Amaan Mansuri, B-Tech Mechanical 2nd Year
Brent crude prices have fallen by over 45% since June 2014 when it was around $115 per barrel. Now, it is below 60%. The fall has been significant in September this year when a decline of 30% was registered.
The oil price is partly determined by actual supply and demand, and partly by expectation. Demand for energy is closely related to economic activity. It also spikes in the winter in the northern hemisphere, and during summers in countries which use air conditioning. Supply is also affected by the geo-political risks, if producers think the price is staying high, they invest, which after a lag boosts supply. Similarly, low prices lead to an investment drought. OPEC’s decisions shape expectations: if it curbs supply sharply, it can send prices spiking. Saudi Arabia produces nearly 10m barrels a day—a third of the OPEC total.
There are four reasons that are contributing to the declining oil prices-
The fall in prices are having a significant impact on the economies around the world. The net exporters are enjoying the bearish run while the net exporters are worse off. However, at the aggregate level, plunging prices will have a positive impact on the global economy.
“Assuming we have a 30% decline (in oil prices), it’s likely to be an additional 0.8% (in economic growth) for most advanced economies, because all of them are importers of oil.” -Christine Lagarde, MD, International Monetary Fund
Let us look how individual economies are responding to the fall in oil prices-
Russia: Russia's condition is the most talk about in the economic world. The country is hugely dependent on oil revenues which make up 45% of the government's budget. The downfall in oil prices has left the country in ruins. Economists predict that Russia's economy will shrink by 4.5% if the oil stays around $60 per barrel in the next year. Plunging oil prices has also resulted in ruble's collapse which in turn has increased inflationary pressures as imports have suddenly become expensive. Russia's Central Bank is trying hard to deal with the crisis. It has hiked interest rates from 10.5% to 17% to prevent people from selling off the rubles but it is not having a significant impact. It is feared that it will further take economy into recession.
Iran: Iran's economy was on road to recovery after recession. International Monetary Fund had predicted Iran's growth rate to be around 2.3%, but it was all before oil prices started to take a plunge. The problem with Iran is that it needs oil prices to be around $100 a barrel to balance its budget. as western sanctions has made it difficult to export. If oil prices remain at this level, Iran will look to rake up revenues from elsewhere, for example by cutting down on subsidies which will call for a social unrest in the country.
India: Weakness in oil prices in India is good for the economic condition of the country as it imports 70% of the country's petroleum requirements and results in 'low inflation, improvement in current and fiscal account balances and higher growth'. Falling oil prices will boost growth through multiple channels. : (1) Lower inflation will boost households real disposable incomes, thereby pushing higher consumer discretionary demand; (2) improved corporate profit margins due to falling input costs will be an additional tailwind to reviving business investment; and, (3) improvement in macro fundamentals (inflation and the twin fiscal and current account deficits) will, at the margin, increase the space for macro (monetary and fiscal) policies to boost growth. It will also reduce the subsidiary burden on the government accounts, reduce the import bill and improve external account.
Saudi Arabia: There is no doubt that Saudi Arabia, world's largest supplier of crude oil will be affected financially from the decreasing oil prices. If oil stays at around $60 a barrel, country will run a deficit equal to 14% of the GDP. But it is determined not to cut the production as it will result in losing its market share. It is looking to finance its deficits through around $740 billion worth of foreign currency that it has amassed over the years. If the problem persists, Saudis will have to cut down on social programs that it had introduced after the Arab oil boom.
U.S.A.: Fall in crude prices will have a variable impact in the US. Gasoline is cheapest in a decade at around $2.47 a gallon. EIA predicts that US drivers will spend $550 less in 2015 if the prices stay the same level as 2014.Falling gasoline prices will give people more money to spend on other things, a nice economic boost. The states of Texas and North Dakota will see a downturn in economic activity as most of the Shale boom is concentrated in these regions. Falling oil prices will result in the companies reducing the Shale oil output as it is economically inefficient to trade at the current price levels.
Brent crude prices have fallen by over 45% since June 2014 when it was around $115 per barrel. Now, it is below 60%. The fall has been significant in September this year when a decline of 30% was registered.
The oil price is partly determined by actual supply and demand, and partly by expectation. Demand for energy is closely related to economic activity. It also spikes in the winter in the northern hemisphere, and during summers in countries which use air conditioning. Supply is also affected by the geo-political risks, if producers think the price is staying high, they invest, which after a lag boosts supply. Similarly, low prices lead to an investment drought. OPEC’s decisions shape expectations: if it curbs supply sharply, it can send prices spiking. Saudi Arabia produces nearly 10m barrels a day—a third of the OPEC total.
There are four reasons that are contributing to the declining oil prices-
- Slow economic growth in Europe and Asia, increased fuel efficiency and switch from oil to other fuels has resulted in low demand of crude oil.
- Shale boom has made America the top oil producing country in the world. It now imports much less oil than it did before and that has resulted in spare supply.
- Civil war in Iraq and Libya, two of the biggest oil producing countries has not affected the production.
- OPEC has refused to cut down the production to maintain the market share.
The fall in prices are having a significant impact on the economies around the world. The net exporters are enjoying the bearish run while the net exporters are worse off. However, at the aggregate level, plunging prices will have a positive impact on the global economy.
“Assuming we have a 30% decline (in oil prices), it’s likely to be an additional 0.8% (in economic growth) for most advanced economies, because all of them are importers of oil.” -Christine Lagarde, MD, International Monetary Fund
Let us look how individual economies are responding to the fall in oil prices-
Russia: Russia's condition is the most talk about in the economic world. The country is hugely dependent on oil revenues which make up 45% of the government's budget. The downfall in oil prices has left the country in ruins. Economists predict that Russia's economy will shrink by 4.5% if the oil stays around $60 per barrel in the next year. Plunging oil prices has also resulted in ruble's collapse which in turn has increased inflationary pressures as imports have suddenly become expensive. Russia's Central Bank is trying hard to deal with the crisis. It has hiked interest rates from 10.5% to 17% to prevent people from selling off the rubles but it is not having a significant impact. It is feared that it will further take economy into recession.
Iran: Iran's economy was on road to recovery after recession. International Monetary Fund had predicted Iran's growth rate to be around 2.3%, but it was all before oil prices started to take a plunge. The problem with Iran is that it needs oil prices to be around $100 a barrel to balance its budget. as western sanctions has made it difficult to export. If oil prices remain at this level, Iran will look to rake up revenues from elsewhere, for example by cutting down on subsidies which will call for a social unrest in the country.
India: Weakness in oil prices in India is good for the economic condition of the country as it imports 70% of the country's petroleum requirements and results in 'low inflation, improvement in current and fiscal account balances and higher growth'. Falling oil prices will boost growth through multiple channels. : (1) Lower inflation will boost households real disposable incomes, thereby pushing higher consumer discretionary demand; (2) improved corporate profit margins due to falling input costs will be an additional tailwind to reviving business investment; and, (3) improvement in macro fundamentals (inflation and the twin fiscal and current account deficits) will, at the margin, increase the space for macro (monetary and fiscal) policies to boost growth. It will also reduce the subsidiary burden on the government accounts, reduce the import bill and improve external account.
Saudi Arabia: There is no doubt that Saudi Arabia, world's largest supplier of crude oil will be affected financially from the decreasing oil prices. If oil stays at around $60 a barrel, country will run a deficit equal to 14% of the GDP. But it is determined not to cut the production as it will result in losing its market share. It is looking to finance its deficits through around $740 billion worth of foreign currency that it has amassed over the years. If the problem persists, Saudis will have to cut down on social programs that it had introduced after the Arab oil boom.
U.S.A.: Fall in crude prices will have a variable impact in the US. Gasoline is cheapest in a decade at around $2.47 a gallon. EIA predicts that US drivers will spend $550 less in 2015 if the prices stay the same level as 2014.Falling gasoline prices will give people more money to spend on other things, a nice economic boost. The states of Texas and North Dakota will see a downturn in economic activity as most of the Shale boom is concentrated in these regions. Falling oil prices will result in the companies reducing the Shale oil output as it is economically inefficient to trade at the current price levels.