Far From A Crude Future

Far From A Crude Future

"Formula for success: rise early, work hard, strike oil." – J. Paul Getty, an American industrialist and Founder of the Getty Oil Company.

As crude oil prices plunge south from $110 to $30 levels, the above quote rings hollow for many who did strike oil, but are now finding it hard to get it off their hands. Oil prices are a major indicator to the health of the global economy and this recent crash has given investors a lot to worry about.

And the story behind this historic event has all the trappings of a thriller novel – political conspiracies, geopolitical tensions, economic roller coaster & ecological impact. What remains to be seen is if the ending would be a happy one!

Reasons Behind the Crash

"Energy forecasting is easy. It's getting it right that's difficult." - Graham Stein

Excess Supply Major oil suppliers like Libya and Iraq halted their production when they were struggling politically. To make up for the supply shortage, US increased its shale oil production by almost double. However, once the conflicts subsided, Iraq doubled its production, adding to a dramatic oversupply that surpassed the demand for the product.

Decreased Demand The economic slowdown in the bigger economies like Europe, China and Russia bought down their demand for oil. As the dollar grew stronger due to America’s oil exports, oil importing companies were forced to curtail their oil consumption, which led to a vicious circle of falling oil prices.

Geo-Politics Saudi Arabia, the biggest supplier of oil, saw an opportunity to crush the American shale oil industry and maintain its share of Asian markets by increasing production in the face of lower demand. They wanted American companies to incur losses from maintaining huge oil reserves that would have no buyers.

One Man's Waste is Another's Treasure

"Like a pebble tossed into a pond, an oil shock creates ripples, or effects, felt everywhere." – Albert Marrin, American historian.

Gainers

Countries Many oil importing countries, like India and China, have found a reason to celebrate due to a lower import expenditure. A host of European countries also stand to gain as they expect substantial growth brought on by the oil sell-off which will boost the Euro currency.

Corporates Companies in a number of sectors like oil refining, car manufacturing, plastics, textiles, and air transport will stand to benefit as they would see much lower raw material costs.

Individuals One of the biggest gainers from the entire situation are the end consumers who are paying far less for oil, which is usually one of the most expensive items in their monthly spends. According to experts, a $40 price cut could shift ~$1.3 trillion from producers to consumers through direct savings. They will also see indirect benefits such as lower inflation due to a fall in prices of products that depend on crude oil.

Losers

Countries There are some nations whose economies are solely dependent on the income from oil exports. Countries like Iran, Yemen, Libya, Venezuela and Nigeria that do not have large foreign reserves will be forced into debt, which would weaken their currencies and drastically hamper their economic stability.

Corporates In spite of the celebrating consumer, the adverse effects of this slump on oil companies and financial institutions is imminent. A number of large oil companies will find these price levels economically unviable with a high possibility of bankruptcy and inability to pay back creditors and renegotiate loans.

Individuals As drilling companies try to cut costs, employees are the first causality, which can lead to high levels of unemployment in the oil sector.

The Road Ahead

"We usually find gas in new places with old ideas. Sometimes, also, we find gas in an old place with a new idea, but we seldom find much gas in an old place with an old idea. Several times in the past we have thought that we were running out of gas, whereas actually we were only running out of ideas." - Parke A. Dickey, a petroleum geologist and retired educator.

Low prices are sure to cause geopolitical tension, leading the economies of Europe, US and Japan towards deflation. Oil producers will have to eventually cut production as the low prices are unsustainable in the long-term. Other developments such as another conflict between Saudi Arabia and Iran could lead to a halt in oil production and reduce the demand/supply gap. A reversal of China’s economic slowdown could also boost demand.

Global Event, Local Impact

"First look at the size of the prize and then the risk involved". - Geology first, Economics second.

India imports 75% of its crude oil, so a price drop would help control its domestic inflation and current account deficit. A decrease of $1 in the price of oil saves the country roughly 4,000 crores, while a fall of $10 in crude oil could reduce the Current Account Deficit by roughly 0.5% of GDP and the fiscal deficit by around 0.1% of GDP.

Companies such as HPCL, CEAT, JK Tyre and Berger Paints which use crude oil and its by-products as raw materials will stand to gain from the lower prices, while private oil drillers like Cairn India might get hit badly.

Take a look at the Future of Crude Primer that lets you invest in companies that are likely to benefit from this event in the medium to long term.

Household budgets are also substantially impacted by the rise and fall of oil prices, thus affecting how people spend and maintain their lifestyles. On a personal level, a decrease in oil prices is generally beneficial for the consumer and helps invigorate the economy.

However, there is a possible downside to the oil price plunge for the Indian markets too. Foreign direct investment (FDI) flows could get adversely affected in the wake of a global turmoil and exports would also get hurt due to a slowdown in the major global economies.