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Saudi Arabia and Russia plan to suspend oil output to counterfeit the dramatic price fall

Top global producers Saudi Arabia and Russia agreed to freeze oil output in a bid to shore up prices after a 70% drop due to chronic oversupply.

Saudi Oil Minister however said that, the move is conditional on other major producers joining in and it is designed to stabilize the market following the dramatic price fall since mid-2014.

Reasons for slump in oil prices?

The oil prices was around $120 per barrel in May 2014, currently it has fallen below $30 per barrel. This slump has been caused due to number of factors.

Supply side factors

• Due to shale gas revolution US domestic production has increased significantly in last 2 years, Due to this there is over supply of oil in the market which has decreased oil prices drastically.

• Canadian and Iraqi oil production and exports are rising year after year. Even the Russians, with all their economic problems, manage to keep pumping. Oil production in Libya also reached the pre-crisis level.

• Even though the prices were falling unlike earlier period (OPEC) Organisation of the Petroleum Exporting Countries did not decrease the production to due to geo-political reasons. Those geo-political reasons we will explain later in the article.

• The war in Syria and Iraq has also seen ISIS, or Islamic State, capturing oil wells. It is estimated it is making about $ 3 m. a day through black market sales - and undercutting market prices by selling at a significant discount - around $ 30-60 a barrel.

Demand side factors

• On the demand side, the economies of Europe and developing countries are growing at laggard pace and vehicles are becoming more energy-efficient. So demand for fuel is lagging a bit.

• The slowdown in China which is currently the second largest economy in the world is also impacting oil prices. Since China is one of the largest oil importer and slowdown in economy has led to fall in demand for oil which has impacted price.

Geopolitical factors

• Saudi Arabia, the world's largest oil exporter and OPEC's most influential member, could support global oil prices by cutting back its own production, but there is little sign it wants to do this. This is due to number of reasons

• To destroy the Nascent Shale gas Industry of USA, since Saudi Arabia with its huge foreign reserve and large market share could sustain itself for sometime even if oil prices is as low as $ 25 but for shale gas producers in USA it would be difficult to produce if the oil price stays so low for long .

• The Saudis and their Gulf allies have decided not to sacrifice their own market share to restore the price. They could curb production sharply, but the main benefits would go to countries they detest such as Iran and Russia. Saudi Arabia can tolerate lower oil prices quite easily. It has $ 900 billion in reserves. Its own oil costs very little (around $ 5-6 per barrel) to get out of the ground.

Implications of This deal for India

If this deal comes into practice it would mean that oil production in Saudi Arabia and Russia would decrease and since they both are one of the largest producer of oil, it would definitely lead to scarcity of oil in the market, which would push the prices.

India is one of the biggest importers of crude oil; however it is also one of the major exporter of refined oil. Thus rise in oil prices due to this deal could have both positive and negative effects on India. 

(a) Negative effects

• It could increase India's trade deficit as it could increase our oil bill. Which could worsen India's Current account deficit.

• Secondly it could increase inflation in India; since oil is one of the most widely used input in all the major industries and increase in oil prices would increase in cost of production in Industries which would ultimately effect supply side of inflation. Also oil is also used in Agriculture especially to run tube wells, tractors and also to run vehicles to transport agriculture goods from farm to market. Thus increase in oil prices would also effect Agriculture inflation.

• Thirdly it could worsen India's Fiscal deficit since slump in oil prices has significantly reduced subsidy burden on India and also low oil prices has allowed Government to increase excise tax on oil goods both of which has helped to reduce India's fiscal deficit 

(b) Positive effects

• Since refined oil exports account for large portion of India's exports, rise in oil prices would increase India's exports which have continuously fallen for last 17 months. It could also boost new investment in the field of oil exploration.

• Due to slump in oil prices many OPEC countries are facing stagnant growth from last few years. Since these countries have large amount of foreign reserves they are a big FII and FDI investors in India. Due to slow growth in these countries investment from these countries to India has slowed down. These countries are also big market for Indian goods, slowdown has also effected there imports from India which has adversely effected Indian industries. All this could change if oil prices would increase since it would revive these ailing economies which could increase investment flow to India and could also boost demand for Indian goods in these countries.

 

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