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Sunday / March 26.

Why Crude Oil Prices Have Been Plummeting and What it Means for the Indian Economy

By Shreya Gandhi

Edited by Nandini Bhatia, Senior Editor, The Indian Economist

The price of crude oil which has recently seen a fall of over 40%, has been declining to historical new lows, with Brent crude falling below $60 a barrel for the first time since May 2009.  Many have been touting this declining trend as an excellent sign for the balance of payments of the Indian economy as crude oil is one of our major imports. The questions, however, that arise are why is this decline happening and what would be the overall impact on the Indian economy.

Until very recently, the Organization of Petroleum Exporting Countries (OPEC) was the main cartel of oil producing countries such as Russia, Venezuela and Saudi Arabia among others, which determined the world market price in a singular manner. This was primarily for two reasons, firstly that there was no alternative fuel as widely accepted and with as big a market share as crude oil and secondly, Saudi Arabia, which produces nearly 10 million barrels a day and controls about one third of OPEC production, curbed its supply whenever the cartel unanimously decided on a spike in prices.

However the OPEC monopoly is almost disappearing, as the Saudis and the Gulf countries have decided to not cut back their own market share for their allies. At a meeting in Vienna on November 27th, the OPEC failed to reach a consensus on curbing supply which caused a major setback to oil exporting economies such as Russia and Iran. Being an OPEC giant, sources say that with its existing reserves, Saudi Arabia could in fact curb production without any risk to its own economy, however it wishes not to do so due to the strained political relations between the Saudis and the aforementioned countries, who would be the main beneficiaries of this action.

Besides the differences between the OPEC members, the fall in the price of crude oil is being understood by many as a either a a measure of barrier of entry to or a direct consequence of an unconventional new oil known as shale oil, produced and exported mainly by the US. Despite being fairly new, shale oil is rapidly gaining much of the oil market share due to its low prices. Philip Verleger, an energy economist, commented that shale is to OPEC what the Apple II was to the IBM mainframe. Some experts are of the opinion that the decision to refrain from curbing supply was to drive the price of crude oil to such a low that it would be below the operating cost of shale oil and hence shale producers will not trade at that price in the world market. This would then be a barrier of entry to shale oil becoming a major threat to crude and replacing it as the most widely available and economically sensible oil to use. Others are of the opinion that any action or inaction of the OPEC would not matter in this case due to the sheer magnitude of shale oil production. Individually, shale oil producers are “price takers” in the market and can drive up supply without impacting the prices. Hence collectively, they are moving towards increased market share which will soon be at par with the OPEC, at comparatively lower prices.

The impact of a fall in the price of crude oil has contradictory effects on the Indian market. The obvious effect as mentioned earlier, is a reduction in import costs. However the balance of payments consists of both imports and exports. The fall in oil prices will lead to a slowdown in oil exporting countries and possibly a decline in global demand which will be detrimental to Indian exports. Adding to that, market sentiment will also be affected due the uncertainty created by the price fall, which will retard growth of global stock markets.

The panning out of the entire effects of OPEC dynamics and shale oil introduction however can only be seen with time however India must be prepared with plans for any counterproductive effects.

Shreya Gandhi is a second year student of Economics at the Lady Shri Ram College for Women. She is an advocate of gender equality and loves dogs. She is extremely interested in current events, specially in the political, economic and financial spheres and hopes to make a career in the finance in the future.