Bloodbath in Oil

 

Oil, is in trouble. The prices of the commodity, widely regarded as the basis of Indian industry, is in distress like never before. The fall has taken the international players by surprise not only because of the level it has reached but how. The excess supply and lagging demand has led to the prices hit rock bottom. To sum it, there has been a bloodbath, a decline of over 35% since June.

Before moving further I intend to make a statement-

The party, has just started for India Inc.

This piece is all about backing up this statement with data and the experience of our “forefathers” (read industry participants).

What’s Causing the Brent to Fall

Let’s take this up from scratch. Dubai- does this name ring a bell? Now most of us would start thinking about palm trees, massive malls, desert safari (yeah belly dance too), world’s largest skyscraper and sheiks. Dubai is United Arab Emirates’ gem, a man made wonder, made on the back of huge oil wells in the backyard. The owners of these oil reserves along with similar entities across the world, fully aware about the power of fuel, joined hands together to form what is known as OPEC (Organisation of Petroleum Exporting Countries). OPEC accounts for more than 40% of the world’s oil production and more than 80% of petroleum reserves identified till date. The take away is- OPEC is very capable of influencing the global oil benchmark- Brent!

Coming back, the increase in non-OPEC oil production- US based Shale boom, and decrease in demand from China and Europe has led to an oversupply in the international oil market.

In the recently concluded meeting held by the OPEC nations, the participants smartly chose to ignore this excess supply (so as to not part which the large chunk of market share in the world with non- OPEC nations) which has pushed the crude prices down by 18% more in November.

See the sharp decline in figure below. The price has reached a 5 year low.

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Figure 1- Brent Crude over the years

Why Oil is Critical

Now I am not going to bore you by writing paras on how oil prices end up affecting national growth rate. Rather we will judge the impact through the domino affect it creates. India’s growth hovers around the import of oil as we imports 70% of our crude requirements. Following is the face of the much larger mechanics which happen underneath –

  1. The decline will lead to a turnaround in the deteriorating fiscal balance
  2. Contract current account deficit ($1 fall in Brent bridges the gap by Rs 5,500 crores)
  3. As a result of cheaper imports, Government would be left with more balance due to decrease in subsidy bill
  4. The fall in crude oil prices ends up reducing inflation (currently at 5.5%). This is irrespective of whether the State passes on the benefits in terms of lower fuel prices, or directs this stimulus towards to enrich its treasury through higher tax realisations and ultimately reducing the fiscal deficit.
  5. Reduced inflation in turn impacts economic growth momentum in the country with greater

a) Personal disposable income- contributing to higher rate of savings

b )And higher corporate profits(due to lesser cost of production)- contributing to higher capital investments

 See the amount for fuel subsidy appropriated from national treasury since 2000

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Figure2- Fuel subsidy in Rs Bn and as a percentage of GDP

With lower inflation, the monetary (controlled by RBI) and fiscal policies (planned by the State) can be tweaked to channelize the increase in savings and profits to more productive uses like funding of capital intensive projects. The monetary easing would lead to a spur in the employment and demand cycle once again. Thus, lower oil prices can trigger a virtuous cycle win the Indian economy. After all, with India’s imports running at an estimated 3.7 mbpd (million barrels per day) in 2013, a $30/barrel decline in oil prices amounts to $40 billion savings bonanza which is almost 2% of GDP. Nomura, a leading Asian financial service company, says every $10 fall in the Brent will contribute to the GDP by 0.1%.

The Virtuous Cycle

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Figure 3: How a decline in price of crude can end up stimulating the industry engine

But Is the fall in Oil Prices Bad for anyone?

Yes, it’s an inferno for oil exporting economies. Google Harold Hamm, the Chairman of multi-billion dollar US Co.- Continental Resources, who on account of the fall in oil prices got his net worth halved in last 3 months (Rubbing salt to wound, the old man had to pay $1 Bn as alimony earlier this year. Ladies).

It remains to be seen the trajectory on which oil and economy’s growth moves further, while the former is sure turning hotter by the day, the latter is what will bring cheer to India Inc. Hence the statement is justified.

 

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