

Iran may decide to reach a nuclear deal with the US to ease economic sanctions.

Effect of falling oil prices on Iran

This will translate into accelerated economic growth to a forecasted

3.5% next year.

Falling oil prices will cause gas prices to go down, which will result in increased

consumer spending.

Effect of falling oil prices on US

The nation's economy is set to shrink some

3% this year and inflation is rampant

In Venezuela oil sales provide both 47% of government revenues

and the main source of foreign currency.

Effect of falling oil prices on Venezuela

Reduced OPEC’s global power

Benefit to Western and European economies

Decline in oil and natural-gas undertakings

Reduction in Commodity priceThe devalue of Oman

Increase in global demand for goods and services

Global Consequences of falling Oil Prices

Monetary & Fiscal Policies

Declining oil prices may reduce medium-term inflation expectations below target. Central banks could respond with additional monetary policy which can support growth

Oil importing countries:

Oil Exporting countries: Lower oil prices might trigger Contractionary Fiscal Policy Measures.

Developing countries: May benefit more from a decline in energy input costs. Household inflation expectations in developing economies may also be more responsive to changes in fuel prices than in developed countries

Effect of falling oil prices on INDIAIndia, which is the fourth largest consumer of oil, is a big beneficiary of falling

oil prices.

India imports nearly two-thirds of crude oil requirements.

The reduced prices will not only lower the import bill but also help save foreign exchange.

And It will also enable oil marketing companies to reduce retail prices of petrol and diesel.

Effect of falling oil prices on INDIAAs per rough estimates, a $10 fall in crude could reduce the current account

deficit by approximately 0.5% of GDP and the fiscal deficit by around 0.1% of GDP.

Lower oil prices have also aided government's efforts to keep inflation low and stable besides curtailing fuel subsidies.

A lower subsidy bill will help contain the country's fiscal deficit, a measure of the amount the government borrows to fund its expenses

With every dollar decrease in oil prices, the government's oil import bill comes down by Rs. 4,000 crore.

Conclusion Following four years of stability at around $105 per barrel, oil prices fell sharply in the second half of 2014.

The decline in oil prices was quite significant compared with the previous episodes of oil price drops during the past three decades.

There have been a number of long-terms and short-term drivers behind the recent plunge in oil prices: several years of large upward surprises in oil supply; some downward surprises in demand; unwinding of some geopolitical risks that had threatened production; change in OPEC policy objectives; and appreciation of U.S. Dollar.

Supply related factors have clearly played a dominant role.

Conclusion The decline in oil prices has significant macroeconomic, financial implications.

If sustained, it will support activity and reduce inflationary, external, and fiscal pressures in oil-importing countries.

On the other hand, it would affect oil-exporting countries adversely by weakening fiscal and external positions and reducing economic activity.

However, declining oil prices also present a significant window of opportunity to reform energy taxes and fuel subsidies, which are substantial in several developing countries, and reinvigorate reforms to diversify oil-reliant economies.

Thank You

Rishabh Hurkat

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