Monday, October 05, 2015

Oil Price Crash – What’s in store for India?

By Archana Mavnur*

Oil as a commodity has come to run the world for a long time now. It influences other commodity pricing and world power. The OPEC member countries have had the power over oil production, with Saudi Arabia contributing the maximum to the production and exports. However, the ever increasing oil prices have received a jolt several times in the past with the prices falling, causing an impact on the oil exporting countries. Oil prices have dropped to $ 50 a barrel since mid-2014 from $ 105 per barrel. Though quite a few parallels could be drawn from the 1986- 87 fall in prices, few other independent causes also lead to the fall of oil prices.

The shale oil production in the US which increased about 70% since 2008 decreased the dependency for the US to import oil from the OPEC nations, causing a drop in oil prices. During the period of 1986-87 also the world witnessed an increase in the supply of oil from oil tanks in North Sea and Mexico because of which oil dropped from $24 per barrel to $9.62 per barrel.  
Second, the increase in supply on both the occasions did not induce Saudi Arabia to reduce it’s supply of oil, with an intent to keep up the market share for oil, Saudi Arabia continued to supply the same amount of oil which pulled the prices down.
The third reason for the fall in oil prices is the slowdown in China’s economy which is the largest consumer of oil with a manufacturing driven economy. Also, the oil production in Libya and Israel continued even amidst the political crisis. The EIA thus estimates that by early 2016, the world oil supply could supersede the world demand.

Taking a quick look at the gainers and losers because of the fall in oil prices, it could be well noted that the oil exporting countries would be the largest losers because of the fall. The oil exporting countries make 80% of their total revenue by exporting oil. If the prices continue to fall then these oil exporting countries would make low returns on their investments, which is not profitable. On the flip side, the oil importing countries could make benefit of this low price with oil now costing less and reducing the budget deficit for the Government.  Additionally the low oil prices could drive as a factor to control inflation, with the prices of other commodities falling. This will ideally give the Central Bank of the oil importing country an inch over policy accommodations.

India, the fourth largest oil importing country could save a fortune because of the fall in prices, 51% from August 2014. Analysing the trends of CAD, inflation and policy rates by RBI could well substantiate whether India is able to gain benefit from this short time fall.

1.       Current Account Deficit – As an oil importing country, the fall in oil prices gives us an opportunity to reduce the Current Account deficit. Evidently, the deficit has narrowed to 6200 USD Million in the second quarter of 2015 from 8200 USD Million earlier this year. The major reason for this fall in deficit could be directly proportionate to the fall in oil prices. In context, a 1$ fall in oil prices from January 2015 to July 2015, decreased the Government deficit by 24% in 7 months.

2.       Inflation – The slump in oil prices has been able to reduce CPI inflation rate for India. Fuel which has over 7% weightage in the CPI has been able to contribute to lower the CPI inflation. The CPI inflation fell to a record low of 3.66 % in August 2015, which is much lower than the forecasts. Inflation rate is a major criteria for the RBI to set the interest rates. A steady inflation for a medium term will provide room for policy accommodations by RBI to assist the borrowers and spur the economic growth.

3.      Policy rate cuts – Taking into account the continuous fall in the oil prices which is leading to the fall in inflation and CAD, RBI has been able to reduce the policy rates being able to pass on the benefits to the investors. From January of this year, RBI has cut repo rate by 125 bps. In the Monthly review in September, RBI lowered the interest rate by 50 bps which was more than expected. The current interest rate of 6.75% has made it possible for a few banks to pass on the benefits to the consumer by reducing the lending rates.

4.       Oil refineries – The fall in oil prices gives India an opportunity to store oil for the future use. India has nearly finished construction of the first phase of Strategic Petroleum Reserves (SPR) to store crude oil in Vishakapatnam, Mangalore and Padur. The three crude reserves can have the storage up to 5.33 million which would last for 13 days, however the International Energy Agency recommends 90 days of storage facility. Keeping in mind the current phase of low oil prices, this is the opportune time for India to proceed with the strategic oil reserve (Phase 2 is being planned at Bikaner in Rajasthan, Rajkot in Gujarat, Chandikhol in Odisha). This will help India to battle the supply shocks of high price shocks in the future.

To summarize, India import 80% of the total oil it consumes and it is predicted by the IEA that by 2020 India would be the largest importer of oil. This fall in oil prices could benefit India to reduce the burden on inflation and the import bill. Both the Central Bank and the Government are looking out for this continuous fall in oil prices and trying to pass on the benefit to the public. The oil exporting countries on the other hand are encountering losses due to the steady fall in oil prices, in fact any further fall in oil prices leaves no incentive for the oil exporting companies to go ahead with their production. The oil price could be easily determined by simple market forces, but the world economies carry a market sentiment to mark their status which has made the price determination a complicated process.

* Author is Research Intern at CPPR. Views are personal.


Sibin Sabu said...

Well written and informative article. I agree with you. However, while the net effect on Indian economy is positive, I think it is not as large as most people think - because of the negative consequences that arise along with falling oil prices.

For example, petroleum companies in India will be negatively affected to a certain extent. Their assets like oil fields within India and abroad have been devalued. It could also have negative effects on companies which export their products to petroleum producing countries. Fall in oil prices will negatively affect economies of oil producing countries which in turn affects their consumption. India's exports has declined over the past year due to this economic slowdown. There will also be a decline in investments from these petroleum producing countries. Is too low oil prices a potential danger to the Indian economy considering, its inter-linkages with the world economy?

Effect on different states could also be different. Kerala, an economy reliant on remittances, will have to face the brunt of falling oil prices since lesser job opportunities in the Middle East could translate to lower remittances. Also, the price of natural rubber has been on the decline as the cost of synthetic rubber fell down due to low petroleum price.

I also wonder if the benefits would have been greater if the decrease in fuel prices was transferred to consumers. GOI has hiked excise duties on petrol and diesel more than thrice since last year to offset the decline in oil prices. Could an even lower fuel price have propelled the Indian economy to a better position than what it currently is in? Or, is it more beneficial for the government to increase fuel prices even more considering the pollution and traffic congestion it could lead to?

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