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Repercussion of lower oil prices

Published on 28th Sep, Edition 39, 2015

 

The oil industry with its past history of huge profitability is in the downswing. Earnings are at present in a lower position for companies that have made landmark profits in recent years, pushing them to retire more than half their rigs and abruptly cut investments in exploration and production. About 100,000 oil workers have lost their jobs, and manufacturing of drilling and production equipment has fallen drastically.

The oil prices have been cut roughly in half since June 2014. It reached levels last seen during the depths of the 2009 recession. Prices recovered a bit in the spring but have fallen again. Executives of oil companies are of the opinion it will be years before oil returns to $90 or $100 a barrel again.

International oil companies drastically cutting back on investments. Around $200 billion worth of projects are on hold. They are likely to cut further due to continuing crude oil surplus and decreasing prices.

Chevron and Royal Dutch Shell recently announced cuts to their payrolls to save cash, and they are in far better shape than many smaller independent oil and gas producers that are cutting dividends and selling assets as they report net losses. Some smaller oil companies that are heavily in debt may go out of business, pressuring some banks that lend to them.

Scotland-based Weir Group anticipates its second-half margins to be slightly below first-half levels, reflecting the full impact of pricing pressure. Some are also looking for opportunities in Iran, which reached a deal in July to curb its nuclear program in exchange for the final removal of sanctions.

UK Oil and gas service companies have fared better than expected in the first half of the year. They warn the second half of the year will likely to be much harder as oil companies cut spending even further after a near 30 per cent fall in oil prices since the start of July. Prices have more than halved since peaks hit in summer last year.

Many oil services companies which do everything from surveying to drilling wells — relied on business in the Middle East to counter balance a drop in activity in costly areas such as the North Sea or the Gulf of Mexico. Oil operations in the Middle East are managed by cash-rich governments which in turn rely on income from the sector. Oil production costs in the region are some of the lowest in the world.

According to IMF the decline in oil prices is benefiting consumers, but not as much as it is thought to be. In the global world crude oil prices fell by about half between June of last year and by the end of the year, retail fuel prices on average globally fell by half as much, so by about a quarter.

The extent to which retail prices have fallen varies a lot across countries and regions of the world. In many countries, retail prices are regulated and, in fact, in many countries retail prices are fixed. So they do not change when world oil prices change.

In Europe, retail prices change in response to changes in international crude oil prices. The pass-through has been about 80 per cent in Europe. In the Americas, North and South America combined and in Asia, it was about half.

 

Calculated technique

In Pakistan, the real benefit of the considerable decline in oil prices has not been passed on to the consumers except a cut of a marginal amount general transport charges, which is merely meant to deceive and does not translate the actual impact on prices.

The middle-class people in Pakistan have to spend a huge amount on electricity and gas bills, education fee of the children and transport charges as compared to the expenditures on food items and groceries.

People of average middle class income are not able to pay the electricity charges hence they have no alternative but to use electricity through an unlawful connection. This causes immense losses running in billions of rupees to KESC and WAPDA on account of line losses or power theft.

Some economic expert maintains that only 75 per cent of the international price decline has so far been passed on to domestic consumers. In Pakistan, the government in order to avoid too much revenue loss, relies heavily particularly on sales tax on petroleum products, Therefore the government has not really passed on the reduction in the international oil price in its totality.

It is pertinent to record that sales tax collected on petroleum products is a major component of total sales tax collected in any given year. Sales tax is concentrated in a few commodities and that petroleum products and natural gas alone contribute around 44 per cent to total sales tax collected in 2013-14.

During last financial year, total sales tax collected from petroleum products was 231 billion rupees while it generated 180.6 billion rupees during the last year of the past government’s tenure. The higher collection last year relative to 2012-13 is attributable to a higher international price of oil that was passed on to the consumers.

Revenue under the petroleum levy budgeted at Rs123 billion for the present year is not likely to be affected with a price decline of oil products in the international market as it is a flat rate and therefore not dependent on the changing price of petroleum products.

There is a worry that while lower oil price in the domestic market would reduce the rate of inflation on the one hand through a reduction in fares and farm to market costs of perishables, yet it would raise inflation on the other hand by raising the budget deficit — an inflationary policy.

There is some sort of consolation in Pakistan that a reduction in the price of petrol only effects undoubtedly on those who own their own transport. But the downtrodden people who are forced to take public transport do not benefit from reduced oil prices.

The question somewhat arises whether the government should move on to pass on the oil price decline in its totality knowing well that it does not have all the abilities to ensure hand on finally to the consumers? It seems that the government is well satisfied that its sales tax collections are not threatened and the budget deficit is contained.

For example in Pakistan drastic cut in the furnace oil prices has pushed particularly the textile industry to lay aside the renewable as well as the alternative energy alternative on hold and to return to confined power plants for electricity generation.

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