FALLING CRUDE OIL PRICES- BRINGING CHEERS TO FEW & TEARS TO MANY

FALLING CRUDE OIL PRICES- BRINGING CHEERS TO FEW & TEARS TO MANY

Name-Saamarth Bali

Designation- Student Manager

Organization- Symbiosis Institute of Management Studies

Course- MBA MBA(Finance), Class of 2015

City- Pune

State- Maharashtra

Country- India

South Asian Journal of Multidisciplinary Studies (SAJMS) ISSN:2349-7858 Volume 2 Issue 1

Published By: Universal Multidisciplinary Research Institute Pvt Ltd

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Abstract

Oil prices have mostly been rising and have seldom fallen. Oil is the fuel of almost every economy, it is the fuel which powers the engine of growth and keeps the economy moving forward. It is because of its utility that oil today commands a very significant position in the commodities market.

Many economies especially the Middle Eastern economies depend upon oil exports for their survival and the recent slump in oil prices has put these economies in a grave situation. On one hand there are countries like India, China, USA and Japan which are likely to benefit because of this fall in oil prices on the other hand there is OPEC and other oil exporting nations such as Russia and Venezuela whose economies are now in shambles. Where the fall in oil prices have brought cheers to some economies it has brought tears to many more.

This essay tries to analyze the impact of fall in crude oil prices on various nations and the likely gainers and losers from the same.

Key Words:Commodities Markets, Crude Oil, Economy, Exports, GDP, Imports, OPEC



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FALLING CRUDE OIL PRICES- BRINGING CHEERS TO FEW & TEARS TO MANY

INTRODUCTION

Oil is a fuel which powers the engine of growth and keeps the wheels of economy moving, it is not without reason that it is also termed as black gold. Besides coal it is by far the only source of energy which is abundantly available and whose extraction, transportation and marketing is commercially viable.

Due to its higher octane value and portability it steals a march over coal as a preferred source of energy resulting in higher demand all over the world and a fat price tag.

CURRENT SCENARIO

Over the last few months crude oil prices have fallen drastically and the slump can be attributed to three main factors, one weak demand from China and European countries due to slowing down of their economies, two spurt in US shale oil production leading to reduction of oil imports by the US and three reluctance of major oil producing countries to curtail production.

On one hand where falling oil prices have brought cheer to countries which are heavily dependent on oil imports such as India it has also brought pain to countries whose economy is primarily dependent on oil exports such as Venezuela.

WINNERS AND LOSERS

In todays world our economies are so intertwined that there can be no winners or losers in this downward march of oil prices. To put things in perspective we will discuss as to how falling oil prices have impacted the economies of few countries in Asia and America and try to fathom whether it has brought joy or sorrow.

IndiaNet import bill of oil and oil products by India stands at $91 billion which is approximately 5.1% of GDP1, falling oil prices would certainly reduce this burden

Net Imports of Oil & Oil Products by India as % of GDP



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Figure1

Source- Financial Times India Current Account to GDP

Figure2

Source- Trading Economics.Com

And narrow down the current account deficit, leading to reduction of subsidies and better fiscal health of the economy.

On the other hand reduction in foreign exchange remittance from oil producing countries due to lost jobs by millions of Indians employed there, reduced exports to these countries due to weak demand and drying up of investments from Sovereign Wealth Funds (SWFs) and pension funds, mainly coming from oil rich countries like Saudi Arabia, Kuwait, and Qatar will adversely affect the Indian economy.

Japanafter the Fukushima nuclear disaster Japan is moving away from nuclear energy, this increases its dependence on oil.From the last fiscal year to March2014, Japan had spent $236 billion on mineral fuels out of which 90% was linked to oil1. Net imports of oil and oil Products accounts for nearly 5.1% of its GDP1. Further Japan is a major exporter of Cars and Vehicle Parts, 13% of Japans visible exports is of Cars2, falling oil prices are likely to boost the global demand for vehicles which in turn will benefit Japanese economy.

Net Imports of Oil & Oil Products by Japan as % of GDP



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Figure3 Source- Financial Times

Japan Inflation Rate MOM

Figure4 Source- Trading Economics.Com

Total Exports of Japan (Excluding Services)



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Figure5 Source- Trading Economics.Com

However, even Japan is not untouched from the ill effects of falling oil prices. Japanese economy is largely driven by its electronics and automobiles exports, weak demand from oil producing nations is likely to impact its exports and adversely affect its economy. Further with rock bottom oil prices Japan may be staring at deflation once again.

Chinathebiggest importer of crude oil in the world spends approximately $270 billion per annum on oil imports, which accounts for nearly 2.8% of its GDP1.

China GDP Annual Growth Rate

Figure 6 Source- Trading Economics.Com



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Net Imports of Oil & Oil Products by China as % of GDP


Slowing down of Chinese growth rate from about12% to 7.3% (from 1st quarter of2010 to 4th quarter of 2014)3 is one of the reasons for fall in oil prices.Falling oil prices do, however present the Chinese government with the opportunity to shore up its strategic oil reserves which currently stands at 91m barrels well short of the 540-600m barrels required to cover 90 days of import as suggested by International energy agency4. However falling oil prices do not appear to spur demand as benefit is not being passed on to the public. Further due to Chinas huge investments in Nigeria and Venezuela its economy will be adversely impacted if Venezuela defaults in payment of its debt.

Saudi Arabiais the largest exporter of Crude, net export of oil and oil products account for 42.9 % of its GDP1. 90% of its fiscal revenue comes from oil1. A price of $891 per barrel is essential for Saudi Government to fulfill its budgetary obligations, with prices hovering below$50 Saudi Arabia will have to cut down on its social sector spending,which may lead to social unrest and eventual Arab Spring in the country. If situation persists Saudi Government could be looking at a deficit of more than 14% of their GDP1. However such a situation is unlikely in the near future due to large forex reserves of nearly $7401 billion with the Saudi Government.

Net Exports of Oil & Oil Products of Saudi Arabia as % of GDP



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Saudi Arabia and other oil producing nations of the middle- east import everything from food grains to weapons. Reduced earnings due to falling oil prices will curtail demand and thus impact the export earning of their trading partners.

Iranreeling under the sanctions imposed by USA and European Union will be impacted the most due to falling oil prices.Net exports of Oil contribute nearly 13% to countrys GDP1. Oil and Gas revenues account for 50% of Irans fiscal receipts1, to balance its budget Iran needs the price of Crude to be about $130 per barrel1, which is more than twice its current price. Since imposition of sanctions in June 2012 Irans economy has been shrinking,the current GDP growth rate of Iran stood at -1.1% for 1st Quarter of 2014 compared to the same quarter previous year5. This would further weaken the bargaining power of Iran while striking a nuclear deal with USA.



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Iran GDP Annual Growth Rate

Figure 9 Source- Trading Economics.Com

Net Exports of Oil & Oil Products of Iran as % of GDP

Figure 10 Source- Financial Times

However, in the long run if oil prices remain low, shale production would become unprofitable then OPEC can restore its dominance by cutting output and increasing prices.

Russiais one the largest producers of oil and has the largest reserves of Natural Gas, it has been badly hit due to fall in oil prices as well as sanctions imposed by USA and European Union due to Ukrainian crisis. Ruble hasfallen drastically against the dollar and thishas adversely affected its



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economy, Russia once again may be staring at recession it faced in early nineties after the breakdown of Soviet Union.

Oil and gas exports are the life blood of the Russian economy, it accounts for nearly 75%1 of the countrys exports and more than 50%1 of its budget revenues, In fact Russia requires the price of crude to be around $105 per barrel to balance its budget1. The drastic fall in Ruble has made it very difficult for the Russian banks and companies to pay off approximately $600bn worth of debts to foreign creditors1.

Net Exports of Oil & Oil Products of Russia as % of GDP


Adding to its worries, inflation in Russia has reached new heights of 16.7% as of February 2015. To combat the rising inflation and a depreciating Ruble the Russian central bank had increased interest rates to about 17% in December last year, which have now been brought down to about 14%. According to World Bank, Russian Economy is likely to contract by 1.7% in 2015.

Since, Oil and gas exports are a major source of foreign exchange for Russia, hence a fall in oil prices has also badly affected Russias Forex reserves. Russias reserves have decreased from $510.5 billion in 2013 to $386.2 billion in 201411.

USA Shale oil revolution in USA is one of the reasons for falling oil prices, USA today is meeting approximately 30% of its oil requirement from domestically produced Shale Oil. This has led to job creation in US market and unemployment rate has come down to 5.6%7 which is the lowest in the past five years. According to the Economist Magazine, the average American



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consumer who spends about $3000 a year on gasoline may save as much as $1000, the equivalent of about a 2% increase in the yearly income of a typical household.

However falling oil prices are no help to US either because a price of less than about $618 per barrel makes shale oil production commercially unviable and could lead to shutting down of facilities and consequent job cuts.

Crude Oil Cost Curve, Canada & United States

Figure12 Source- Vox (How Far do Oil Prices Have to Fall to Throttle the US Shale Boom)

Further US exports a large number of items to the entire world from food grains to aircraft, weak demand from importing nations would shut down its factories and slow down its economy.

Venezuelais a poor country with social moorings, revenue from oil drives its economyand fall in crude oil prices have played havoc with its economy.Economists expect that one dollar drop in the price of crude would result in Venezuela losing about $700 million1. Oil accounts for nearly 96%



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of Venezuelas export earnings. It is expected that because of the fall in oil prices the economy is likely to shrink by 3%1.

Inflation is a big challenge before Venezuela, with inflation hovering over 60%1, there is a scarcity of basic necessities such as food, clothing and shelter. Accounts of a doctor reveals that there is a huge dearth of medical supplies as well in Venezuela.

The prime reason for Venezuela being amongst the worst affected nations is the populist policies of the government, the social sector spending by Venezuela is tremendous. Venezuela spends much more than it earns. Even when the price of crude was at record high, Venezuelan government managed a deficit of about 17% of GDP10.

What is even worse is that out of the total production of crude of about 2.6 million barrels in a day, Venezuela doesnt get paid for approximately half (1.2 million) of what it produces10. It is because this oil is given away to places like Cuba, or supplied to domestic markets at heavily subsidized prices.

To balance its budget Venezuela requires the price of Crude to be about $114.5 a barrel1, but with the current prices of crude hovering around $50 a barrel, such high price of crude seems like a distant dream. Adding to its basket of problems is the fact that huge investments have been made by countries like China in Venezuela, a fall in the price of Crude Oil hampers the debt servicing ability of the nation and the Venezuelan economy may be staring at a debt default .

WAY FORWARD

Falling oil prices are a cause of concern,no country can remain untouched by its repercussions. To prevent a global recession from spreading the gloom following three courses are recommended, first in the short termwhile on one hand oil producing nations should cut down their production to sustainable levels which do not lead to job cuts or closing down of facilities, on the other hand oil importing nations such as India should increase their imports to shore up their strategic oil reserves, cut oil subsidies, improve their own fiscal health, and at the same time prevent economies of oil producing nations from collapsing.

Second in the medium term net importers and exporters should resort to bilateral trade in oil rather than trading through exchanges in international market. A similar arrangement recently arrived at between China and Russia will benefit both the countries.

Thirdly in the long term countries heavily dependent on oil revenues should diversify themselves, and make their economies more resilient to such shocks in the oil market. An example of such diversification is UAE, especially Dubai which has successfully transformed itself from a crude dependent economy to an attractive tourist destination. Iran also is on course correction with 50%9 contribution to its GDP coming from service sector and real estate.

CONCLUSION



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In conclusion one can say that in the long run there are no clear losers or gainers due to the downward spiral of oil prices. However in the short run certain Asian economies like Japan, China, and India etc. are likely to gain whereas major oil exporting economies such as Russia, Venezuela, Saudi Arabia, Iran etc. are likely to lose.

References for Data

1 Financial Times (Winners and Losers of Oil Price Plunge)

Link http://www.ft.com/intl/cms/s/2/3f5e4914-8490-11e4-ba4f-00144feabdc0.html#axzz3MGyvjHJ2

2 Observatory of Economic Complexity

Linkhttp://atlas.media.mit.edu/explore/tree_map/hs/export/jpn/all/show/2012/

3 Trading Economics.com

Linkhttp://www.tradingeconomics.com/china/gdp-growth-annual

4 Financial Times (China Releases First Formal Estimate of Strategic Oil (Reserves)

Linkhttp://www.ft.com/intl/cms/s/2/3f5e4914-8490-11e4-ba4f-00144feabdc0.html#axzz3MGyvjHJ2


Linkhttp://www.tradingeconomics.com/iran/gdp-growth-annual

6 CNBC.com (Russia peace talks in doubt as ruble falls)

Linkhttp://www.cnbc.com/id/102328502


Linkhttp://www.tradingeconomics.com/united-states/unemployment-rate

8Vox (How Far do Oil Prices Have to Fall to Throttle the US Shale Boom)

Linkhttp://www.vox.com/2014/12/3/7327147/oil-prices-breakeven-shale


Link http://www.tradingeconomics.com/iran/gdp-growth-annual

10 CNBC Latin America (Why Venezuela is so desperate, in 5 easy charts)

Link http://www.cnbc.com/id/102097797

11 Investopedia (Sanctions & Oil Prices Bring the Russian Economy ear Collapse)



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Link http://www.investopedia.com/articles/investing/012115/sanctions-oil-prices-bring-russian-economy-near-collapse.asp


Link http://www.tradingeconomics.com/russia/inflation-cpi

References for Figures

Figure1- Source: Financial Times (Winners and Losers of Oil Price Plunge)


Figure2- Source: Trading Economics.com

Linkhttp://www.tradingeconomics.com/india/current-account-to-gdp



Figure4- Source:Trading Economics.com

Linkhttp://www.tradingeconomics.com/japan/inflation-rate-mom

Figure5- Source: Observatory of Economic Complexity

Linkhttp://atlas.media.mit.edu/explore/tree_map/hs/export/jpn/all/show/2012/


Linkhttp://www.tradingeconomics.com/china/gdp-growth-annual






Linkhttp://www.tradingeconomics.com/iran/gdp-growth-annual



Figure 11- Source: Financial Times (Winners and Losers of Oil Price Plunge)



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Figure12- Source: Vox (How Far do Oil Prices Have to Fall to Throttle the US Shale Boom)

Link http://www.vox.com/2014/12/3/7327147/oil-prices-breakeven-shale

General References/ Bibliography

Commodities: A partial pump primer

Link http://www.ft.com/intl/cms/s/0/f6cd6fe6-5a95-11e4-b449-00144feab7de.html?siteedition=intl#axzz3JzeR37Hc

Counter punch

Link http://www.counterpunch.org/2014/12/08/the-economic-consequences-of-global-oil-deflation/

Business Insider India (Heres How the Oil Crash Is Affecting Asian Countries)

Link http://www.businessinsider.in/Heres-How-The-Oil-Crash-Is-Affecting-Asian-Countries/articleshow/45308099.cms

The guardian (Falling Oil, rising cucumber prices: how much trouble is Russia in?

Link http://www.theguardian.com/world/datablog/2014/dec/11/russia-oil-inflation-prices-putin

The guardian (Recession in Russia, revolt in Venezuela? The knock-on effects of tumbling oil prices)

Linkhttp://www.theguardian.com/news/datablog/2014/oct/16/datablog-low-oil-prices-chill-producer-economies

The Economic Times (Falling Oil Prices may adversely impact India, global markets)

Linkhttp://articles.economictimes.indiatimes.com/2014-12-15/news/57071927_1_crude-prices-neelkanth-mishra-brent-crude

International Business Times (How Russia, Iran and other oil rich nations will be slammed by Falling Crude Oil Prices)

Linkhttp://www.ibtimes.com/how-russia-iran-other-oil-rich-nations-will-be-slammed-falling-crude-oil-prices-1716476

Financial Times (Low oil prices bolster Indias sputtering auto sector)

Linkhttp://www.ft.com/intl/cms/s/0/17dbb740-7f6e-11e4-b4f5-00144feabdc0.html?siteedition=intl#axzz3Lc2W3qgE

NDTV Profit (How Falling Crude Oil Prices Can Help Investors Become Rich)

Linkhttp://profit.ndtv.com/news/commodities/article-how-falling-crude-oil-prices-can-help-investors-become-rich-708505



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Moneycontrol.com (How Falling Crude Will Impact Various Oil Companies: Kotak)

Linkhttp://www.moneycontrol.com/news/brokerage-recos-fundamental/how-falling-crude-will-impact-various-oil-companies-kotak_1268821.html

FALLING CRUDE OIL PRICES- BRINGING CHEERS TO FEW & TEARS TO MANY

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