Crude Nosedive: Impact of Falling Crude Prices and What Lies Ahead

Crude nosedive: Impact of falling crude prices and what lies ahead

One of the biggest economic surprises of last year is that the stunning drop in black gold (oil) prices. The global benchmark, Brent crude oil, is trading around 31$ per barrel from the high of 110$ in June 2014. [pic 1]

Both supply and demand side factors have contributed to this stunning drop. Demand has been poor thanks mainly to slowdown in China, in addition to that Europe and North America has lowered consumption of natural gas and heating oil due to mild winter season. On the supply side, OPEC (The Organization of the Petroleum Exporting Countries) has signalled that it would continue to pump in high volumes of oil amidst fear of losing market share to other oil exporting countries and soon to be coming Iranian oil. The United States, too, has produced a significant amount of oil, despite increased financial pressure on many U.S. producers.

All these demand & supply factors may well push prices into the $10 to $20 per barrel range as predicted by many investment banks including Morgan Stanley & RBS.

The effect of stumbling oil prices on the overall world GDP has been positive, most macroeconomic models suggest that the impact on global growth has been 0.5% of global GDP. However, as Charles Dickens wrote in “A Tale of Two Cities”, -“It was the best of times, it was the worst of times.” Good times for net oil importers like U.S., Europe, and Asia who are getting a nearly $900 billion economic stimulus from cheaper oil prices. Bad times for main oil-exporting countries (Middle East countries, Russia Colombia, Mexico etc.) as they are struggling to balance their budgets because oil is trading at 31$ per barrel well below their break-even budget point.

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Most of oil importing countries such as India and China try to keep oil prices down for consumers through massive government subsidies. The costs of these subsidies have taken a toll on the government fiscal deficits. Thus, as oil prices have fallen, emerging-market governments have taken advantage of the opportunity to reduce the fiscal subsidies or as in the case of India, increasing the excise duty to contain current fiscal deficit within the 3.9% of GDP target.

As per the CLSA report, India imports nearly 80 per cent of its oil demand. In the first eight months of FY16, oil imports fell 43 per cent year-on-year to $61 billion from $107 billion in the same period of FY15.On the flipside, India's oil-related exports have fallen 52 per cent year-on-year to $21 billion from $44 billion. The net impact is clearly positive.