Global Implications Of The Plunge In Oil Prices – Economic Analysis

Background

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Oil and gas resources are the most sensitive yet growth oriented sector in international economy. The recent plunge in the oil price across world has been alarming for both oil importing and exporting countries, affecting them in a macro and micro level. The weak global demand aligned with excess supply of oil has resulted in a major price drop, causing extreme pressure to both the financial and production capacity of the oil producing nations. Also causing volatility in currency market affecting capital inflow and investment planning. The report will analyze the economic theory of supply and demand with respect to oil prices, studying impact on both oil importing and exporting countries as well as its influence in overall industrial growth.

Oil prices have experienced stronger fluctuations in the past causing supply as well as demand differential and creating new scope to enhance the market production along with growth in earlier events. The oil market expansion has resulted to another oil plunge since 2014 causing change in the macro economic conditions, driving shock to international economic activity as well as global growth.
Background
Attaining stability in oil prices from 2010-2014 at around $105 per barrel, the prices have sharply declined since June 2014 to a current level of $38 per barrel in 2016. This fall in price triggered due to increase in supply of oil production followed by fall in demand has negated the behaviour of law of demand and supply due to numerous reasons.
Scope
The study would analyze the micro and macroeconomic factors of the issue causing price fluctuation along with its effect on the business activity around the world. It shall discuss the current domestic as well as global economic issues, implication resulting to such change and industries affecting due to such change.
Aim of the report
The report will conduct a brief review on international oil market, understanding the reason and rate of change in oil prices between the period of 2014 to 2016. The study would also explore how has the plunge in oil outlay has impacted the global performance of oil importing and exporting economies along with the implication of fall in price on international business.
International Oil Market Review
In the past there has been evidence showing similar fall in oil prices with related magnitude in 1985-1986, this is when the OPEC members has reversed the production done an earlier by imposing cuts. The second incident took place during the economic crises took place in 2008-09 during the period of global financial crises. The reason for the drop in 1985-86 was completely supply driven i.e. excess of supply whereas the in 2008-09 it was short of demand at a global platform. The current plunge is expected to be the amalgamation of the two (Baffes, et al., 2015).
Oil prices Plunge from 2014 – 2016
The oil prices around the world has been dwelling causing an imbalance with in the supply and demand; supply is facing a situation of abundance in oil production whereas the demand of oil is falling down due to the slumping of overall economic growth. The excess of oil production along with other economic factors causes excess production of oil, further affecting fall in oil price to around $60 per barrel in 2015 from $ 105 per barrel in 2014 to $38 per barrel in 2016 (Obstfeld, et al., 2016).

Figure 1: Demand and Supply Curve
According to the law of demand and supply, as supply increases the demand also increase to correct the fall in price whereas in the oil industry the rise in supply leads to falls in demand leading to further fall in the oil price, as shown in the above figure.
Global Performance of Oil Price Drop
The international slump in the oil prices has occurred due to various reasons including the change in the OPEC Policy Decision; Devalue of US currency; Over-supply of Crude Oil; Geopolitical Development and Reducing Demand.
Organization of Petroleum Exporting Countries (OPEC), cartel of oil producers in the world, considering to control and stabilize the scenario decided to cut-down the oil production in 2014. Indifference between the OPEC countries with regards to reducing the supply where Iran, Venezuela and Algeria agreeing to the decision whereas Gulf and Emirates countries allies to refuse, leading to oversupply (Cashin, et al., 2014).

Scope

US being a major importer of oil has created self-sufficiency through extracting oil and gas from different resources. Countries like USA and Indonesia with a huge domestic consumption of oil have arranged for these resources through domestic production. This results in reducing the market demand of oil against the supply available. The rise in the value of US dollar makes the currency stronger adding further pressure on the oil prices for countries where oil commodity value expressed in $ currency. The higher oil prices in these countries further reduces the demand for oil and higher supply from non US$ suppliers (Du, et al., 2010).
Over-supply of Crude Oil
The global oil market has witness greater un-anticipated supply and less anticipated demand causing the production from different sources like Shale in US increasing to an upside of 0.9 million barrel per day in 2014 created oversupply in the market. Though the oil supply in 2015 fell to 0.8 million barrel. The economies advancing way to use oil and gas efficiently has further reduced the demand (Frankel, 2014).
Geopolitical Factors
The geopolitical tensions have also had a down-sided effect on oil prices leading to disturbances in Middle East that continue to persist. Libya despite civil conflict recovered its production by 0.5 million barrel per day in 2015. The Iran nuclear deal between Iran and other countries seek to resign, reduce and convert Iran nuclear facility. Such deal would increase Iran oil exporter leading to oversupply of oil (Kilian, 2014).
Impact on China & Indian economies – Oil Importers
Oil prices majorly affect the growth rate and inflation in oil import countries, causing direct impact on the importer activity, monetary and fiscal policy response and investment opportunities. The reducing oil prices in oil-importing countries like India has a positive impact by fading the medium-term inflation as well as reducing the financial pressure through external sources; local banks tend to loosen-up the monetary policy supporting more investment initiatives as well as growth.
The benefit of lower price eventually is passed on to the consumers in the form of subsidies on the fuel consumption, in a way giving more spending power to the consumer. Also the lower prices leave less investment returns in the oil sector with regards to production and exploration, causing countries making investment into different sectors. The fall in the oil prices makes sector that are oil dependent such as electricity, transportation, petroleum, packaging, paper etc much more reasonable. This leads to oil-dependent sector moving faster with respect to their growth level, having more supportive conditions for making investment as well as providing better employment opportunities. The consumer in general would have higher disposable incomes in oil-importing countries with lower price scenarios (Kilian, et al., 2009).
Impact on Iran & Saudi Arabia economies – Oil Exporter
Un-precedent change in the oil prices has a negative effect on the oil-exporting countries with respect to managing the production at lower prices, causing excessive financial pressure to adjust both the imports as well as government spending on the same hand. The oil-price shock creates insecurity among oil producing countries forcing them to devalue their currency against US$. The oil exporters have dependency on oil earning as a source of their tax revenue to fund government revenue, future investment as well as social funding. Countries like Iran having dependency on oil revenue to support social and economic growth are adversely affected.
Countries like Saudi Arabia and UAE are still likely to sustain the shock pertaining to the enough foreign reserve maintained by these countries. Other economies like Russia that are majorly depended on oil and gas industry, accounting for 70% of exports income has faced rapid devaluation of their currency Ruble leading to a continuous recession in the country. Economies like Venezuela largest oil exporter facing the most difficult economic distress with inflation at the rate of 60% and oil prices falling to the lowest level causing spending cuts as well as subsidy (Kilian & Lewis, 2011).
Implication of Price fall on International Business
The fall in the oil price has received mixed response by industries dependent or non-dependent of the oil price movement. The implication of the fall in price has benefit some industries whereas it has affected some badly.
Positive Business Inclination due to change Oil Price
Airline Industry – Air passengers
The reduction in the crude oil according to International Air Transport Association has passed on the price differential benefit to the airline industries saving more than $90 billion in US in 2015. The oil price has led airline industry to run more competitively, passing on to the saving to the customer in a way of cost effective air fares and major frequency flights (Peersman & Van Robays, 2012).
Automobile Industry
The overall automobile industry has been successful in transforming the savings gained from lower prices to the consumers, promoting them to buy heavy vehicles like minivans, SUVs etc (Benes, et al., 2015).
Negative Business Inclination due to change in Oil Price
Oil producing Country
The oil producing countries from Russia to Iran where oil acts as a prime source of earning are tend to face deficit, causing financial pressure to meet the government expenses as well as further growth opportunities for their people (Baumeister & Peersman, 2013).
Environment – Eco-Friendly Technology
The fall in oil price would encourage people to use more vehicles using gas, heat convectors and oil based technology whereas investment required in the green technology fades away (Arezki, et al., 2015).

Conclusion

The above study highlights the macro and micro economic factors affecting the fall in oil prices both for long as well as short run. The decline is significant reasoning to factors including OPEC policy objective, Geopolitical risks, US currency devalue etc causing macroeconomic, policy as well as financial implications. The micro economic factors can be seen as a result to fall in price through increasing inflation, cost management as well as credit issue causing further fall in demand.

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