Article on

Trends in crude oil prices and its impact on global economy and capital

Submitted to:
NITIE, Mumbai

Submitted by:
Anuj Agrawal (p17anuja@iimsambalpur.ac.in)
Zaid Bin Nafees (p17zaidn@iimsambalpur.ac.in)
Trends in crude oil prices and its impact on global economy and capital

Introduction

Crude oil also known as ‘Black gold’ is one of the most sought-after natural resources in the
world. Crude oil, a fossil fuel formed due to decomposition of organic matter under high heat
and pressure for centuries has a very high calorific value and is of prime importance to many
industries. Crude oil is refined by a process known as fractional distillation to get many products
such as petrol, diesel, kerosene, liquefied petroleum gas, wax, etc. The age of oil which started in
mid-nineteenth century propelled Industrial revolution to new highs. Many economies
predominantly the Arabian countries such as Saudi Arabia, UAE, and Iran thrive on their vast oil
reserves (Exhibit 1). The main reason for this importance to oil is the difference between supply
and demand of oil and only a handful of countries such as USA, Russia and Saudi Arabia control
majority share of oil reserve.

Trends in oil prices

. The price of oil generally refers to the spot price of a barrel of benchmark crude oil. A reference
price for buyers and sellers of crude oil is West Texas Intermediate (WTI), Brent ICE, Dubai
Crude, OPEC Reference Basket, Tapis Crude, Bonny Light, Urals oil, Isthmus and Western
Canadian Select (WCS). Higher oil price is beneficial for oil producing countries whereas oil
importing countries such as India has to bear the higher oil prices which usually lead to inflation
in the market. Oil prices have usually seen major fluctuations throughout the history (Exhibit 2).
As we can see that the price of crude oil went to as high as $147.27/barrel in July 2008 from less
than $20/barrel during the late 1990s due to higher demand from developing countries such as
India and China. This surge in demand was due to rapid growth due to industrialization and
higher demand for oil from automobiles in these countries. The price of oil plummeted to $31.28
in December 2008 because of global financial crisis. The price of oil again started to show
bullish trends after financial crisis until the mid of 2014 when it plummeted to as low as $30/
barrel due to a glut in the market because of excess supply of oil in the market. This excess
supply was a result of oil production by the USA to revive its economy and decrease in demand
for oil by emerging economies. Currently, the global price of crude oil is trading around
$65/barrel.

Global economy and oil prices fluctuations

Historically Oil reserve has been a major reason for a country’s growth. Countries such as Saudi
Arabia and UAE developed due to their vast oil reserve. During the early 2000s, the prices of
crude oil were rising, and investors started to invest in the oil market to gain short-term gain
which further led to a surge in pricing. Such speculative investing is called as arbitrage trading.
Since the short-term price elasticity of oil is limited, higher prices have a devastating effect on
importing countries.

The decline in oil price can even lead to the disintegration of the country as it happened with
the Soviet Union during 1985-90. Russia is a major producer and supplier of oil in the world, fall
in oil prices during the cold war led to halting in its industrial growth which in turn crippled the
economy (exhibit 3). Other effects of low oil prices are less violence because lower oil prices are
generally followed by lower food prices. This lead to low crime for survival especially in oil
importing countries.

There are two kinds of oil produced in the world: crude oil and shale oil. Shale oil is extracted
from rocks whereas crude oil is extracted by drilling into the earth or sea. The process of
extracting shale oil is higher than that of crude oil. The United States of America is the largest
producer of shale oil in the world, and as and when the price of oil reaches a breakeven price of
around $50 per barrel, it starts producing shale oil. Recently India imported 1.6 million barrels of
shale oil from the USA. India is fed up with OPEC (Oil producing and exporting countries)
countries due to a premium charged by them decided to import Shale oil from the USA. This
import could lead to better economic relations with the USA. This move will benefit both US
and India driving their economies. Oil was imported from India in a very large Crude
Carrier(VLCC) and docked it at Paradip port in Odisha. This import will help in bringing down
the trade deficit of USD 24 billion.

Higher oil prices for an oil importing country can lead to a rise in inflation which increases the
yield rate of government bonds. This increase in Bond rates causes the bond price to fall and also
reduce the sentiment of investors to invest in that economy.
Oil price and its impact on capital financing

Some of the biggest companies run due to oil. The whole of oil refinery industry depends
primarily on oil. Automobile industry also has the bear the shock of fluctuating oil industry.
Lower Oil prices make oil companies reduce their supply so that the price could reach its
equilibrium price. In 2016, major Oil companies such as BP cut thousands of jobs as crude oil
plummeted to a low of $30 per barrel. This affected BP’s bottom line adversely. Another
instance of Brazil’s Petro bras cutting tens of billions of dollar spending due to lower oil prices
shows the impact of oil price on company’s financing and job scenario. So unless we find a
substitute for Crude oil, it will tend to influence the global economy and our lives.
Exhibit 1 Countries with highest oil reserves (Source: Oil and gas journal, EIA,2016)

Exhibit 2 (historical price of WTI crude oil) (Source: www.macrotrends.net/1369/crude-oil-

price-history-chart)
REFERENCES

https://www.investopedia.com/terms/c/crude-oil.asp assessed on 15th March 2018

http://www.mhi.com/discover/earth/issue/history/history.html assessed on 15th March 2018

https://en.wikipedia.org/wiki/Price_of_oil assessed on 16th March 2018

http://www.macrotrends.net/1369/crude-oil-price-history-chart assessed on 17th March 2018

https://www.moneycontrol.com/news/business/economy/why-indias-import-of-us-shale-oil-is-a-
big-deal-2404081.html assessed on 23rd March 2018

“Effects of the Oil Price Upsurge on the World Economy” by Hiromi Kato(pages 1-

20)