www.caspot.com brings you the exclusive post of Why are the Prices Of Crude Oil Falling? - Know The Reason Behind This Fall..!!
Has the recent crash in Crude Oil price left you wondering what it means to the global economy and you? This article might help you understand, Read On!
Take a look at the monthly chart of Crude
Oil below and see the various Geopolitical, economic factors that have
affected the Crude Oil price in the past:
Driven on the back of rapidly increasing
demand worldwide in the mid 2000's, majorly from China, Crude Oil
rallied from under $25 a barrel in 2000 to around $150 in mid 2008. And
then came the crash that took it to under $35 in just few months and
then with the recovery seen in the global economy, Crude Oil prices
rallied back up to around $114 and moved around $100 for few years until
now. Crude Oil prices have fallen from $107 in June, 2014 to around $54
in December, 2014 which means more than a 50% drop in just 6 months!
Lets try to understand what caused this fall.
Demand and Supply:
As studied in economics, price of any
commodity is driven by two forces: Demand and Supply. Let's see what
changes have come in Demand and Supply of Crude Oil.
From the first line chart, you can see how
supply has become more than the demand. The above chart shows the spike
in Crude production in USA in recent years. Due to high prices of
Crude, Oil companies in USA started to extract oil from Shale formations
in North Dakota and Alberta's oil sands. Oil prices thus on back of
more supply started drifting lower. The markets expected the Oil cartel
known as OPEC to step in and cut down on it's production in November,
2014 as prices were falling dramatically. OPEC (Largely influenced by
Saudi Arabia) did nothing. Saudi Arabia wanted Oil prices to drift lower
so that the oil boom in USA could be controlled. Oil prices now are
well below the cost of producing oil for many countries and for
countries like Venezuela, Russia whose economy is largely dependent on
Oil, this means disaster. The chart below shows the breakeven prices for
OPEC countries.
Though Saudi Arabia has let Oil drop below
it's breakeven price too, they have done it keeping in mind the large
reserves they have that will help them bear these losses for years! In
the process, they expect to force the US oil manufacturers to shut shop
and thus they will regain the market share they enjoyed earlier. Keep in
mind: Saudi Arabia is the largest producer of OIL in the world! In the
1980's when Oil prices had started falling, Saudi Arabia had cut down on
Oil production but the oil prices continued falling which saw the Arabs
lose out on a big chunk of revenue and market share as well. In short,
the current scenario is a price war between USA (Where high oil prices
prompted companies to start extracting oil from tough areas) and Saudi
Arabia (Who wants to regain it's lost market share). Saudi Arabia does
hope that Oil prices will stabilize later. So this was the story of
increase in supply.
China's growth is slowing down and it's
alarmingly high pollution levels have prompted authorities to look at
cleaner sources of energy. Infact, the whole world is now moving
(slowly), towards alternate sources of energy. This is causing a slow in
the growth of demand for Oil.
Impact:
i) Russia:
Oil revenues make up 45% of the
government's budget. Of Oil stays at $60 then the country's GDP will
shrink 4.5%. Now Russia's currency Rubel is losing value at an alarming
rate (Already down 50%) against the dollar. The central bank there hiked
interest rates from 10% to 17% to stop people from selling Rubel but it
has not worked till now. A large financial crisis is looming on the
world's biggest country.
ii) Saudi Arabia:
With $740 Billion worth of forex reserves
the country will just sit behind and watch the world run into chaos. If
needed, they will cut down on social programs started after the Arab
spring to counter the 15% deficit to the GDP that will happen if Oil
stays near $60.
iii) United States of America:
It is a mixed scenario for USA. The Oil
producing companies could head towards closure and the country will lose
market share though authorities have indicated that the country
continues towards it's plans of raising production by 700,000 barrels a
day in 2015. Consumers will benefit from cheap gasoline prices. They
will have more money to spend which will benefit the economy and will
shift from small energy efficient cars to bigger ones.
iv) India:
India is a net importer of Oil. Falling
crude prices will do nothing but benefit the economy in a big way! The
government is already taking advantage of this situation by reducing the
fiscal deficit (That is why Petrol prices have not gone below Rs. 50).
But the worry is that due to falling prices of Oil and the subsequent
strengthening of the $, the rupee will continue to fall and this will
hurt importers. IT & Pharma sector will benefit from a stronger
dollar. With so many economies nearing a crisis with falling oil prices,
investors will withdraw their investments in these countries and other
emerging markets and put into safer assets like $, Gold, etc. Due to
this, $ will gain strength globally and result in a weaker rupee. Will Oil Prices go up again?
Our View: Eventually,
Yes. How? Maybe some new war in some middle east country which will
lower supplies. Maybe an economic miracle in China which will push up
demand again. Maybe Saudi Arabia deciding that it's time to cut losses
and thus cut production. We don't know the way but it will happen.
Last but not the least: Here is a chart of the Rouble against the Dollar:
Raghav Behani is a CA Final Student and an active blogger on financial markets on his own blog http://www.dalalstreetbulls.com
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