6 Fluctuation in Crude Oil Price, 2021

Fluctuation in Crude Oil Price, 2021

By: Anyatama Basak

(Xavier Business School, St. Xavier’s University Kolkata)

Crude oil prices all over the world are influenced by a number of factors, such as

 Decisions of the oil-producer like Organization of Petroleum Exporting Countries (OPEC – a consortium of 13 countries namely Algeria, Angola, Congo, Nigeria, Equatorial

Guinea, Gabon, Iran, Iraq, Libya, Kuwait, Saudi Arabia, the United Arab Emirates and

Venezuela).  Independent producer countries like Russia, private oil-producing firms like ExxonMobil and others.  Political instability in the Middle East as the region accounts for the lion’s share of the worldwide oil supply.  Cost of production and difference in oil storage across regions.  Increase in interest rate followed by raise in manufacturing cost and resulting in less money in hand and less time spent for driving.  Demand and supply of oil from non-OPEC countries, balance between OECD inventories and future spread, spot prices, operations in financial markets.

Surprisingly, unlike other natural disasters which increase the price of oil by generating a supply shock, COVID-19 pandemic has created a demand shock by several lockdown and cancellation of both domestic and international flights in different nations throughout the world during different phases of lockdown.

Pre-pandemic era:

It is a common thought that fluctuation of crude oil price directly impact on the financial sector of the economies. The stock market, interest rate, cost of production, cost of transportation etc. are affected by this. Less exploration activity can cause less availability of oil since most of the new sources are unconventional and leads to a higher cost per barrel than a conventional source of oil reserves. Lower level of oil price can affect the production process in different ways such as increase in transportation cost, rise in prices of consumer goods followed by effect on company’s stock prices. The present supply, the future supply and the expected demand of oil are the three important factors that influence the oil price.

Graph 1: Calculations by West Texas Intermediate (US$ per barrel)

Effect on Indian economy:

Despite the challenges of 2020, crude oil remains one of the most important commodities for Indian import sector and it creates impact on Indian stock market in various ways. Being one of the largest importers of crude oil, India fulfills more than three-fourths of its requirement through importing oil. Hence, a decline in the price will have a positive effect on current account deficit (CAD) situation of the country. Lower CAD refers to reduced need of foreign currency outflows which in turn, can lead to appreciation of rupee. The imports will be cheaper if the value of rupee appreciates. The companies, who depend on import of crude oil and other raw materials, will be affected by this, in their business. Thus the price of stocks of those companies will experience a rise.

Companies dealing with tires, lubricants, logistics, footwear hugely depend on crude oil prices along with refinery and airlines industries. Commodities like paints will also benefit from reduced oil prices since most of the paints used today are oil-based. A decline in price affects the cost of input for production of these goods. Therefore, a reduction in oil price has a positive result on the stocks of such companies.

Graph 2: Monthly average of India’s Crude Oil Basket (till February 2021, US$ per barrel)

Fluctuation in oil prices affects the cost of transportation of products. The prices have a remarkable impact on the prices of goods like consumer durables. These commodities are manufactured in industrial units and then sold in various cities across India. Decline in the logistics cost of such goods will lower their final price which will raise its demand followed by its stock price.

Every rise in oil price results in increase in Consumer Price Index (CPI). Crude oil has an impact on the prices of many agricultural commodities or manufactured products and services, change in oil price affect their Manufacturing Retail Price (MRP). A considerable decline in prices of goods and services will ease inflation. Inflation is often viewed to have a negative effect, by an investor. Hence, a comparatively lower inflation level will be beneficial for the stock market.

Present Scenario:

As evident from the experiences of past few months and the last year, almost every country in the world has faced different economic changes due to Covid-19 pandemic. A major issue has been the sudden fall in crude oil price which has affected other financial activities as well. The urgency of lockdown and its expansion in different phases for various nations have worsened the preexisting oil-price regime. The shutdown of many business units, the slow rate of operation of the biggest oil-importing industries, the cease on vehicles and airlines, both domestic and international, have resulted in continuous low level of oil-price as depicted in the following diagram. Both the supply and demand of oil have been affected. The step by step release of lockdown has helped to bring some positivity in the price.

Graph 3: Global oil supply and demand by month (Million barrels per day)

As given by the Short-Term Energy Outlook (STEO), the U.S. Energy Information Administration or EIA says that Brent crude oil spot prices has averaged at $68 per barrel during May, 2021 rising $4/b from April,’21 since global oil inventories have continued to decline, in comparatively slower pace than the first four months of the year.

Future Prospect:

Graph 4: Brent crude oil price forecast by EIA (US$ per barrel)

It is expected that in the upcoming months, the global oil production will increase to serve the increase in global oil consumption. This rise in production will put an end on persistent draw of global oil inventory which has taken place in last year and will lead to relatively balanced scenario in the next half of 2021 due to growth acceleration. EIA assumes to have Bent prices near $68/b. The resurgent global economy will drive this recovery followed by increase in GDP growth. OPEC is trying to keep market in balance and avoid surpluses as the economies recover, though nonOPEC supply will be less as like as the first few months of the year. It is also evident from the predictions by different sources.

Graph 5: Average crude oil price forecast by IMF (US$ per barrel)

Since both the Central and state governments have increased taxes on petrol and diesel, hence Indian consumers were unable to experience the gains of fall in international crude oil prices in 2020-21. The government has enjoyed the windfall gain in taxes and this situation will continue until the globalprice of petroleum comes down to a usual equilibrium level.

References

1. News articles by Hindustan Times 2. Reports by EIA 3. Report by Forbes 4. Reports by Energyworld.com 5. Analysis by Kotak Securities