Pros & cons of cheaper crude oil

Views differ on how much more crude oil prices will drop. But, there is no ambiguity that low rates are here to stay for some time.While some say a levelbelow $44 a barrel can drag the energy product to $35 and a further fall to $13.5. Others see prices plummeting to as low as $20 a barrel.

According to Raoul Pal of The Global Macro Investor newsletter, crude prices could crash to $20 due to a strong dollar and weak economy in Europe and China.

The commodity is currently down 51 per cent compared with the same period a year ago. Prices of Brent crude, which matters more for India, were quoted at $58.35 a barrel early on Thursday. Western Texas crude was ruling at $48.54 a barrel.

Prospects of recovery in crude oil prices look bleak since supplies in the US have increased to 80-year high of 448.8 million barrels. The US Energy Information Administration (EIA) says that a lot of the world’s oversupply is finding its way to storage in North America. Compared with the same period a year ago, inventories are up 20 per cent.

The situation is not conducive for producers since higher production and supply will result in pressure on prices continuing.

Not all producers will be able to run at these low costs. The average cost of producing shale oil in the US is $61 a barrel. While production costs are lower for some, they are in the high $80s for others.

US government data released on Tuesday showed that shale oil drillers have become vulnerable to lower prices. Drillers in the US have idled 653 rigs since the start of December.

The number of active machines seeking oil was 922 as of March 6, the lowest since April 2011, according to Baker Inc.

The problem of oversupply will continue since the Organisation of Petroleum Exporting Countries, which accounts for 40 per cent of the global production, and US shale oil producers are locked in a tussle to assert their supremacy.

Both fear that they may stand to lose market share by cutting production and thus push prices up.

For OPEC, Saudi Arabia has been the prime force in not agreeing to any production cut, which could boost prices psychologically.

The Gulf nation has also set aside $750 billion reserves to tackle any situation arising out of lower crude oil prices.

However, the situation is precarious elsewhere with economies of Venezuela, Russia, Equador and Nigeria being affected by the crude oil plunge.

There are fears that a prolonged bearish trend will lead to serious economic and social problems in West Asia, which depends solely on earnings from crude oil. Job cuts and recession too are likely.

For India, the fourth largest crude oil importer, cheaper crude oil will help lower its current account deficit since 71 per cent of the total domestic demand is met through imports. Also, crude oil accounts for 34 per cent of the country’s total imports.

According to Government data, crude oil imports during January were valued at $8.25 billion, 37 per cent lower than that in January 2014. Shipments into the country during April-January in the current fiscal were 7.87 per cent lower at $124.75 billion ($135.40 billion in the same period a year ago).

A windfall from cheaper crude oil will result in drop in production costs for various industries. But there are other drawbacks from lower crude oil prices. The global market is already feeling the pinch of the plunge as prices of most commodities have sunk.

Ethanol, heating oil, natural gas, coal, copper, steel, corn, cotton, rice, rubber, soyabean, sugar, rice and wheat have all dropped by over 20 per cent in the last one year. This means returns to farmers will be lower, thus curbing their purchasing power.

Will that have an effect on consumer goods, electronics and other such products? We will have to wait and see, though it is most likely.

On Thursday, the issue of lower rubber prices figured in the Rajya Sabha. The reality is that with crude oil prices ruling low, natural rubber will be on leash since the user industry has the option to switch over to cheaper synthetic rubber. Corn and vegetable oils will also be under pressure in view of lower prices. Ethanol production at current crude oil level is unviable, while demand for vegetable oils for bio-diesel will be subdued.

There are other dangers too such as exports being affected. India depends on West Asia and Russia a lot for its exports. When these economies suffer from lower crude oil prices, they will tend to import less or ensure that their foreign exchange outgo is curbed. In turn, Indian shipments abroad could be hit.