Why oil prices are going down and how it affects the Indian economy

As Saudi Arabia initiated a price war against Russia, the crude oil price fell by 30%, registering its single-largest fall since 1990 Gulf War.

Representational image | Ali Mohammadi | Bloomberg

New Delhi: As Saudi Arabia initiated a price war against Russia, the crude oil price fell by 30 per cent, registering its single-largest fall since the 1990 Gulf War. 

Brent Crude — a key international benchmark price index for oil — continued to trade around the $30 mark Monday. 

In an effort to regain its position in the oil market, Riyadh has decided to raise its production and cut prices at the same time. 

The aggressive tactic has left stock markets across the world in a spin — where investors’ worries are now being compounded by the twin shocks of oil prices and the coronavirus outbreak. 

ThePrint looks at the picture behind the rapid fall in oil prices and its effects on the Indian economy. 

What is a price war?

A price war is an economic tactic used by large players to regain lost market share. 

The idea is to cut prices, which forces the firms’ competitors to do the same. Eventually, the smaller and marginal firms struggle to survive at such low prices — thus forcing them to quit the market. In turn, the vacated market share is regained by the large firm. 

Why has Saudi Arabia started an oil price war? 

The US shale oil and gas industry picked up steam a decade ago, and has led to rapid growth in the country’s oil production. In this light, Saudi and other oil-producing Gulf states have seen their market share gradually decline. 

Saudi Arabia decided to initiate a price war after it failed to convince its OPEC (Organisation of the Petroleum-Exporting Countries, world’s largest oil-producing cartel) allies and Russia to make a substantial cut to oil production and support prices in the face of the spread of coronavirus, which has adversely affected the global economy and oil demand. 

Saudi and Russia have worked together since 2016 in an effort to prop up oil prices. 

When Russia refused to accept Saudi’s one-time offer to initiate deep production cuts, Riyadh decided to initiate a price war — especially as a retaliatory measure against its OPEC partners and Russia. 

“Saudi Arabia, OPEC’s de facto leader, is now seen as trying to take on and even punish Russia in a fight for market share, including targeting customers in Russia’s traditional backyard in Europe,” noted a report in The Financial Times. 

“A price war will also squeeze other high-cost producers, including hitting the US shale sector, the growth of which over the past decade first brought Moscow and Riyadh together,” it added. 

Unique situation 

This is not the first occasion when Saudi Arabia has tried to initiate a price war in order to regain its lost market share. It tried to do the same in 2014.

However, analysts say the link to the coronavirus outbreak makes the current situation unique. 

The rapid spread of coronavirus has severely affected the global economy. In the face of an economic slowdown, global oil demand has remained very weak over the past few weeks. 

“It is very rare for a demand collapse to coincide with a supply surge. It is the most crude price-bearish combination since the early 1930s (post Great Depression). The price collapse has just begun,” Bob McNally of the US-based Rapidan Energy Group, an energy market, policy and geopolitical consulting firm, told The Financial Times.  

How low oil prices may impact Indian economy

Since India imports nearly 82 per cent of its oil, a fall in prices could give its flailing economy some breathing space. 

In 2018-19, India spent $87 billion on oil imports. 

If the crude oil prices continue to remain low, India could see its overall import bill come down. For each drop of a dollar in crude prices, India’s import bill comes down by almost Rs 3,000 crore. Some analysis suggests that if prices remain around the $30/barrel mark, India could see its oil import bill halve.

Historically, the condition of the Indian economy has been greatly influenced by oil prices. In the past, a rapid rise in oil prices has precipitated economic crisis. 

For instance, the 1991 balance-of-payments crisis, which eventually propelled the government to initiate large-scale economic liberalisation, had its roots in India’s growing oil import bill starting the mid-1980s. 

By 1991, owing to the Gulf War, oil prices went up from $17 to nearly $37, increasing the Indian current account deficit. This, along with falling exports, was a key factor that led to the 1991 balance-of-payments crisis. 

Low oil prices at this stage will help India control its current account deficit and make the rupee stronger.