The power and energy sector at a global level has been constantly changing and have been quite volatile in nature for quite some time now. In 2018, we have seen both very low and very high crude prices. Crude oil prices rose from $66.57 per barrel in January 2018 to $86 per barrel in October and finally settles at $53.82 per barrel. But do we know why is such volatility occurring in the market? Let’s find out.
First, to know about crude oil prices, we need to understand how oil prices are determined.
How oil prices are determined?
Crude oil prices are generally measured in derivatives, that is, spot contracts and futures contracts. Spot contracts state the current market prices of crude oil. Money is exchanged, and the purchaser accepts delivery of the goods. In the case of oil, the demand for immediate delivery versus future delivery is small, due in no small part to the logistics of transporting oil to users. An oil futures contract is an agreement to buy or sell a certain number of barrels set amount of oil at a predetermined price, on a predetermined date.
Reasons for Oil Price Hike at a Global Scenario
The crude oil prices shot up to $80 dollars per barrel. This gave a state of shock at a global scenario. There were three major reasons which led to situation and they are:
1) Sanctions by US on Iran
One of the major reasons which shot up the prices were the sanctions imposed by US President Donald Trump on Iran. It was the President’s decision to withdraw Iran from the nuclear deal on May 8. Imposing such sanctions led to expectation of shortage of supply of crude oil. As waiver of such sanctions was nearly impossible, the expectations of the investors and countries were that the oil supply would be cut down. It was stated that the Iranian crude was too high and the US administration had demanded that the OPEC or Organization of the Petroleum Exporting Countries and Russia to increase their supplies to make up for the expected fall in Iranian exports.
2) Instability in the economy of Venezuela
Another reason which led to such hike in price was the instability in the economy of Venezuela. India has been importing a considerable amount of crude oil from Iran. This led to increase in demand but could not match with the supply. There was a situation of excess demand and shortage of supply which shot the prices up. Due to crisis situations in 2014, when there was a mass migration, the number of workers got reduced to a considerable number. This caused less production of crude. Venezuela depends on its exports of oil as it comprises of a major portion of the country’s GDP. When the production fell to 1.34 million barrels per day which is 800,000-barrel drop since the last year, there was a shortage of supply.
3) Instability in the Middle East when tensions between Saudi Arabia and Iran
Thirdly, there was instability in the Middle East when tensions between Saudi Arabia and Iran had begun after the Saudi Crown Prince visiting US President considers ending the Iranian Nuclear deal.
Impact on The Indian Economy Due Rise in Crude Oil Prices
India, which imports over 80% of its oil, is attracted to Iran’s crude largely due to geographic proximity that can save on shipping costs, as well as the favourable financial terms offered by Iran, including the longest credit period among all of India’s suppliers, a Bloomberg report said. Iran has supplied about 18.4 million tonnes of crude oil from April 2017 to January 2018. The rise in crude oil prices led to the depreciation of the Indian rupee against dollar. The rupee depreciated to Rs 74.34 against one dollar. The Indian stock markets have faced a lot of pressure due to the rise in crude oil prices. Between 1 and 24 May, 2018 alone, the Sensex fell by 2.3%. In comparison, the BSE small cap and mid-cap indices have had it worse with a drop of nearly 8%. With crude oil prices touching $80 per barrel, there has been a sell-off in small cap and mid cap stocks. Analysts warn that this could continue if the crude oil price continues to rise. Oil is a very important commodity and it is required to meet domestic fuel needs. And in addition to that, it is a necessary raw material used in a number of industries. An increase in the price of crude oil means that would increase the cost of producing goods. This price rise would finally be passed on to consumers resulting in inflation. Experts believe that an increase of $10/barrel in crude oil prices could raise inflation by 10 basis points (0.1%).
Why did the Crude Oil Prices fall?
The Crude Oil prices fell because of the fear of oversupply in the oil market itself. Russia announced that its output had increased to more than 11.4 million barrels a day. Production in Saudi Arabia has also risen to a 22-month high of 7.7 million barrels a day, figures from the Joint Organisations Data Initiative suggested. the US Energy Department reported that the United States was producing 11.6 million barrels of crude oil a day, nearly a million barrels more than a year ago. US shale oil production is set to reach 8.2 million barrels a day on average in January, up by 134,000 barrels from the estimated December average. Adding to worries about oversupply, the American Petroleum Institute has reported that US crude stocks rose unexpectedly last week, while gasoline inventories also increased.
Impact on the Indian Economy Due to Fall in Crude Oil Prices
A fall in price of crude oil would eventually bring down the import bill to a considerable amount. US President Donald Trump’s insistence on lower oil prices, his Iran sanctions and a US-China trade war seem to have helped temper oil prices in recent times. A relentless rise in crude oil price that took it above $86 a barrel on October 3 was fuelled by fears that US sanctions on Iran may not allow many waivers, leaving Saudi and other producers struggling to fill the gap after significant Iran supply goes out of the market.
The drop in crude prices helped the government to raise excise duty by Rs. 12 on petrol per litre and Rs. 13.77 on diesel per litre since April 2014 and also helped prune Current Account Deficit thus raising GDP expectations. Off late, Brent Crude prices have risen by $18 per barrel while petrol and Diesel prices have gone up by over Rs.3 per litre. For India, lower oil prices mean lower import bill, less pressure on the rupee, narrowing current account deficit lower subsidy payout, higher public resources for other welfare projects, lower risk of inflation and increased room for RBI to cut interest rate.