Crude is the unexpurgated story
of oil, from the circumstances of its birth millions of years ago to the
spectacle of its rise as the indispensable ingredient of modern life. In
addition to fuelling our SUVs and illuminating our cities, crude oil and its
by-products fertilize our produce; pave our roads, and make plastic possible. Newborn
babies slide from their mothers into petro-plastic-gloved hands, are swaddled
in petro-polyester blankets, and are hurried off to be warmed by oil-burning
heaters.” The modern world is drenched in oil.
Due to the same reason it has
been the most important component of modern international politics. Many
battles have been fought for its supremacy and control and many would follow.
Oil
played a role in the prelude to World War II. The debate in Japan over whether
to go to war with the United States centered on the longer-term availability of
oil for the Japanese military, which the United States was trying to cut off in
response to Japan’s invasion of China. Like Imperial Japan, Nazi Germany sought
to conquer oil lands rather than purchase petroleum on the open market.
Securing oil supplies became a top wartime goal of all countries involved in
the conflict—again, often to the neglect of other vital raw materials.
In
1945, President Roosevelt reached an agreement with King Abdul Aziz of Saudi
Arabia of lasting significance: the kingdom would give the United States access
to oil in exchange for military assistance. Shapers of postwar U.S. foreign
policy argued that the United States should import more foreign oil rather than
use domestic supplies that would be relied upon if war broke out again. The
Soviets’ delay in leaving Iran in 1946 added to cold-war tensions and gave a
sense of urgency to the military protection of foreign oil supplies.
Since the World War-II, crude oil
has become the integral part of countries politics. The countries being blessed
with it has become the centre of attraction since then. The oil importing
countries have used their influence to make them their allies at any cost. US,
being the largest importer of crude oil have gone on the extent of making them
their second home. The countries who are sitting on this liquid gold have
formed a group OPEC (Organization of the Petroleum Exporting Countries). Its member is:
Saudi Arabia, Iraq, Kuwait, Nigeria, Iran, Venezuela etc.
They controlled around 80% of
overall proven reserves in the world and hence the Oil prices have always
remains to their mercy for last 50 years. Crude Oil Price is used as a main
weapon by them to subvert the countries to their wimps and fancies.
In
October 1973, OPEC declared an oil embargo in response to the United States'
and Western Europe's support of Israel in the Yom Kippur War of 1973. The result was a rise in oil prices from $3
per barrel to $12. One of the most lasting effects of the 1973 oil embargo was
a global economic recession. Unemployment rose to the highest percentage on
record while inflation also spiked. Consumer interest in large gas guzzling
vehicles fell and production dropped. Although the embargo only lasted a year,
during that time oil prices had quadrupled and OPEC nations discovered that
their oil could be used as both a political and economic weapon against other
nations.
In 1979 and 1980, events in Iran and
Iraq led to another round of crude oil price increases. The Iranian revolution
resulted in the loss of 2.0-2.5 million barrels per day of oil production
between November 1978 and June 1979. At one point production almost
halted. In September 1980, Iran already weakened by the revolution was invaded
by Iraq. By November, the combined production of both countries was only
a million barrels per day. It was down 6.5 million barrels per day from a year
before. The loss of production from the combined effects of the Iranian
revolution and the Iraq-Iran War caused crude oil prices to more than
double. The nominal price went from $14 in 1978 to $35 per barrel in
1981. Similar scenario happened in 1991 when Iraq invaded Kuwait and US
intervened and that resulted in a 1st gulf war. This war was solely
fought for the purpose of supremacy over oil production. After the gulf war, The
United States economy was strong and the Asian Pacific region was booming. From
1991 to 1997, world oil consumption increased 6.2 million barrels per day.
Asian consumption accounted for all but 300,000 barrels per day of that gain
and contributed to a price recovery that extended into 1997. Declining Russian
production contributed to the price recovery. Between 1991 and 1996 Russian
production declined more than five million barrels per day. Apart from minor glitches
the oil prices remained steady afterwards in the region of 70-85$ but in early
2007 it again started to move upwards most on speculation and peaked in mid 2008
with a record high of 147$ on Nymax. Leman brother later found guilty of
trading in crude oil with public money for which they suffered heavily and
later filed for solvency. With the start of biggest US recession since the
great recession in early 1930’s the crude oil suddenly dropped from the highs
of 140$ to a low of 40$ in no times.
But it followed with a spectacular
recovery from levels of 40$ to 85$ in early 2009 which made us believe that the
real value of crude is in the range of 85-100$. Prices remain more or less in a range from 2010 to 2014.
But
in mid of 2014 suddenly oil prices started to show some weakness. Many analysts
initially thought it to be a temporary phenomenon and predicted it to be over
sooner or later. But as soon as oil prices dropped below 85$ globally many
people started to believe that it is just a tip of ice berg and price may fall
below 40$. The main reason for the above it the expanding exploration activity
in the shale reason of US. The production of Shale reason touched an all time
high and it has caused a great oil surplus in the market. Suddenly OPEC was
under a tremendous pressure to reduce its production to realize better prices
for their inventories. Many power hungry countries(including India) looked
towards the recent development with the greedy eyes and soon got their wishes
fulfilled when OPEC decided to keep its production unchanged which led to a
huge fall in crude oil prices and they crash landed to a multi-year low of 65$.
OPEC
in past have altered their production to keep the price steady but this time
they have realised that if they decrease the production they would simply lose
the market share to the US shale production and this in turn would challenge
their supremacy in the market. In spite huge pressure from the poor OPEC
countries they decided to wipe out entire shale production in a single go by
bringing the crude price below their production cost. This led to a price war
between US and OPEC and brought down crude to a level of 55$ in no time. Incidentally
55$ was supposed to be the production cost of the shale region. But soon it was
realised that the actual production cost of shale region is in the range of
35-45$ which started the second leg of drop with prices dropping below 45$
levels in jan-2015.
Many
countries like Russia, Venezuela and Nigeria is paying a heavy price for this
sudden and huge drop in crude oil. According to one estimate Russia is losing
approximately 2$ Billion for every one dollar drop in oil prices. Russian currency
(rouble) has recently seen a blood bath when it has depreciated by 17% on a
single day causing a wide spread panic in Russia. Imagine everything in the supermarket
suddenly costing 33% extra (twice the depreciation of rouble) people will
panic. It remind us with the great Zimbabwean currency crisis when Zimbabwe
dollar suddenly started losing its value and in no time it become junk. On a
similar line rouble has lost have its value since 2014 and S&P has reduced
its rating to ‘BB+’ which comes in the category of junk this means Russia will
face a huge problem in raising money from the international market.
Similarly
countries like Venezuela and Nigeria is facing a lot of problems, the government
has started defaulting on payments many welfare schemes have been shut-down. There
is a lot of unrest in the local public due to expenditure cut in the government
spending. People have resort to violence at many places and there is a risk of
riots in the countries. Saudi Arabia has posted a fiscal deficit for the first
time in their history, but they are sitting on the mountain of cash surplus so
they will not face any problem in the near future.
On
the other side countries like India and China are in the celebration mood as
crude oil constitutes more than 50% of their import bills. India has for the
first time in her history has seen a 10 straight oil price cuts. The petrol
which has seen a high of 82 Rs. has suddenly dropped to 56 Rs. has brought
smiles on made faces. Everything seems to be going in a right path but there is
trap, in India, we are not accustomed of seeing deflation because baring 2-3
years since independence we have seen that the prices of normal household
products have increased by some amount from the previous year’s sometime they
have increased out of propositions causing the wide unrest in the public.
But consider a scenario
in which country has slipped into. In the IS/LM model (INVESTMENT and Saving equilibrium/ Liquidity
Preference and Money Supply equilibrium model), deflation is caused by a shift
in the supply and demand curve for goods and services, particularly a fall in
the aggregate level of demand. That is, there is
a fall in how much the whole economy is willing to buy and the going price for
goods. Because the price of goods is falling, consumers have an incentive to
delay purchases and consumption until prices fall further, which in turn
reduces overall economic activity. Since this idles the productive capacity, investments also
falls, leading to further reductions in aggregate demand. In a deflationary economy, wages as well as prices often
have to fall – and it’s a fact of life that it’s very hard to cut nominal wages
— there’s downward
nominal wage rigidity. What this means is that in
general economies don’t manage to have falling wages unless they also have mass
unemployment, so that workers are desperate enough to accept those wage
declines.
Hence
too much reduction in oil prices is also not good for India as it will take
away the main advantage of cheap labor from our market and would force many
countries to shift their manufacturing hub from India to their parent
countries. The best case scenario for India is that if crude remain in the range
of 60-65$ for next 4-5 years it will help in managing our fiscal deficits and
boast our production by further minimizing our overall cost.
