[Document

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ANVITHA PHUTANE

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THE BREATHTAKING DECLINE

For the last two years, global oil prices have been in free fall,
and no one seems to know when it will stop. In June 2014 you
had to plunk down $110 to purchase a barrel of Brent crude. By
early 2015 that had dropped to $60.
Today it costs even less to buy that barrel of oil a level not
seen since
2004.
It's a

breathtaking decline. People are literally throwing barrels of a

plank.

Oil supply (in green) remains much higher than demand

(yellow) about 1.5 million barrels per day higher with the
excess getting saved for later in stockpiles (blue). And, the
International Energy Agency said in January, that glut is
currently expected to persist for the rest of 2016, keeping
prices low: "Unless something changes, the oil market could
drown in over-supply."

HISTORY OF THE DECLINE

This wasn't always the case. Between 2010 and 2014, oil
demand was soaring around the world, as countries recovered
from the financial crisis but global production was struggling to
keep up. Many older oil fields were stagnating. Conflicts in
places like Libya and Iraq were restricting supply. Countries had
to draw down their stockpiles, and prices soared to around
$100 per barrel.
Those high prices, however, spurred drillers in the United States
to use innovative hydraulic fracturing and horizontal drilling
techniques to unlock vast quantities of oil from shale
formations in places like North Dakota and Texas. It's hard to
overstate the impact of the fracking boom: US crude oil
production has nearly doubled since 2010.
Eventually, supply caught up with demand and then
surpassed it. That's when the crash came.
By mid-2014, global demand was starting to slow down. Europe
was still reeling from the euro zone mess. China's economy was
starting to stumble. But the United States continued to produce
more and more oil. Iraq and Libya were also starting to bring
more production back online. So prices began sliding, down to
$70 per barrel.

At that point, many people expected Saudi Arabia and other oil
producers in OPEC to cut back on their own production to prop
up prices, as they have in the past. (Conventional wisdom had
held that Saudi Arabia needed $100 per barrel oil to balance its
budget.)
Surprisingly, that didn't happen. Saudi Arabia decided to
increase production in order to maintain its market share,
hoping that the subsequent fall in oil prices would crush US,
who require higher prices to stay profitable.
Ever since Saudi Arabia's decision to maintain output in late
2014, prices have kept tumbling and tumbling to $50 per
barrel, then $40, then $30 largely because supply has
remained strong and demand has been weaker than expected.
US drillers turned out to be far more adaptable to low oil prices
than the Saudis thought, as companies cut costs and boosted
productivity in order to keep the oil flowing. (US production has
finally stopped growing over the past few months, but the
decline has been far less severe than originally predicted.) Iraq
has nearly doubled production since 2014 to more than 4
million barrels per day as it recovers from conflict. Thanks to
the nuclear deal with the US, Iran will start exporting more oil
this year as sanctions are lifted, offsetting declines elsewhere.
In the meantime, major developing economies like China,
Russia, and Brazil remain mired in a slump, putting a damper
on oil consumption. An unusually mild winter helped suppress
demand for heating oil. And a stronger dollar means that some
countries now have to pay more for crude imports, which
further limits consumption.
As long as supply far outstrips demand, oil prices will stay
relatively low.
Cratering prices are having all sorts of ripple effects around the
world. Car owners in places like the United States, Europe, and
Japan are suddenly paying way less for gasoline, which
means they have more money to spend on other things.
(Arguably, low prices have helped bolster the US economy over
the past year.) SUVs and gas guzzlers are coming back in style.

On the flip side, crude producers like Saudi Arabia, Russia, and
Venezuela are struggling to balance their budgets and suffering
from a major revenue crunch. Oil companies in the United
States and elsewhere are watching profits evaporate. Banks
that financed the US shale boom are reeling from a wave of
defaults. Developing nations that previously relied on
petrodollars for financing are now hurting. It's a major
disruption.
The plummeting price of oil is still the biggest energy story in
the world. It's bringing back cheap gasoline to the United States
while wreaking havoc on oil-producing countries like Russia and
Venezuela.

FUTURE OF OIL
The future of the oil prices is largely uncertain. Lots of bets are
being placed in the financial markets on this regard.
Some banks project oil prices to keep plummeting down to $20
per barrel this year. Others expect a rebound to around $50 or
$60 per barrel by year's end as the US shale boom tapers off
and demand recovers.
In January, the IEA pointed out that prices could easily slide
lower this year if Iran ramps up production faster than
expected. "In a scenario whereby Iran adds 600 kb/d to the
market by mid-year and other members maintain current
output, global oil supply could exceed demand by 1.5 mb/d in
the first half of 2016. So its very much possible that the price
could go lower.
Ultimately, the supply and demand dynamic is the thing to
keep an eye on. And expectations matter enormously here.
Whenever new data shows an unexpected boost in oil
production or an unexpected drop in oil demand, prices tend to
go down. Conversely, a surprise drop in supply or a surprise
surge in demand will push prices back up.
So if, say, the cold war between Saudi Arabia and Iran heats up
and somehow leads to conflict that crimps production, prices
could rise. If low prices are harder for the US shale industry to
handle than anyone thought, that could also cause prices to
rise higher. If China's economy suddenly rebounds
unexpectedly, that could have a similar effect. Or maybe Iran
will do something that causes EU and US oil sanctions to snap
back into place.
Alternatively, perhaps the supply glut and hence low prices
will persist indefinitely. It's a guessing game, and there are
lots of plausible guesses.
The IEA significantly increased its projections of future oil costs
in this year's report due to the changing outlook for demand
and production costs. It now expects crude oil to average $100

per barrel over the next two decades and more than $200 per
barrel in 2030, in nominal terms. Last year's forecast estimated
that a 2030 barrel would amount to only $108.
Will there be a spike or glut? These are very possible but
radically different scenarios.

GLOBAL IMPACT
The plunge in oil prices is having significant economic
consequences around the world.

RUSSIA:
Russia's situation is getting the most attention these days. The
country's is hugely dependent on oil and gas production with
oil revenues making up 45 percent of the government budget
and the sharp fall on prices has been ruinous.
Economists now estimate that Russia's GDP will shrink at least
4.5 percent in 2015 if oil says below $60 per barrel. The
plunging price of oil has also caused the ruble's value to
collapse which is leading to panic inside Russia and a rise in
inflation, as imports become drastically more expensive. Many
Russians, worried that their savings may vanish, have been
rushing out to buy cars and washing machines anything that
has more lasting value than currency.
So far, Russia's central bank has been struggling to deal with
this crisis. On December 15, 2014, the country suddenly hiked
interest rates from 10.5 percent to 17 percent in an attempt to
stop people from selling off rubles. But those rate hikes are
likely to slow the country's economy down even further.

IRAN:
Iran's economy had recently started to rebound after years of
recession. The International Monetary Fund had been projecting
that the country was on track to grow 2.3 percent next year.
But that was all before oil prices started to plunge a
potentially precarious situation for the country.

One big problem for Iran is that it also needs oil prices well
north of $100 per barrel to balance its budget, especially since
Western sanctions have made it much harder to export crude. If
oil prices keep falling, the Iranian government may need to
make up revenues elsewhere say, by paring back domestic
fuel subsidies (always an unpopular move, at least in the short
term).

VENEZUELA:
There's growing concern that the oil crash could cause
Venezuela, another major oil producer, to default. The nation's
economy heavily dependent on oil revenue is set to shrink
some 3 percent this year and inflation is rampant.

SAUDI ARABIA:
There's no question that Saudi Arabia, the world's secondlargest crude producer (after Russia), will suffer financially from
cheap oil. If oil stays at around $60 per barrel next year, the
government will run a deficit equal to 14 percent of GDP.
For now, however, the Saudis are toughing this out and show
no sign of trying to prop up prices as they have in the past. The
kingdom has built up a stockpile of foreign currency worth
some $750 billion, which it will use to finance its deficits. In
December, the country's oil minister, Ali al-Naimi, said he didn't
care if prices crashed to $20 or $40 per barrel, he wasn't going
to budge from his position. "It is not in the interest of OPEC
producers to cut their production, whatever the price is," he
said.
That said, if low oil prices persist, Saudi Arabia may have to cut
back on some of the social programs it had instituted after the
Arab Spring. And Naimi's strategy of maintaining oil output is
controversial within the kingdom. (In January 2015, Saudi King

Abdullah died, but his successor Salman said he would maintain

the current oil policy.)

THE UNITED STATES:

In the US, meanwhile, a fall in crude prices will have both
positive and negative impacts. For many people, it will offer an
excellent economic boost: cheaper oil means lower gasoline
prices which have fallen to $2.04 per gallon, the lowest since
2009.
The EIA projects that US drivers will spend about $550 less on
gasoline in 2015 than they did in 2014, assuming prices stay
low. That will give consumers more money to spend on other
things.

But it's not all good news. Oil-producing states like Texas and
North Dakota are likely to see a drop in revenues and economic
activity. The falling price of oil is also putting severe pressure
on Alaska's state budget. All told, oil prices are likely to be good
for 42 states (in green) and bad for the other 8 (in red):

If the price drop lasts a long time, that could also spur people to
start using more oil. Case in point: In recent years, high

gasoline prices have spurred many Americans to buy smaller,

more efficient cars. But if gasoline prices fall, bigger cars and
SUVs could make a comeback.

IMPACT ON INDIA
Oil is one of the most important commodities in recent times. It
greatly influences the functioning of the economy and India is
no exception. Here are some of the ways in which the decline in
oil prices have affected India:

CURRENT ACCOUNT BALANCE:

India is one of the largest importers of oil in the world. It
imports nearly 80% of its total oil needs. This accounts for one
third of its total imports. For this reason, the price of oil affects
India a lot. A fall in price would drive down the value of its
imports. This helps narrow India's current account deficit - the
amount India owes to the world in foreign currency. A fall in oil
prices by $10 per barrel helps reduce the current account
deficit by $9.2 billion, according to a report by Livemint. This
amounts to nearly 0.43% of the Gross Domestic Product - a
measure of the size of the economy.

INFLATION:
Oil price affects the entire economy, especially because of its
use in transportation of goods and services. A rise in oil price
leads to an increase in prices of all goods and services. It also
affects us all directly as petrol and diesel prices rise. As a
result, inflation rises. A high inflation is bad for an economy. It
also affects companies - directly because of a rise in input costs
and indirectly through a fall in consumer demand. This is why
the fall in global crude prices comes as a boon to India. Every
$10 per barrel fall in crude oil price helps reduce retail inflation
by 0.2% and wholesale price inflation by 0.5%, according to a
Moneycontrol report.

 OIL SUBSIDY AND FISCAL DEFICIT:

The government fixes the price of fuel at a subsidised rate. It
then compensates companies for any loss from selling fuel
products at lower rates. These losses are called underrecoveries. This adds to the government's total expenditure and
leads to a rise in fiscal deficit - the amount it borrows from the
markets. A fall in oil prices reduces companies' losses, oil
subsidies and thus helps narrow fiscal deficit. However, since
diesel was recently deregulated, the fall in oil prices will likely
have less effect on the government's fiscal deficit. Moreover,
the government still has to pay for previous under-recoveries.
Any benefit from the fall will be offset by payments for the past
under-recoveries.

RUPEE EXCHANGE RATE:

The value of a free currency like Rupee depends on its demand
in the currency market. This is why it depends to a great extent
on the current account deficit. A high deficit means the country
has to sell rupees and buy dollars to pay its bills. This reduces
the value of the rupee. A fall in oil prices is, thus, good for the
rupee. However, the downside is that the dollar strengthens
every time the value of oil falls. This negates any benefits from
a fall in current account deficit.

PETROLEUM PRODUCERS:
The fall in global oil prices may be beneficial to India, but it also
has its downsides. Directly, it affects the exporters of petroleum
producers in the country. India is the sixth largest exporter of
petroleum products in the world, according to media reports.
This helps it earn $60 billion annually. Any fall in oil prices
negatively impacts exports. At a time when India is running a
trade deficit - high imports and low exports, any fall in exports
is bad news. Moreover, a lot of India's trade partners and
buyers of its exports are net oil exporters. A fall in oil price may

impact their economy, and hamper demand for Indian

products. This would indirectly affect India and its companies.
For example, the share prices of Bharti Airtel and Bajaj Auto fell
because of the devaluation of the Nigerian currency - Naira.
Both the companies have a significant presence in the African
country.
Indians staying abroad sent $70 billion worth money
back home in 2013, according to a report by The Hindu,
a national newspaper. This is important because India
uses this inflow to fund its current account deficit.
Majority of this money comes from Indians staying in
Gulf countries. A fall in oil prices could affect some of the
oil-exporting Gulf countries. This could in turn affect the