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Falling oil prices: who are the winners and losers?

Published on 9th Mar, Edition 10, 2015

 

Almost 40 percent of the world oil supply and price is controlled by the largest cartel in the world i.e. OPEC (Organization of the Petroleum Exporting Countries). Being an export commodity, GDP of exporting nations is defined through the price of oil, subsequently budgets and expeditions are finalized. It is in vested interest of OPEC nations to keep oil prices high. There have been numerous instances where OPEC has commented on price trends and claimed that it is unlikely that oil price will dip to anything below US$100 per barrel. Major research houses world over never predicted oil prices to fall below US$90-92 per barrel if prices bottom down. With current prices, which are half of what they were, breaking the US$50 barrier, it is beyond comprehension what may have caused the crash. Various assumptions have to do with excess supply and low demand springing from China. It is interesting that despite OPEC keeping constant supply, prices continue to dwindle, which shows that there may be factors other than simple demand and supply.

According to International Energy Agency (IEA), with high demand springing from China since 2010, drilling and exploration was expedited which has resulted in higher supply than demand. Even with unrest in Libya and Iran, supply has not been constrained. Simultaneously, with new drilling sites in US and Canada, demand on the West has substituted imports where possible. If supply is reduced in hope to increase price and prices remain at existing levels, it will affect the foreign exchange of OPEC. However, if prices do fall, it will become unprofitable for other producers to compete with OPEC prices, hence profitability will increase at the back of volume. There are still assumptions at par with initial research that oil prices will be, however, between US$90 per barrel to US$100 per barrel if not less. Another prediction is that if prices keep falling, new exploration and drilling will stop and oil companies will consolidate and focus to meet existing supply than estimate capital expenditure against future demand.
When it comes to other players in the market other than the West, crisis and political unrest between Ukraine and Russia is making news. Effectively, with decline in prices, value of ruble, Russian currency, has also reduced, imports are expensive. Iran has been under US radar for long. The problem is that Iran’s economy is only dependent on export of oil and the higher the price, the better for people. If prices decline, it will result in higher taxation, which the people are not ready for. Venezuela may face a similar situation being the second largest producer after Saudi Arabia. The advantage to Saudi Arabia is sheer volume, however, risk of GDP growth will prevail. There was another assumption that will lower oil prices, Saudi Arabia could consider taxations to substitute for the loss in revenue. Another assumption states that Saudi Arabia would only view the declining prices as a temporary phase and that prices will rebound to previous levels. It seems unlikely that OPEC would curtail supply only to maneuver price keeping other factors constant.

 

Current oil prices are US$48 per barrel. The winner with low prices is the customers and auto manufacturers. There will likely be an upsurge in demand for SUVs. In addition, for countries importing oil, it will reduce the current account deficit. The losers in this equation are oil exporting nations and companies world over who sell oil. If demand remains same and price falls, lower revenue will cause margin pressures if other costs to generate revenue do not follow.

In current circumstances, it’s a widely believe that oil prices will rebound soon and will not bottom down beyond existing levels. It is also expected that since oil prices have reduced over a period of 7 months, rebound of prices could take similar time. Factors which could increase the price from current levels include demand from China and India, unrest in Libya, Iran and Russia, improvement in European debt crisis and OPEC deciding on curtailing production. Any of the given factors could increase the price. Factors which could further reduce the price and opposite of the above. Another challenge is to predict the direction of the stock through technical analysis, which involves the study of statistics such as past prices, trends and forecasts maybe used as a suggestion to predict the oil movements or that of any stock.

Using a combination of fundamentals and technical, some analysts may guide investors in the right direction while others may completely miss triggers in the market. With thousands of analysts and traders speculating the oil price, volatility is bound to continue.

With lower oil prices, it gives countries a chance to review its revenue stream and look for avenues which could supplement foreign exchange from oil. There must be a plan to substitute oil revenue with manufacturing and services in various different industries. Renewal energy is an option, however, if oil prices remain low, the viability of renewal or alternate energy may decrease. Demand from developing nations will continue to drive demand, therefore, GDP growth of largest imports must be monitored consistently.

In international markets, oil traders bet on oil prices for a healthy return and to hedge against devaluation in the currency e.g. the US Dollar and inflation. OPEC has often announced price revisions citing demand and supply issues through the real reason maybe very different. For OPEC, the GDP of oil exporting countries is dependent on the price of fuel which means that the higher the price, the higher the GDP translating into economic prosperity. The oil price volatility will affect the overall prices of commodities consumers buy and will result in supply side inflation if not controlled through a strong price control mechanism. Any volatility in the oil prices will particularly affect the developing countries where inflation is highly skewed with price of inputs used for production particularly oil. Though it is difficult to predict the future movement of oil prices, it is expected that prices will rise beyond current levels.

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