Report By:

Mohit Goyal

M Satyam

Recent decline in oil prices of crude

oil: Causes and Global Impact

Overview

Introduction

Reasons for decline in oil prices

Financial Implications

Macroeconomic effects - Oil exporting countries

- Oil importing countries

Effects on India

Conclusion

References

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

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 $45 per barrel in Jan 2015.

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

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 sulfur (making

a "sweet" crude oil).

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

sulfur (making it a "sweet"

crude oil, but again slightly

less "sweet" than WTI).

Reasons for decline in oil prices

Supply and demand Role of OPEC

Strengthening US DollarMiddle East countries are

back

Declining crude oil prices

Supply And Demand

Technological shift from vertical to horizontal drilling in US led to it becoming a

producer from a consumer.

Major boom in shale gas production causes the production increase by 0.9 million

barrel per day.

Between July and Dec 2014 alone, the projected oil demand for 2015 is

downwards by 0.8 million barrel per day.

The US is producing record amounts of oils plenty of supply out of OPEC and Russia.

But there’s not enough demand from developing economies

like China and India to consume all the oil that’s being supplied.

A global recession has left Asian demand weaker than expected, and

governments are slashing fuel subsidies across Asia.

It’s not just Asia, though. Austerity measures and decreased consumption

across Europe are curbing oil demand throughout that continent, too.

Role of OPEC

OPEC coordinates and unifies the petroleum policies of its members.

In 2014 OPEC comprised 12 members: Algeria, Angola, Ecuador, Iran, Iraq,

Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela.

OPEC member countries produce about 40 percent of the world's crude oil.

Equally important to global prices, OPEC's oil exports represent about 60 percent of the

total petroleum traded internationally

On November 27, 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 prices continued to slip onwards of September 2014.(remove it) During the November 27, 2014 Vienna meeting of OPEC countries the major oil producing

members like Saudi Arabia and Iran, did nothing to arrest the falling price.

Some countries, like Venezuela and Iran, wanted the cartel (mainly Saudi Arabia) to cut

back on production in order to prop up the price. These countries need high prices in

order to "break even" on their budgets and pay for all the government spending.

On the other side Saudi Arabia, the world's second-largest crude oil producer, which was

opposed to cutting production and seemed willing to let prices keep dropping.

In the 1980s, when prices fell and the country tried to cut back on production to prop

them up. The result was that prices kept declining anyway and Saudi Arabia simply lost

market share.

"We will produce 30 million barrels a day for the next 6 months, and we will watch to

see how the market behaves," said OPEC Secretary-General Abdalla El-Badri.

That caused the price of oil to start crashing even further.

The price of Brent crude went from $80 per barrel to $70 per barrel in just a few days. And

it kept tumbling to down below $60 per barrel by mid-December and $50 by January.

OPEC is now engaged in a "price war" with the US.

It's relatively cheap to pump oil out of places like Saudi Arabia and Kuwait. But it's

more expensive to extract oil from shale formations in places like Texas and North Dakota.

So as the price of oil keeps falling, some US producers may become unprofitable and

go out of business. And the price of oil will stabilize. At least that's what OPEC members

hope.

Strengthening Dollar

Across the globe the crude oil is bought and sold in dollars.

Dollar 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.

high estimates suggest that a 10 percent appreciation is associated with a decline of about 10

percent in the oil price, whereas the low estimates suggest 3 percent or less.

Even though global oil prices are falling, they’re falling less for countries with currencies that are

weaker than the US dollar.

Financial Implications

Input CostsReal Income

ShiftsMonetary and Fiscal Policies

Global Growth

Reduced investment in

new development

Input Costs

Lower oil prices reduce energy costs generally, as prices of competing energy

materials are forced down too.

Oil is feedstock for various sectors, including petrochemicals, paper, and

aluminium, the decline in price directly impacts a wide range of processed or

semi-processed inputs.

The transportation, petrochemicals, and agricultural sectors, and some

manufacturing industries, would be major beneficiaries from lower prices.

Real Income Shifts

Oil price declines generate changes in real income benefiting oil-importers and

losses hurting oil-exporters.

The shift in income from oil exporting economies with higher average saving

rates to net importers with a higher propensity to spend should generally result in

stronger global demand over the medium-term.

Monetary and Fiscal Policy

Oil importing countries:

declining oil prices may reduce medium-term inflation expectations below target

central banks could respond with additional monetary policy which can support growth

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

Reduced investment in new exploration or development.

Lower oil prices would especially put at risk oil investment projects in low-income

countries (e.g., Mozambique, Uganda)

also unconventional sources such as shale oil, tar sands, deep sea oil fields (especially in

Brazil, Mexico, Canada and the United States), and oil in the Arctic zone.

Macroeconomic Effect

In 2014-15 the price of crude oil has fallen more than 50%. This fall in the price

of oil has a significant impact in reducing transport and other business costs.

Falling oil prices is good news for oil importers, such as Western Europe, China,

India and Japan; however, it is bad news for oil exporters, such as Russia,

Venezuela, Kuwait, Iraq and Nigeria.

Oil Exporting Countries

Many oil exporting countries rely on tax revenue from oil production to fund

government spending.

For example, Russia gains 70% of all tax revenues from oil and gas. Falling oil

prices will lead to a government budget deficit, social problems and will require

either higher taxes or government spending cuts.

Some oil-exporting countries in the Middle East and North Africa, could contract

by 0.8–2.5 percentage points in the year following a 10 percent decline in the

annual average oil price.

Further we discuss in detail about oil exporting countries.

Oil Exporting Countries:

RUSSIA

SAUDI ARAB

IRAN

UNITED STATES OF AMERICA

VENEZUELA

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

Image Courtesy: http://www.kp24.fi/data/attachments/6488fd17-c93a-453c-b788-eedd292063d9_389541.jpg

Russia is the world’s largest crude oil producer.

Russia gains 70% of all tax revenues from oil and gas.

Oil revenues makes up 45% of the government budget and falling oil prices will lead to a

government budget deficit, and will require either higher taxes or government spending.

Russia’s economy is expected to shrink 4.5% next year if oil stays at $60 per barrel.

The plunging price of oil has also caused the ruble's value to collapse.

Oil company in Nefteyugansk, Russia, owned by Rosneft

2. Saudi Arabia

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

It produces 10 million barrel per day.

It will suffer financially from cheap oil.

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

equal to 14% of GDP.

It can afford temporary falls in oil prices because they have substantial reserves. It

has build up a stockpile of foreign currency worth some $740 billion, which it will

use to finance its deficits.

This is why Saudi Arabia has so far not responded by cutting output.

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

social programs.

Petrochemical plant, Jubail, Saudi Arabia

3. Venezuela

It is another major oil producer.

In Venezuela oil sales provide both 47% of government revenues and the main

source of foreign currency.

Venezuela are relying on oil revenues to fund generous social spending.

A fall in oil prices could lead to a significant budget deficit and social problems.

The nation's economy is set to shrink some 3% this year and inflation is rampant.

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

Image Courtesy: http://www.ulkeajans.com/images/haberler/obama_uluslararasi_toplum_gazzede_ateskes_icin_calismali_h56636.jpg

In the US a fall in crude prices would have more varied impacts.

For many people, it will offer a nice economic boost: cheaper oil means lowergasoline prices which have fallen to $2.47 per gallon.

However oil-producing states like Texas and North Dakota are likely to see a drop inrevenues and economic activity.

The falling price of oil is also putting severe pressure onAlaska’s state budget.

All told, oil prices are likely to be good for 42 states and bad for the other 8.

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.

Image Courtesy - http://www.timesofisrael.com/irans-supreme-leader-undergoes-prostate-surgery//

Effect of falling oil prices on Iran

5. Iran

One big problem for Iran is that it needs oil prices well north of $100 per barrel to

balance its budget, especially since Western sanctions have made it much harder

to export crude.

If oil prices keep falling, the Iranian government may need to make up revenues

elsewhere say, by paring back domestic fuel subsidies (always an unpopular

move, at least in the short term).

Oil Importing Countries

There are three main channels through which a decrease in the price of oil affects

oil importers.

The first is the effect of the increase in real income on consumption.

The second is the decrease in the cost of production of final goods, and in turn on

profit and investment.

The third is the effect on the rate of inflation.

A 10 percent decrease in oil prices would raise growth in oil-importing economies by some

0.1– 0.5 percentage points, depending on the share of oil imports in GDP.

In China, for example, the impact of lower oil prices on growth is expected to boost

activity by 0.1-0.2 percent because oil accounts for only 18 percent of energy

consumption, whereas 68 percent is accounted for by coal.

Japan is also a major importer of oil and oil-related products with imports valued at $210

billion in 2014, roughly equivalent to 4% of the country’s GDP.

Japan’s manufacturing sector is set to experience. a significant upside from lower raw

material and electricity costs. This includes companies in the steel, tyres, glass and

paper sectors.

Several other large oil-importing emerging market economies also stand to benefit from

lower oil prices.

In Brazil, India, Indonesia, South Africa and Turkey, the fall in oil prices will help

lower inflation and reduce current account deficits a major source of vulnerability for

many of these countries.

Some oil importers would also be affected by a slowdown in oil-exporting countries.

A sharp recession in Russia would dampen growth in Central Asia, while weakening

external accounts in Venezuela or the Gulf Cooperation Council (GCC) countries may put

at risk external financing support they provide to neighbouring countries.

How does the fall in oil prices affect India?

India, 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.

As 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 — at the budgeted level of 4.1% of

GDP in 2014-15.

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.

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.

http://www.bangkokpost.com/business/news/464181/impact-of-lower-oil-

prices-on-asian-economies

http://blog-imfdirect.imf.org/2014/12/22/seven-questions-about-the-recent-

oil-price-slump/

http://www.bbc.com/news/business-29643612