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IMPACT OF CRUDE OIL PRICES ON GLOBAL ECONOMY

Rathesh J.13 Nagarjuna K. M.14 Adarsha Shetty U.15

ABSTRACT

Crude oil is one of the most necessitated worldwide-required commodities. The price of crude oil has traditionally been

determined by great market forces demand and supply fundamentals. However, there are new emerging drivers of oil prices.

The oil market has become complex, with a variety of factors having an impact on oil prices. Huge use of petroleum products

will have large impact international market shoots up. Oil price fluctuations reached unprecedented level in 2008, when world

crude oil price swung wildly, from $147 per barrel in July to $30 per barrel in last December. Any slight fluctuations in crude

oil prices can have both direct and indirect influence on the economy. In this paper compared the effect of crude oil price on

economy and this article focuses on the relationship between oil prices and other sector. The crude oil prices also have an

impact on the gold prices.

KEYWORDS

Organization of Petroleum Exporting Countries (OPEC), Gross Domestic Product GDP, Million Barrels per day

(MBPD), Economist Intelligence Unit (EIU), Liquid Natural Gas (LNG) etc.

INTRODUCTION

Oil was initially traded for its fundamental purposes, but over time gained a permanent place in the investment portfolio. Oil and

its derivatives are specific with high liquidity, volatility and relatively high profit opportunities for investors. Price formation is an

important factor influencing the oil market. Determining the price of this commodity is derived from the market mechanism (the

relationship of the global and regional supply and demand).

The oil market is differentiated from other commodity market by certain specifics. Oil market shows considerable deviation from

the perfect market, where the price range is just above marginal costs. There are many reasons, but mainly it is caused by an

attempt of the dominant producers to control the sale prices. Quoting price of oil affects the pricing of all major oil producers and

they regulate the supply of oil in order to achieve price targets. This market is also largely determined by political factors and

internal situations in major producing and consuming countries, as well as international conflicts and tensions.

Historical development of the oil market formed a few main production and consumption centers, with their own quoting price.

These are mainly spot markets in different parts of the world arranged according to mining areas (North Sea crude oil market,

Russian oil market, etc.) and commodity exchange centres (IPE, NYMEX, etc.). Prices in these markets have a very high

correlation and reaction to each other. Price differences are due to different quality and amount of transport costs. Given the

possibility of arbitrage, there are not significant differences between long-term sustainable prices. Price development in the years

1970 to 2010 can be seen in following figure.

Figure-1: Oil Prices in 1970-2010

Sources: Authors Compilation

13Research Scholar, Alva‘s P.G. Department of Commerce, Karnataka, India, rathesh.bj@gmail.com 14Research Scholar, Alva‘s P.G. Department of Commerce, Karnataka, India, shetty.adarshu91@gmail.com 15Research Scholar, Alva‘s P.G. Department of Commerce, Karnataka, India, kvmsamrat@gmail.com

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The oil price is partly determined by actual supply and demand, and partly by expectation. Demand for energy is closely related to

economic activity. It also spikes in the winter in the northern hemisphere, and during summers in countries, which use air

conditioning. Supply can be affected by weather (which prevents tankers loading) and by geopolitical upsets. If producers think

the price is staying high, they invest, which after a lag boosts supply. Similarly, low prices lead to an investment drought. OPEC‘s

decisions shape expectations: if it curbs supply sharply, it can send prices spiking. Saudi Arabia produces nearly 10m barrels a

day - a third of the OPEC total.

Four things are now affecting the picture. Demand is low because of weak economic activity, increased efficiency, and a growing

switch away from oil to other fuels. Second, turmoil in Iraq and Libya—two big oil producers with nearly 4m barrels a day

combined has not affected their output. The market is more sanguine about geopolitical risk. Thirdly, America has become the

world‘s largest oil producer. Though it does not export crude oil, it now imports much less, creating a lot of spare supply. Finally,

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.

OBJECTIVES OF STUDY

To analyze the impact of oil prices on the economy.

To identify the top oil trading companies around the globe.

To know the depth reason for the fluctuations in the oil prices.

To analyze the effect of oil prices on Indian company.

REVIEW OF LITERATURE

Some existing studies look into co-movement, co-integration and lead lag relationship between crude oil and gold, but almost

every study does it different way. Some of the researchers choose to investigate potential long run relationship between spot price

and some financial instruments with the same underlying asset – gold or crude oil. Other researchers look for relationship between

this commodities and macroeconomic factors. Most of analysis use traditional time series models, but few studies that are more

recent use new methods of examining asymmetrical processes.

Relationship examined through the common factor is less common. Most of these studies explained link between gold and oil

prices through the inflation channel. There are several studies (Hunt, 2006; Hooker, 2002) that have established this link

empirically. When oil prices rise, almost every price rises (Furlong et al., 1996). It follows that when inflation rises, the price of

gold (as a good) goes up as well. Different channel was researched by Melvin and Sultan (1990). Their main thesis is the impact

on gold prices through the export revenue channel. Gold is basic part of the international reserve portfolio of most countries,

including the oil producing countries. When oil price rises, oil exporter‘s revenues from oil rise and this may have implications for

the gold price level, if gold consists of a significant share of the asset portfolio of oil exporters and oil exporters purchase gold in

proportion to their property. In that case, an oil price rise leads to a rise in gold price.

In this paper are partly replicated the previous researches, but with newer data including recession years and except inflation,

other common determinants are examined.

THE WORLD'S 10 MOST INDEBTED OIL COMPANIES

The recent sharp decline in oil prices along with the industry‘s high cost of operations have pushed previously flush oil companies

deeply into debt. Declining oil prices caused by weak global demand, additional supply through new frocking technology, and the

decision by major suppliers such as OPEC, Mexico, and Russia not to cut their oil production have resulted in oversupply and

inventory pile-up. Despite the cut in profits, oil companies must continue to spend significant amounts on exploration, production,

drilling, refining, labor, machinery, and transport. New oil drilling locations are often remote and inaccessible, which further

increases costs. Companies with the most debt may have trouble weathering current conditions. Here are the 10 global public and

private oil companies carrying the most debt. (Related: World's Top 10 Oil Companies):

1. Petrobras (PBR). Petroleo Brasilerio SA is a Brazil-based state-run integrated oil and gas company with global

operations. Owing to the high debt of $120.6 billion reported as of September 2014, it takes the top slot in this list. Due

to the high debt, the company faces threats of default from investors on capital amount ranging to the tune of $54

billion.

2. Petroleos Mexicanos (Pemex). The state-owned oil and gas company of Mexico is reported to have hit a record total

debt of $74 billion as reported by Bloomberg. The company plans to sell bonds worth $15 billion in 2015 (offering $8

billion domestically and the remaining $7 billion internationally). According to Pemex, the funds from the planned bond

sale are ―aimed at financing investments to stem output decline.‖

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3. Gazprom (OGZPY). Based in Moscow and founded in 1993, Gazprom is next in the list of oil companies with the

highest debt. It has $65.09 billion reported debt as of September 2014. The company is engaged in geological

exploration, production, storage, transportation, and sale of oil, gas, and related components at a global level. Gazprom

is the largest gas supplier to Europe with a 30 percent market share. It was in the news recently owing to the price and

debt disputes due to Ukrainian crisis and potential impacts of European Union and U.S. sanctions on Russia.

4. Total SA. Founded in 1924, the France-based Total SA operates in three segments of upstream, refining and chemicals,

and marketing and services through its multiple subsidies worldwide. It is reported to have a total debt of $55.1 billion

as of September 2014. It is listed on Euronext Paris, with other subsidiaries and associated instruments listed on

multiple exchanges across the globe.

5. British Petroleum (BP). Founded in 1889, the London-headquartered integrated oil and gas company operates in

almost all segments with global presence. It is reported to have a debt of $52.85 billion as of December 2014, making it

the fifth entrant in the list of most indebted oil companies of the world.

6. Royal Dutch Shell (RDS-A). Based in The Netherlands, Royal Dutch Shell is an independent and integrated oil and gas

company with operations worldwide. Its various subsidiaries are listed on multiple exchanges across the globe including

London, Euronext Amsterdam, and the New York Stock Exchange. As of December 2014, its total debt stood at $45.54

billion

7. Eni (E). Italy-based ENI SPA is an integrated oil and gas company involved in exploration, field development, and

production activities, as well as supply, trading and transportation, refining, and marketing. Its natural gas operations are

spread in 42 different countries. It was founded in Rome in 1953 and is reported to have a total debt of $30.28 billion as

of September 2014.

8. Chevron (CVX). This U.S.-based integrated oil and gas company has a debt of $25.71 billion. Founded in 1879, it is

listed on the New York Stock Exchange with headquarters in San Ramon, Calif. The company is involved in petroleum,

energy, chemicals, mining, and power generation operations globally through its subsidiaries.

9. Exxon Mobil Corporation (XOM). NYSE-listed Exxon was founded in 1870 and is headquartered in Irving, Tex. It is

one of the largest global oil and gas companies when ranked by revenue. It is reported to have a total debt of $21.83

billion as of December 31, 2014.

10. ConocoPhillips (COP). Founded in 1917, Texas-based ConocoPhillips is listed on the New York Stock Exchange. It

had debt of $21.2 billion as of December 2014.

Going into debt can be healthy for certain businesses. For example, debt can allow a company to accumulate capital for startup,

operations, and growth. However, debt can quickly turn deadly if the business faces falling prices, excess inventory from

oversupply, and decline in demand as is occurring in the oil industry. Oil and gas businesses require a large amount of working

capital. A balanced mixed of debt and equity, a possibility of restructuring, and a cautious approach can help circumvent some

debt problems in global oil companies.

WHY OIL HAS FALLEN DRAMATICALLY AND WHY IT COULD DROP TO $62

Oil markets seem to have defied logic in the second half of 2014. From late-June to mid-September, crude oil prices surged 28.9%

despite an oversupplied market and cooling demand as the global economy slowed, supposedly on fears over a possible conflict

between Israel and Iran. Exactly as the Fed unleashed, WTI peaked, and has since tumbled more than 12%, dropping 4.2% on

despite the pledge of unlimited liquidity from Bernanke, the ECB, and other major global central banks.

Two factors could be driving the return to what appear to be fundamentals in oil markets: Israeli‘s Prime Minister Benjamin

Netanyahu‘s less aggressive rhetoric toward Iran, and the pricing-in of easing expectations. Crude oil may be but one more

indicator that the effects of quantitative easing are preemptive, expressing themselves in prices all the way to the announcement,

but not necessarily as the policy is being executed.

―Oil prices performed strongly in the anticipation global easing and are maybe now slipping as the news was already priced in,‖

explained Caroline Bain, lead commodities analyst at the Economist Intelligence Unit (EIU). This hypothesis appears plausible, as

it is an effect that can be observed in the price movements of several risk-assets: a three-month chart of the gold, the Dow, and the

euro-dollar exchange rates all show a big move up to mid-September, followed by plateaus.

Indeed, oil markets had been trading out of sync with the underlying supply and demand environment this year, as I explained in a

column titled What‘s Wrong With This Picture? Oil Up More Than 20% As World Stagnates. Bain puts it in perspective, she

notes, ―the demand and supply outlook for the oil market certainly suggests prices could or should ease,‖ adding that consumption

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in both the U.S. and Europe has been contracting have joined with bearish news out of China, ―the only source of global oil

consumption growth in the last year or so.‖

China‘s non-manufacturing PMI survey slipped to 53.7 in September, while the Department of Energy announced that crude

output was up 11,000 barrels per day to 6.52 million, the highest since December 1996. According to Anthony Lazzara, CEO of

Lido Isle Advisors, if supplies, which are on the rise, remain high, and crude can‘t break $93 to the upside, then it could fall the

way to $82 in the near-to-medium term.

Returning now to the geopolitical issue, traders may have taken their cue from Israeli Prime Minister Benjamin Netanyahu. At the

United Nations, and with the help of a cartoonish drawing of a bomb, Netanyahu indicated that ―Iran‘s capability to enrich

uranium must be stopped before next spring or early summer,‖ suggesting ―that by that time the country will be in a position to

make a short, perhaps undetectable, sprint to manufacture its first nuclear weapon,‖ according to The New York Times. (He did

this by drawing a red line on his bomb diagram).

Israel is receding rhetoric and a push toward sanctions, along with Netanyahu‘s suggestion that a possible strike may wait until

next year, could have pushed investors to lower their expectations for oil price jumps. However, risk, Bain explains, is ―decidedly

to the upside: However, and somewhat frustratingly, political risk premia will continue to exert pressure in the global oil market

so prices could be higher than fundamentals suggest. If the EU‘s proposed tightening of sanctions goes ahead (seemingly likely)

then it will make it even more difficult for Iran to export its oil so bringing the country‘s economy to its knees and raising the

likelihood of a major geopolitical event next year.

Major oil producers seem to have followed in crude‘s tracks. Exxon Mobil, Chevron, and BP, for example, have rallied in tandem

with oil prices but have not dropped since mid-September; rather, they have gone sideways. Oil field service names like

Halliburton and Schlumberger, on the other hand, seem to be more closely linked to crude, having followed a similar trajectory

even over the last few weeks.

It has been a weird second half of the year for oil. Traders pushed prices up on their perceptions of geopolitical risk and the

pricing in of easing expectations. With the Fed and Mario Draghi having delivered, and with an apparent move toward diplomacy

by Israel, prices have fallen dramatically. But the Fed hasn‘t even bought bonds aggressively yet, and the ECB hasn‘t even

received a bailout request from Spain, which on the face of it means the easing is yet to come, which should be bullish for prices.

Commodities are by nature volatile, and oil has proven it can play the game. The question now is, where does it go next?

REASONS OIL PRICES ARE DROPPING

As oil prices continue to fall, analysts and producers are trying to wrap their heads around the reasons and identify a floor price.

Even though crude benchmarks like Brent and WTI keep dropping, the cost of finding oil continues to rise. What are some of the

key drivers that have created this paradox?

The U.S. Oil Boom

America‘s oil boom is well documented. Shale oil production has grown by roughly 4 million barrels per day (mbpd) since 2008.

Imports from OPEC have been cut in half and for the first time in 30 years, the U.S. has stopped importing crude from Nigeria.

Libya is Back

Because of internal strife, analysts have until recently assumed that Libya‘s output would hover around 150,000-250,000 thousand

barrels per day. It turns out that Libya has sorted out their disruptions much quicker than anticipated, producing 810,000 barrels

per day in September. Libyan officials told the Wall Street Journal last week that they expect to produce a million barrels per day

by the end of the month and 1.2 million barrels a day by early next year.

OPEC Infighting

There have been numerous reports about the discord between OPEC members, leading many to believe that OPEC will not be

able to reign in production like the one it has done so in the past. The Saudis and Kuwaitis have reportedly been in an oil price

war, repeatedly lowering their prices in order to maintain their market share in Asia. John Kingston, the news director at Platts,

believes that the Saudis will not be willing to give up market share as they have done during previous price drops. A new type of

investment just recently became available to individual oil & gas investors. Because of the recent crash in oil and the timing of a

new law, it could be the most lucrative investment in modern history. I want to give you a systematic guide (at no cost) on how

you can get started and potentially retire from it.

Negative European Economic Outlook

European Central Bank president Mario Draghi has left investors concerned about the continent‘s slow growth. Germany‘s

exports were down 5.8 percent in August, stoking the fears of anxious investors that the EU‘s largest economy had double dipped

into recession last quarter. Across the Eurozone, the IMF again lowered its growth forecast to 0.8 percent in 2014 and 1.3 percent

in 2015.

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Tepid Asian Demand

Beyond slow economic growth and currency depreciation, a number of Asian countries have begun cutting energy subsidies,

resulting in higher fuel costs despite a drop in global oil prices. In 2012, Asia‘s top spenders on energy subsidies, as a percentage

of GDP included: Indonesia 3 percent; Thailand 2.6 percent; Vietnam 2.5 percent, Malaysia 2.3 percent, and India 2.3 percent.

India is a primary example. Between 2008-2012, India‘s diesel demand grew between 6 percent and 11 percent annually. In

January 2013, the country started cutting the subsidies of diesel. Since then, diesel consumption has plateaued.

Figure-2

Sources: http://www.euanmearns.com/wp-content/uploads/2015/01/opec12_Nov14.png

OPEC production plus spare capacity in grey. The chart conveys what OPEC could produce if all countries pumped flat out and

there are signs that OPEC production capacity is descending slowly which casts a different light on the current glut. OPEC

countries have skillfully raised and lowered production to compensate for Libya that has come and gone in recent years, and for

fluctuations in global supply and demand. However, with OPEC production broadly flat for the last three years, all production

growth to meet increased demand has come from elsewhere, namely N America. Total OPEC production was 30.32 Mbpd in

November down 320,000 bpd from October.

Total liquids = crude oil + condensate + natural gas liquids + refinery gains + biofuel. The chart reveals surprisingly little about

the current low price crisis with a barely perceptible blip above the trend line. Most areas of the world have either stable or slowly

falling production. The bogey in the pack is the USA that has seen production skyrocket by 4 Mbpd in 4 years.

IMPACT OF OIL PRICE CRASH ON DIFFERENT INDUSTRIES AND OVERALL ECONOMY

The steep fall in crude prices has caught the global economy by surprise, not to miss the existing & emerging potential oil

exporting nations. On one hand the downward trend is highly detrimental to the nations with major revenue chunk linked to oil

exports and those who have invested heavily on the alternate energy sources such as renewable, shale, etc., on the other hand the

major net oil importers such as the Asian nations led by India are looking overjoyed on account of anticipated national fiscal

savings on buying of cheaper crude oil and in fuel prices at consumer end.

On the surface, one may claim that falling crude oil prices are oil importing nation's moment of delight and oil exporting nation's

worst nightmare. However, is it really all good and great for a crude oil import dependent nation such as India? There is a need to

go beyond pre-conceived notions and understand that the reverse of the common phrase, "Every cloud has a silver lining" is also

true, especially for a country like India. For a nation like India, there is a need to identify the could under the silver lining.

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While it may be assumed that India will be able to reduce fiscal deficit, reduce inflation, lower interest rates and recover from oil

subsidy on account of lower oil import bill. However, the steep decline in crude oil price is expected to leave a bitter taste on the

government's tax revenues, translate into lower growth of both exports & imports and impact the GDP growth of the country. It is

worth to note that the government has increased the excise duty on petrol and diesel twice in a move to aid the tax revenues. For

E&P companies such as ONGC, the price drop is expected to impact negatively due to lower realization, although reduced

subsidy burden may have some healing effect.

THE ECONOMIC IMPACT OF FALLING OIL PRICES: 'EXPANSIONARY DISINFLATION'

Forget about the ―secular stagnation‖ theory of an ailing U.S. economy. Accordingly, to the Labor Department, payrolls grew at a

seasonally adjusted increase of 242,000 in December adding to the soaring U.S. job growth of 2014, which represents the

strongest annual job creation since 1999. The unemployment rate also fell to 5.6% in December, down from 7% a year earlier and

far below predictions made by economists at the beginning of 2014.

In addition, the past 2 quarters of GDP growth have been well above an annualized 4%. What complicates this rosy picture

however for the Federal Reserve and its dual mandate is that core CPI inflation has fallen to 1.3%, well below the Fed‘s 2% target

and will likely continue to fall given the recent significant decline in the price of crude oil, an input to several products included in

core inflation. The trend of economic expansion and falling inflation (―expansionary disinflation‖) may persist if oil prices

continue to fall bolstering what economists would call a ―positive supply shock.‖

ECONOMIC EXPANSION AND FALLING INFLATION: A RESULT OF A POSITIVE OIL SUPPLY SHOCK

While most declines in inflation coincide with economic stagnation, the U.S. is experiencing a rare event: falling inflation

(disinflation) and economic expansion. The current low inflation expansion (―expansionary disinflation‖) economy is the

complete opposite of the 1970‘s stagflation that was characterized by a surge in consumer prices, soaring oil prices and stagnating

economic activity. This causes a serious problem for economists who are accustomed to the idea that inflation and employment

move together, a concept crystallized in the Phillips Curve.

The recent decline in inflation may be a ―supply side‖ effect associated with the declining price of oil, in the same respect that the

surge in oil prices in the 1970‘s was responsible for soaring inflation. The recent decline in inflation may be a ―supply side‖ effect

associated with the declining price of oil, in the same respect that the surge in oil prices in the 1970‘s was responsible for soaring

inflation.

Falling oil prices are also an important part of the recent phenomenon of resurging economic growth in the U.S. Much like how

the increase in the price of oil in the 1970‘s was ―a negative supply shock‖ effectively creating unemployment and declining

output, this recent decline in the price of oil is behind a ―positive supply shock‖ in part responsible for the recent boost in

economic activity and decline in unemployment.

IMPACT OF FALLING OIL PRICES ON LNG

The recent surprise drop in crude oil prices is having big impacts on international LNG prices and may cause a slowdown in the

development of LNG export plants globally. LNG is liquefied natural gas, cooled to a temperature of -260° F, for the purpose of

compression and transportation. International shipments of LNG by container ship are generally price-indexed to crude oil,

meaning that falling oil prices have led to a comparable drop in LNG prices.

Demand for LNG in Asia has been soft due to mild weather this winter, contributing to the slide in prices. 75% of global LNG

demand is in Asia with the bulk of the cargoes going to Japan, followed by South Korea and then China, India and Taiwan.

In South Korea, 2014 imports were down nine per cent year-on-year. Slowing gas demand growth has also led to concerns that

China will struggle to absorb contracted LNG, volumes of which will double over the next three years.

Supply of LNG in the Pacific basin has grown substantially in recent years, leading to an oversupplied market.

Prices for LNG in Japan hit $10.069 per million Btu (MMBtu) on December 15, having fallen from around $16 at the start of

2014. As LNG contract prices are typically based on the average of the preceding six to nine months, it will be mid-2015 before

suppliers feel the full effects of lower oil prices on their cash flow.

When Brent crude sells for $100, oil-linked natural gas contracts typically translate to around $14 MMBtu, giving U.S. LNG a big

price advantage. This advantage disappears as crude prices fall, with crude at $60 LNG indexes to $8.40 per MMBtu. U.S. LNG

producers have been targeting prices of $11 or $12 per MMBtu to be profitable after absorbing the costs of buying the gas,

liquefying it, shipping it around the globe and degasifying it.

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Figure-3

Sources: http://breakingenergy.com/wp-content/uploads/sites/2/2015/01/dodge-oil-lng1.jpg

When crude oil prices dropped below $80 per barrel, LNG from the US became less competitive in Asia compared to plentiful gas

from Australia and Qatar. Falling oil prices have the effect of increasing competition from oil. Price action in Asia may lead to

more gas being diverted to Europe and South America, where U.S. gas may find a niche. Such a shift also could reshape European

gas markets by lowering prices and squeezing out some Russian pipeline gas.

Many countries have entered the LNG export trade in the last decade, contributing to a crowded market. Egypt began shipping

LNG in 2005, Equatorial Guinea and Norway in 2007, Russia and Yemen in 2009, Peru in 2010, Angola in 2013 and Papua New

Guinea in 2014. Australia has also greatly increased its export capacity and expects to overtake Qatar as the world export leader.

Major project proposals are also in the works in Russia, Canada and East Africa, all of which contribute to a well-supplied

international market.

Even though the U.S. has only ever had minimal LNG exports, US LNG suppliers have been seen as attractive to Asian buyers

due to the perception of the U.S. offering very secure supply, with firm contract commitments.

LNG suppliers will be hoping for a cold 2015, but the background of a low oil price environment will place pressure on LNG

prices in the near term. However, long-term growth prospects remain compelling due to demand expectations.

EFFECT OF DECLINING OIL PRICES ON OIL EXPORTING COUNTRIES

The price of oil is of critical importance to today's world economy, given that oil is the largest internationally traded good, both in

volume and value terms, creating what some analysts have called a hydrocarbon economy. In addition, the prices of energy-

intensive goods and services are linked to energy prices, of which oil makes up the single most important share. Finally, the price

of oil is linked to some extent to the price of other fuels. Therefore, abrupt changes in the pi-ice of oil have wide-ranging

ramifications for both oil-producing and oil-consuming countries. The sharp decline in world oil prices since late 1997 certainly

qualify as an abrupt and significant change.

OIL PRICE HISTORY AND ANALYSIS - POST WORLD WAR 11

Oil prices behave much as any other commodity with wide price swings ill times of shortage or oversupply. The domestic

industry's price has been regulated though the production or price controls throughout the twentieth century.

PRE EMBARGO PERIOD

Crude oil prices ranged between $2.50 and $3.00 from 1948 through the end of the 1960's. Throughout the post war period,

exporting countries found an increasing demand for their crude oil and a 40ul decline in the purchasing power of a barrel of crude.

In March 1971, the balance of power shifted. This happened as a result of the Texas Railroad Commission setting a proration at

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100%, for the first time. This meant that Texas producers were no longer limited for oil that they could produce. More

importantly, it meant that the power to control crude oil prices shifted from the US (Texas, Oklahoma, and Louisiana) to OPEC.

YOM KIPPUR WAR – ARAB OIL EMBARGO

In 1972, the price of crude oil was about $3.00 and by the end of 1974, the price of oil had quadrupled to $12.00. The Yom

Kippur War started with an attack on Israel by Syria and Egypt on October 5, 1973. The US and many western countries

supported Israel. Because of this support, Arab oil exporting nations imposed an embargo on the nations supporting Israel. Arab

nations curtailed production by 5 million barrels per day (MBPD). About I MBPD was made up by increased production by other

countries. The net loss of 4 MBPD extended through March 1974 and represented 7 percent of the free world production. Prices

increased 400% in six short months!

CRISES IN IRAN AND IRAQ

Events in Iran and Iraq led to another round of crude oil price increases from 1979-80. The Iranian revolution resulted in the loss

of 2.5 MBPD between 1978 and 1979. In 1980, Iraq's oil production fell 2.7 MBPD and Iran's production by 600,000 barrels per

day during the Iran-Iraq War. The combination of these two events resulted in crude prices more than doubling from $14 in 197 8

to $35 per day in 1981.

OIL PRICES - AN ECONOMIC ANALYSIS

Low oil prices since late 1997 have been caused by several main factors, including:

OPEC's December 1, 1997 agreement to raise the group's production quota by 10%.

A warmer-than-normal winter (1997/1998) in the northern hemisphere.

Increasing Iraqi oil exports.

Reduced oil demand due to the severe economic crisis in East Asia.

If low oil prices continue for a prolonged period, this could result in long-term reductions in OPEC oil export revenues, and would

force OPEC countries to make difficult economic, social, and political tradeoffs.

A sharp decline in oil prices benefits oil importing nations and hurts oil exporters. For importers, lower oil prices act similarly as a

tax cut, increasing consumer disposable income. This allows for looser monetary policy and hence lower interest rates with lower

inflation and stronger economic growth (as in the case of the US). Sharper oil prices, on the other hand, have been identified as a

major cause in seven out of eight post WW II recessions in the US.

Firstly, oil revenues earned by producers are to a large extent "recycled" back to consumers in imports of all types of goods and

services. In this way, oil-importing nations earn back much of the petrodollars they originally spend on oil purchases. A drop in

oil revenues for oil exporters, as in the present situation, leaves oil producers with fewer petrodollars to "recycle".

Another complicating factor is considering the impact of oil prices fluctuations on oil importing countries is that certain states

within a country may be affected very different from other states, while the effect of the overall economy may be positive or

negative. In the US for instance, Texas and Alaska are major oil exporting states and are therefore hurt on balance by lower oil

prices.

OPEC - FAILURE TO CONTROL OIL PRICES

OPEC (Organization of Petroleum Exporting Countries) was founded in 1960 with five founding members: Iran, Iraq, Kuwait,

Saudi Arabia, and Venezuela. By the end of 1971, six other nations had joined the group: Qatar, Indonesia, Libya, UAE, Algeria,

and Nigeria. These nations had experienced a decline in the real value of their product since foundation of the OPEC.

OPEC has seldom been effective as a cartel. The rapid price increases caused several reactions among consumers: better

insulation in new homes, increased insulation in older homes, and automobiles with higher mileage. These factors along with a

global recession caused a reduction on demand that led to falling crude pi-ices. Unfortunately, for OPEC, only the global

recession was temporary. Nobody rushed to remove the insulation from their homes or to replace the energy efficient plants and

equipment; much of the reaction to the oil price increase by the end of the decade was permanent and would not respond to lower

prices with increased demand for oil.

From 1982 to 1985, OPEC attempted to set production quotas low enough to stabilize prices. These attempts met with repeated

failure, as various members of OPEC would produce beyond their quotas. During most of this period, Saudi Arabia acted as the

swing producer cutting its production to stein the free falling prices. In August of 1985, the Saudi's linked their oil prices to the

spot market for crude. Crude oil prices plummeted below $1() per barrel by mid-year.

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The price of crude oil increased in 1990 with the uncertainty associated with the Iraqi invasion of Kuwait and the ensuing Gulf

War. However, following the war, pi-ices entered a steady decline until in 1994, inflation adjusted prices attained their lowest

level since 1973.

With a strong economy in the US and a booming economy in Asia, increased demand led a steady price recovery well into 1997.

This came to a rapid end when OPEC underestimated the impact of the financial crisis in Asia. In December, OPEC increased its

quotas by 10% to 27.5 MBPD but the rapid growth in Asian economies had come to a halt.

IMPACT ON OIL PRODUCERS

Algeria

Algeria is heavily reliant on oil and natural gas export revenues. In 1997, Algeria hydrocarbon exports revenues accounted for

97% of Algeria's total export revenues, and 58% of total fiscal revenues. A rule of thumb for Algeria is that every $1 per barrel

drops in the price of Algerian Saliaran Blend results in a $560 million annual revenue loss (around 4.3% of normal export levels,

2.6170 of the country‘s budget, and 0.8% of GDP). Declining oil revenues are a complicating factor for a country, which is

already experiencing severe economic and social tensions and has suffered an estimated 75,000 deaths resulting from a six-year

conflict with the Islamic Salvation Front and the Armed Islamic Group.

Indonesia

Indonesia's oil revenues were expected to fall 32clo, to $3.5 billion, in 1998, compared to $5.1 billion in 1997. This comes in

addition to the already dire economic conditions that Indonesia finds itself in as part of the Asian economic crisis. For 1998,

Indonesia‘s economy was expected to fall 13.5-20% in real terms. To cope with its economic crisis (which is being aggravated by

low prices), the country has taken a number of measures, including lowering its oil price projection for the country's 1998/99

budget from $17 per barrel to $13 per barrel currently.

Iran Oil exports account for about 36% of Iran's state revenues, and 80-85% of total export earnings. In March 1998, Iran's Central

Bank Governor, Dr. Mohsen Nourbaksh, estimated that Iran had $26.4 billion in foreign debt obligations, including $14.1 billion

in confirmed debt. Repayment of this debt will be made much more difficult due to the sharp decline in Iran's oil revenues. Iran

also will most likely experience a larger budget deficit, a depreciation of the Iranian riyal, and a shortage of foreign currency.

Other problems facing Iran's economy include inflation and unemployment. At current oil export levels, Iran loses about $1

billion per year in oil export revenues for every $1 drop in oil prices. A serious implication of the decline Iran‘s oil export

revenues has been lack of available cash for much-needed investment in the country's oil sector. As a result, Iran is looking

towards Western capital markets as a source of capital investment.

Iraq

Iraqi oil exports continue to be constrained by United Nations oil export sanctions, imposed following Iraq's invasion of Kuwait in

1990. But they continue to be increasing steadily, reaching an estimated 1.7 MBPD in July 1998. This increase in oil exports has

been playing a significant role in the sharp decline in world oil prices since late 1997. For 1998, Iraq was forecast to earn $6.1

billion in oil export revenues, up 45% from $4.2 billion in 1997.

Kuwait

Oil revenue accounts for about 90% of Kuwait's government income, which comprises nearly half the country's GDP. For 1998,

Kuwait oil export revenues were expected to reach $7.9 billion, down 33% from $11.8 billion in 1997. At the beginning of March

1998, in response to plummeting oil pi-ices, Kuwait's finance minister asked state bodies to cut spending by 25% for the

remainder of the fiscal year ending June 30, 1998.

Libya

Libya was expected to earn $5.8 billion from oil exports in 1998. This represents a 36% decline from Libya's earnings of $9.0

billion. Oil export revenues account for about 95% of Libya's hard currency earnings. In addition to lower oil prices, Libyan oil

export production and export earnings have been affected by UN sanctions imposed following the 1988 bombing of Pan Am flight

I03 over Lockerble, Scotland, in which 270 people were killed. Because of both sanctions and lower oil prices, Libya's economy

has barely grown in several years (0.7% growth in 1996, 0.6% in 1997, 0.5% in 1998). The country has been forced to adopt a

more conservative fiscal policy and to limit public infrastructure spending to a few main projects.

Nigeria

Crude oil exports generate over 90%, of Nigeria's foreign exchange earnings. Due to lower oil prices and production cuts,

Nigeria's crude oil export revenues were expected to fall by 36% in 1998, to $9.2 billion, compared to $14.5 billion in 1997. The

sharp decline in world oil prices and export revenues comes amidst a period of political instability and social turmoil for Nigeria,

especially following the deaths of President Sani Abacha on June 8, 1998 and of Masliood Abiola (presumed winner of the 1993

presidential elections) on July 7. All this is having a serious effect on Nigeria's short-term economic and fiscal growth.

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Qatar

Oil accounts for about 70% of Qatar‘s government revenues, and also has an impact on production of condensate and associated

natural gas. Qatar has tile third largest gas reserves in the world, after Russia and Iran. Qatar's oil export revenues for 1998 were

forecast at $3.0 billion, down 26% from $4.0 billion in 1997. Despite the fall in oil prices, Qatar is still planning to increase oil

production capacity by 20%, from 714,000 billion barrels per day at present to 854,000 billion barrels, by the end of 1999.

Saudi Arabia

Saudi Arabia is the largest OPEC producer and is a leader in the organization's quota decisions. It is a critically important player

behind the recent oil price collapse, and in actions taken to reverse tile Situation. Saudi Arabia's difficulties are being compounded

by the economic crisis in Asia, since Asia accounts for around 60% of Saudi oil sales. Saudi Arabia earned about $45.5 billion in

1997 from crude oil exports. In 1998, it was expected to fall by 35% to around $29.4 billion. Saudi Arabia is being affected both

positively and negatively by the decline in oil prices as well as by its supply cutbacks of 725,000 bbl/d.

On the positive side, lower oil prices to some point can be helpful for several reasons. Firstly, it has at least 250 billion barrels of

oil in the ground and is among the world's lowest-cost oil producers. Considering the country's high reserve to production ratio of

100 years or more, low oil pi-ices can help accomplish several economic objectives like deterring development of alternative

energy sources, maintaining Saudi market share against its main competitors in and out of both OPEC, and deterring marginal

non-OPEC oil production investment. On the negative side, Saudi Arabia remains heavily dependent on oil revenues, for 88%of

total export earnings, about 75% of state revenues, and 40% of GDP. The dramatic reduction in revenues will result in a

significantly lower GDP growth rate, as well as higher budget deficit.

UAE

UAE's economy is slowing significantly, at least in part due to the decline in oil prices. This country has not been hit as hard as

the other Gulf States because a significant portion of its revenue comes from business and trade. In response to falling oil export

revenues, UAE has called for restraint in government expenditures.

Venezuela

Venezuela was expected to earn $11.1 billion in oil export revenues for 1998, down 37% from $17.7 billion in 1997. This is

seriously hurting its economy, which could see a contraction of –2%, in 1998, compared to 5"/, growth in 1997, and has adding

political uncertainty in the wake of the December elections. In response to its economic crisis (including a 40%, drop in the

country's stock market in the first 9 months of 1998), Venezuela is attempting to Curb expenditures by the government and by

state-owned corporations, as well as to increase revenues wherever possible.

Mexico

Mexico has been forced to cut its budget three times during 1998 to make up for lost oil export income, which amounted to as

much as $4.0 billion. Partly because of low oil prices, Mexico's stock market fell 40% between mid-July and early September

1997; while the peso was down by 13%, during the same period. To counter this threat, the government has recalculated its budget

based on an oil price of $11.50 per barrel, down from $15.50 per barrel contained in the original budget.

Russia

Russian oil export revenues fell by about 25%, despite higher export volumes, during the first half of 1998, compared to the first

half of 1997. This has contributed to a severe deterioration in Russia's trade balance. On August 17, 1998, Russia announced that

it would allow the ruble to fall by as much as 34%, suspended trading of Treasury bonds, and announced a 90-day moratorium on

repayment of corporate and bank debt.

TRENDS IN US PETROLEUM CONSUMPTION AND IMPORTS

The US is steadily increasing its reliance oil imported oil. The importance of petroleum products to the economic and energy

security of the US was dramatically highlighted in 1991 by US willingness to go to war with Iraq to ensure access to Persian Gulf

oil under Favourable conditions. Paradoxically, while the US was willing to fight to protect petroleum supplies on the other side

of the world, it has no long-term strategy to reduce national dependence on imported oil wither by improving energy efficiency or

by developing alternative energy sources. Between 1983 and 1996, oil imports to the US increased by around 40%. By 2015, the

Dept. of Energy expects imports to account for 61% of US oil supply.

Gold and Oil

Diversified Portfolios, which contain assets such as private equity, hedge funds, real estate and commodities, can be enhanced by

adding a discrete allocation to gold as a foundation. Investors are looking to increase their risk-adjusted returns and add

diversification. However, gold produces benefits that separate it from other investments. It is not only an ideal source of

diversification for an investor‘s portfolio, but also provides a foundation which investors rely on to manage risk and preserve

capital more efficiently, especially in times of financial turmoil when stability is needed the most. Moreover, an allocation to gold

provides investors with the confidence to invest in a wider range of strategies including alternative assets.

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Trend of market interconnectivity in the world economy is noticeable also in the commodity field, with its most important

representatives – gold and oil. Gold, the most traded precious metal and oil, the most traded raw material, play an important role

in shaping economy. The first connection between gold and oil has begun in history, when producers of the Middle East required

gold in exchange for crude oil. Important milestone was in 1933. In 1933, the original oil concession in Saudi Arabia could be

traded in gold only. Because of many historical events, gold and oil markets went through huge development and significant

relationship between these two commodities was no longer determined at the level of payment only.

Today, gold, oil and other commodities are predominantly quoted in U.S. Dollars. In relation to oil, major player is OPEC (The

Organization of the Petroleum Exporting Countries), which formally agreed to sale its oil production exclusively in U.S. Dollars.

In the case of gold, it is important to mention that from 1944 to 1971, U.S. dollars were convertible into gold, in order to prevent

any trade imbalances between countries. Immediately, price of gold was fixed at $35 per troy ounce. Even the price of oil was

relatively stable at around $3 per barrel. After 1971, when the dollar convertibility into gold was cancelled, price stability of both

researched commodities has disappeared, but despite the significant volatility in their price levels, kind of common trend can still

be seen in their price development.

The crude oil is one of the factors for inflation. As the prices of crude oil increases, economy always falls into a recession there is

upward pressure on inflation. In order to hedge against the inflation people invest in gold. Therefore, it can say that there is a

relationship between gold and crude oil prices. It will be clearer from the following discussion. Gold has usually been the most-

highly-sought-after universal store of wealth and the gold is the king of all the currencies. The demand for crude oil is in elastic.

Now paper currencies lose their purchasing power with time but this does not happen with the gold. So during inflationary period

when other currencies lose their value more gold can be purchased with gold due to its purchasing power stability. So during high

crude oil prices, high inflation, and declining equity market gold can be stored to hedge the inflation.

HIGH OIL AND GOLD PRICES – A REFLECTION

The rise of gold price in 1980 could be attributed to political reasons. At the time, the Soviet invasion of Afghanistan, which

began around Christmas 1979, was a terrible global shock. The Soviets had just signed a ―bilateral treaty of cooperation‖ with

Afghanistan in 1978, but by the next year, relations had deteriorated. In the midst of cold war, this action was a major setback to

America, which had already been weakened by high inflation and unemployment and energy prices. The future of the American

economy and American power did not feel at all certain. As a safe haven in times of panic and strife, gold simply reflected that

fear.

However, the buying panic quickly subsided and this all-time peak was followed by the beginning of a 22-year-old bear market in

gold. Between 2000 and 2010, the price of gold jumped from $255 to over $1400 per ounce. In 2009 and 2010, the inflation

percentages have dropped dramatically even dipping into deflationary levels at times. The stock market is down significantly from

its 2007 highs. The indexes are ambivalent as to direction as of late 2010. The global economy is recovering from a recession and

still on shaky ground. These conflicting indicators create mixed signals for gold buyers. Still, it is worth noting that gold is only

10 years into its long-term bull cycle. Oil prices hit an all-time high of $145 a barrel in July 2008. This drove gas prices to $4.00 a

gallon. Most news sources blamed this on surging demand from China and India, combined with decreasing supply from Nigeria

and Iraq oil fields. In fact, global demand was actually down and global supply up during that time. Oil consumption decreased

from 86.66 million barrels per day (bpd) in the fourth quarter 2007 to 85.73 million bpd in the first quarter of 2008. At the same

time, supply increased from 85.49 to 86.17 million bpd. It was also stated that commodity prices drove up the oil prices. As

investors retreated from the falling real estate and global stock markets, they diverting their funds to oil futures .This sudden surge

drove up oil prices, creating a speculative bubble. This bubble soon spread to other commodities. Investor funds swamped wheat,

gold and other related futures markets. This speculation drove up food prices dramatically around the world. High oil prices were

also said to be driven by a decline in the dollar. Most oil contracts around the world are traded in dollars. As a result, oil-exporting

countries usually peg their currency to the dollar. When the dollar declines, so do their oil revenues, but their costs go up.

INDIAN AVIATION INDUSTRY

The Indian Aviation Industry has been going through a turbulent phase over the past several years facing multiple headwinds –

high oil prices and limited pricing power contributed by industry wide over capacity and periods of subdued demand growth. Over

the near term, the challenges facing the airline operators are related to high debt burden and liquidity constraints - most operators

need significant equity infusion to effect a meaningful improvement in balance sheet. Improved financial profile would also allow

these players to focus on steps to improve long-term viability and brand building through differentiated customer service. Over the

long term, the operators need to focus on improving cost structure, through rationalization at all levels including mix of fleet and

routes, aimed at cost efficiency. At the industry level, long-term viability also requires return of pricing power through better

alignment of capacity to the underlying demand growth.

While in the beginning of 2008-09, the sector was impacted by sharp rise in crude oil prices, it was the decline in passenger traffic

growth, which led to severe underperformance during H2, 2008-09 to H1 2009-10. The operating environment improved for a

brief period in 2010-11 on back of recovery in passenger traffic, industry-wide capacity discipline and relatively stable fuel prices.

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However, elevated fuel prices over the last three quarters coupled with intense competition and Unfavourable foreign exchange

environment has again deteriorated the financial performance of airlines. During this period, while the passenger traffic growth

has been steady (averaging 14% in 9m 2011-12), intense competition has affected yields and forced airlines back into losses in an

inflated cost base scenario. To address the concerns surrounding the operating viability of Indian carriers, the Government on its

part has recently initiated a series of measures including (a) proposal to allow foreign carriers to make strategic investments (up to

49% stake) in Indian Carriers (b) proposal to allow airlines to directly import ATF (c) lifting the freeze on international

expansions of private airlines and (d) financial assistance to the national carrier. However, these steps alone may not be adequate

to address the fundamental problems affecting the industry.

While the domestic airlines have not been able to attract foreign investors (up to 49% FDI is allowed, though foreign airlines are

currently not allowed any stake), foreign airlines may be interested in taking strategic stakes due to their deeper business

understanding, longer investment horizons and overall longer term commitment towards the global aviation industry. Healthy

passenger traffic growth because of favourable demographics, rising disposable incomes and low air travel penetration could

attract long-term strategic investments in the sector. However, in our opinion, there are two key challenges: i) aviation economics

is currently not favourable in India resulting in weak financial performance of airlines and ii) Internationally, too airlines are going

through period of stress, which could possibly dissuade their investment plans in newer markets. Besides, foreign carriers already

enjoy significant market share of profitable international routes and have wide access to Indian market through code-sharing

arrangements with domestic players. Given these considerations, we believe, foreign airlines are likely to be more cautious in their

investment decisions and strategies are likely to be long drawn rather than focused on short-term valuations. On the proposal to

allow import of ATF, we feel that the duty differential between sales tax (averaging around 22-26% for domestic fuel uplifts)

being currently paid by airlines on domestic routes and import duty (8.5%-10.0%) is an attractive proposition for airlines.

However, the challenges in importing, storing and transporting jet fuel will be a considerable roadblock for airlines due to OMCs

monopoly on infrastructure at most Indian airports. From the working capital standpoint too, airlines will need to deploy

significant amount of resources in sourcing fuel, which may not be easy given the stretched balance sheets and tight liquidity

profile of most airlines.

CONCLUSION

Oil sector is the key-motivator for all the economic activities of the nation. Since we are aware that all our activities are driven by

impact of oil price directly, affect the transport sector there by effecting economic activities. From the study, it is observed that, in

the recent past there is more fluctuation in the oil price affecting many industries and their activities. The management of these

fluctuations is becoming more challenging for the companies. They are attempting to protect themselves by adopting the risk

management technique to cover their risk. This paper has attempted to highlight the effect of oil sector on different industries and

their by attempting to develop the measure to protect the economy.

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