The plunge in oil prices, which in mid-January were trading beneath $50 a barrel, or 60% lower than their peak in 2014, has trembled the oil and gas industry which has in turn devastated upstream investment plans. Oil prices fell steeply in the second half of 2014, bringing to an end a nearly four year period of constant price of around $105 per barrel.
The essay addresses three major questions about the magnitude, causes and consequences of the recent oil price drop:
- How does the present oil price decline compare with older experiences?
- What are the drivers of this sharp decline?
- Who are mainly getting affected by this decline and how?
How does the present oil price decline compare with older experiences?
Compared to the past thirty years’ records to the price decline, the fall in oil prices in summer 2014 qualifies as a major episode. There are total five other episodes, between 1984-2013, of oil price declines of around 30 percent in the span of six-months: an increase in the supply of oil (1985-86); recessions in U.S.(1990-910 and 2001); the Asian crisis; and the global financial crisis (2007-09).
There are so many similarities between the recent decline and the collapse in oil prices in 1985-86. In 1985, due to advancement in technologies which reduced the intensity of oil consumption and made possible to extract oil from various offshore fields, there was steep decline in oil price preceded by the sharp increase in oil prices in the 1970s.
The present decline in the 2014 intensified after change in policy at the OPEC meeting in late November. They decided not to cut their production due fall off oil prices in the market.
What are the drivers of this sharp decline?
The long turn trend in the prices of oil and gas are determined by actual demand and supply whereas, in the short run movements in market sentiment and expectations exert an influence too. Demand of energy is affected by economic activity while supply gets affected by weather and by geopolitical ups and downs. There are mainly three things which are affecting the whole scenario. First, America has become larger oil producer. Though it does not export oil, but it greatly decreased its imports, creating a lot of spare supply. Second, the Saudis and their partners have decided not to cut their production to regulate the price. They could easily curb production, but the main benefits would g. to countries they dislike the most. Finally, demand is very low due to weak economic activity, increased efficiency and improving ways to deviate from oil to other fuels.
Who are mainly getting affected by this decline and how?
The decline in oil prices is having significant economic impact around the world. This resulted into shortage of revenues in many oil exporting countries while consumers in the oil importing countries are getting benefit of paying less for driving their vehicle and heating their homes. Here are some examples:
India: India is the fourth largest consumer of oil. India imports around two-thirds of its requirement. A drop of one dollar in the price not only saves the country about ₹40 billion but helps lower the import bill and save foreign exchange. There are also negative impacts of oil prices fall on the country. The fact that a large part of the working Indians is working in oil producing countries, any slowdown can also affect the inward transmittals. There will be positive impact of falling prices on some sectors such as plastic industries, automobiles, paints and footwear manufacturers, chemicals and resins selectively.
Russia: Russia is being viewed as most affected because the fact that up to 45 percent of the government budget is based on oil revenues and the steep decline has been ruinous. As imports are becoming drastically more expensive, there is rise in inflation leading to panic inside Russia. Economist also forecasted that Russia’s GDP will fall by at least 4.5 percent if oil price stays below $60 per barrel. To prevent people from selling off rubles, Russia increased interest rates to 17 percent from 10.5 percent.
Saudi Arabia: Saudi Arabia, being the most influential member of OPEC, could have easily cut their own production to support the global oil prices, but there is no chance of doing this as their own cost of producing oil from the ground is around $5-6 per barrel and also have around $700 billion in reserves.
There might be two reasons- to try to impart some discipline among other OPEC oil producers, and perhaps keeping shale oil and gas industry of U.S. under pressure. If a period of lower prices were to force to shut down, then Riyadh might hope to pick up market share.
United States: US oil production are at their highest in 30 years but a fall in crude price will have both positive and negative impacts on the US. There will be drop in revenues for the oil the producing countries like Texas and North Dakota. Oil and gas is being produced from shale formations by using hydraulic fracturing or fracking, which has been the biggest cause of oil prices. Production from shale formations reduced the dependency of US on imports and increased percentage of increased supply in the global market.