Effect of Rising OIL

PRICES on Global &

Indian Economy
“Where are we
heading …???”
“OIL”
 Oil Shocks
Have a stagflationary effect on the macroeconomy of an oil
importing country:

 slows down the growth rate ( may even reduce the level of
output – recession)
 leads to an increase in the price level and potentially an
increase in the inflation rate
 acts like a tax on consumption

The size of the shock, both in terms of the percentage increase in

oil prices and the real price.
 The shock’s persistence
 The dependency of the economy on oil and energy
 The policy response of monetary and fiscal authorities
How Oil Shock affects
Market???

“Five Shocks”
Black dots indicate oil shocks. The first two are the OPEC embargo (1974) and the Iranian Revolution (1980).
The second set involve the future shocks which may occur in near future due to various reasons such as:

 Low Supply More Demand

 Cartel by OPEC
 Political Reasons
 Depression of the Economy
 1973-75 OPEC SQUEEZES THE WEST

“In the background was a long period of OPEC frustration that

constant oil prices, against the backdrop of rising global
inflation were resulting in steady decline in real oil
revenues”

• An inflationary upsurge-Prices of all kinds of

commodities were skyrocketing.
• Monetary policy was being tightened in response,
making a decline into recession inevitable.
• Because of the cartelized nature of the oil market, oil
prices responded with a lag, just as the world
economy was beginning its downturn.
1979-81: IRANIAN REVOLUTION
AND IRAN-IRAQ WAR

In 1981 recession was caused by the

Volker credit squeeze, when interest
rates were increased sharply, with the
objective of ending an inflationary
spiral of which rising oil prices were a
symptom rather than a cause.
1990-91 IRAQ INVADES KUWAIT AND
FIRST GULF WAR

“The impact of oil prices was

negligible, not least because Saudi
Arabia and other Arab nations were
allied with U.S. forces and made
efforts to counteract the price
increase”
1996-99: DEMAND-INDUCED PRICE
SURGE

“Global demand began to swell as the

high-tech bubble encouraged a big
investment boom in North America
and Europe and as the Asian
economies began to recover.”
2002-05: IRAQ II AND SURGING DIL
DEMAND

“The tripling of crude oil prices since

2002 has had generally more muted
and often paradoxical effects on the
financial markets”
 1973-75 1979-81 1990-91 1996-99 2002-05

YOM IRAN-IRAQ GULF WAR DEMAND IRAQII

EVENTS KIPPUR WAR INDUCED
WAR PRICE
SURGE
6.5%-8.5% 9%-11%- 8%-9% 4.5%-6% LITTLE
BONDS 13.5% CONCERN
INVESTOR
Avg. MOVED TO
STOCK ENERGY HIGH TECH
STOCK
PRICES STOCKS(No Fluctuating STOCKS
MARKET OVERSHADOW Skeptic
HALVED OR Permanent net
erosion of ED HIGH OIL
$600 bn PRICES
equity value)

YEN, CATER YEN & YEN DOLLAR

DEUTSCHE BONDS D’MARK BECOMES DEPRECIA
& GERMAN D’MARK BECOMES STRONG TES
GETTING STRONG AND D’MARK
CURRENCY MARK STRONGER AND THEN WEAKENS
WEAKENED
WEAKENS
 Emerging Concepts

The Oil Gauge Model

• To assess the response of activity and inflation to higher oil prices

• This model examines the impact of oil prices on inflation by looking both at
the long-run positive correlation between inflation and growth, as well as on
the asymmetric impact of oil prices on activity.
• net oil price Increase is used which is real (inflation-
adjusted)
• With the use of a VAR methodology, impulse response functions of
real activity and inflation to a 10% increase in the price of oil is
derived.
• Our Oil gauge Model finds that a 10% increase in the price of oil
shaves G7 real GDP by 0.15% in the first year and 0.30% over two
years. The response of inflation to an oil price increase of 10% is
0.26% in the first year and 0.45% over two years. These estimates
suggest that the developed economies have become better
 EMERGING CONCEPTS
HUBBERT PEAK OF OIL PRODUCTION
 HUBBERT’S PEAK THEORY
The law of conservation of energy states that energy can not be created, only converted. Despite the
apparent abundance of oil it follows this law of nature. Geophysicist M. King Hubbert created a
mathematical model of petroleum extraction which predicted that the total amount of oil extracted
over time would follow a logistic curve. This in turn implies that the predicted rate of oil extraction
at any given time would then be given by the rate of change of the logistic curve, which follows a
bell-shaped curve now known as the Hubbert curve.

The question now is that can we make our ride down the curve a little smoother instead of going

crashing down. Can we make the curve a little flater?

HUBBERT’S PEAK THEORY
 IVANHOES PROJECTION

• According to Ivanhoe (a renowned Economist), the critical date is

when global Oil demand will substantially exceed the available
supply from the few Persian Gulf Moslem oil exporters.

• The permanent global oil shortage will begin when the world's oil
demand exceeds global production( around 2010) if normal oil-fields
decline occurs & the world's key oil producer, Saudi Arabia, has
serious political problems that curtail its exports.

• World oil production will thereafter continue to decline at a

dwindling rate.

• The major discoveries of oil is nearly over and even in future if some
discoveries happens it would be not as huge as earlier ones. Hence the
production would increase due to some technological advances but
ultimately the supply would come down and there would be huge increase
price of oil.
IVANHOES PROJECTION
 PAPER BARRELS
"What About So Called 'Reserve Growth'"?

In recent years, the USGS and other agencies have estimated

US domestic oil production would not peak until well into the 21st
century, and possibly not until the 22nd century. This was despite
the fact US production had already peaked in 1970, just as
Hubbert had predicted. Unfortunately, these upwards revisions
are best classified as "paper barrels", meaning they exist on
paper only, not in the real world.

• This concept of paper barrel actually means that the oil is only
present in the paper not physically.
• This makes the oil trading in the derivative market very volatile .
• The basic reason for the investor would be if there is lot of oil then
price would come down which would bring down the cost of
production for the manufacturing companies which would make
greater profits.
 Oil price shocks would
normally affect
macroeconomic performance
HIGHER OIL PRICES
through a number of
channels.
Transfer of Income from Oil Increased inflation via higher prices
Reduced industry output through
exporting Countries to net oil of imported goods and petroleum
higher costs of production
exporting countries products

Upward spiral of
Wages &
increased interest
rates.

Affects Macroeconomic Performance

 OIL AND GDP
• Granger Causality

• Multi Hubbert Curve-A Hubbert forecast of oil production shows that Soviet and former Soviet oil production is following a

multi-cycle Hubbert trend and that the region’s oil production is forecast to peak in 2009. First cycle was from 19th century to

1996, with a 1987 peak. Discovery peaked in the 1960s. Privatization of Russian oil in 1996, better property rights and

resumption of production at old fields fueled recent growth.

Rate of Production (millions of

Figure 2. Former Soviet Union Oil Production as Function of

Cumulative Production--Forecast

6000
Actual 95% Confidence
barrels per year)

Production 2009 Interval

5000

4000

3000
1985

2000
Forecast
Peak in
1996 Production
1000

0
0 50000 100000 150000 200000 250000

Cumulative Production (millions of barrels)

OIL SHOCKS AND GDP
IS LM Curve
The effect on interest rates of a change in demand for money:
money supply kept at fixed level by the authorities
MS
Rate of interest

r1

L'

L
O
Money
 The demand for and supply of money
M S' MS
Rate of interest

r2

r1

O Q2 Q1
Money
 Effect of Rising Oil prices-Shift in IS LM Curves

LM
Rate of interest

r1

r2

IS1

IS2

O Y2 Y1
National incom e
 Interest Rate

Global Demand

Oil Price Should Rise

(Especially when Prod. is tight)
 THE ROLE OF THE USA
• Dependency on imported oil for the US is growing
• Even before the 9/11 attack USA was trying to expand its Strategic Petroleum Reserve (SPR):
– to maintain the domestic price of oil at a desired level by releasing petroleum from time to time to the
domestic market
– to maintain a massive reserve in case of any major political changes either in the Middle – East or in
Venezuela
• Given the need for the US war efforts, its budget deficits are increasing.-the value of dollars in the
international market is falling

More demand for dollars &

DOLLARS( only means of exchange Oil Price Increases
increased Value for Dollars

If USA has Balance Of Payments Deficit Increased sales of US Govt. Bonds Increased sales of US Govt. Bonds

Increased profits of the Western oil companies and as a result increased tax revenues of the US government
 THE UNSOLVED PUZZLE…..

What exactly do oil

exporting countries
do with their export
surplus?
Exporters of oil are saving more of their recent windfall than in
previous price booms. It's hard to spot where the money is
going…
 PETRODOLLARS

• IMF’S Estimate

• Surplus as a % of
GDP

• Three options; Spend,

Save or Invest.
 IMF Estimates

• Oil Exporters’ total current account surplus of around

$500 Bn
• Saudi Arabia – 32% of GDP
• Middle East -25% of GDP
• Russia-13% & Vnezuela-18%.
• In Contrast China- 6%( combined with other Asian
economies around $188Bn)
 Money Saved-Where is it going???
(Proving much harder to track…)

 1970s and early 1980s surplus petrodollars were largely deposited in banks in
America or Europe-again lent lent too many of them to oil-importing developing
countries

 went into foreign shares and bonds rather than into western banks.( increased
official scrutiny after september 11 attacks)

 bulk of OPEC's surplus revenues has so far gone into dollar-denominated assets,
those assets are increasingly held outside the United States( around 67% pushing
down Americas’ Bond Yields)

 hedge funds and offshore financial institutions, which are unregulated

 Oil Exporters

Spend Save

Import PETRODOLLARS Saving Rate is

Around 40%

Maintains a Slowdown in
Global Demand Global Demand
 Oil Exporters
Invest
Lending Increase
Finance in the
Invest in Global
oil importers Fuel bills back to the
Capital Markets
CAD consumer

Push Down Bond Yields Increase in

Boosting Demand
In Oil Importing the Asset
Countries For Financial
Prices Assets
 How might the flow of oil money
affect the
Oil Traded dollar?
in Dollars

Rising Oil prices-demand for

dollars increase
CONTRARY VIEW
SUPPLY ISSUES
DEMAND ISSUES
GLOBAL SPARE CAPACITY
 IMPACT OF RISING OIL
PRICES ON INDIAN ECONOMY
SOME FACTS & FIGURES
Growth Rate of Oil Consumption (per cent change in thousand barrels
per day

Countries 1970-79** 1980-89 1990-99 2000 2001 2002 2003 2004

Brazil 9.9 0.9 3.8 -1.3 2.2 -2.3 -3.7 2.5
China 16.9 2.2 7.0 12.9 0.9 6.9 7.7 15.4
India 4.9 6.3 6.3 5.6 1.3 3.9 1.9 5.6
South Korea 14.1 6.1 10.3 2.3 0.3 2.1 0.8 -0.9
Thailand 10.1 5.1 7.6 -1.3 -3.3 9.2 9.2 8.7
TOTAL WORLD 4.3 0.1 1.4 1.2 0.7 1.0 1.6 3.1
Of which European Union 25# 3.1 -1.3 1.0 -0.9 1.0 -0.7 0.6 0.7
OECD 3.4 -0.7 1.5 0.3 0.1 -0.1 1.3 1.0
Former Soviet Union 6.1 0.2 -7.8 -3.7 -0.7 0.3 3.0 4.8
Other EMEs 7.0 2.7 4.2 3.7 1.9 3.2 2.1 6.8
Subsidies on Major Petroleum Products (Rs. crore)

Kerosene 1993/94 1996/97 1999/00 2000/01 2001/02 2002/03 2003/04a 2004/05a

(domestic use)
High-speed diesel 3773 6540 8151 7522 5310 3018 0 0
LPG (domestic use) 575 8090 5070 8845 - - 2783 1465
Total subsidies on 6596 18600 17714 23091 11140 6709 4801 2417
petroleum oil and
lubricant productsb
Total central government 12682 16125 24487 26838 31207 44618 44709 43517
subsidies
Total subsidies 19278 26020 42201 49933 42347 51327 49510 45934
Petroleum, oil, and 34.22 53.56 41.98 46.25 26.31 13.07 9.70 5.26
lubricants subsidy as a
percentage of total
subsidy
Annual Growth Rate (per cent) of Major Financial Indicators

of Petroleum Industry
Items 1990-91 to 1995-96 to 2000-01 2001-02 2002-03 2003-04
1994-95 1999-00
Investment -5.9 21.5 14.3 143.8 22.5 14.9
Income 11.5 28.8 29.2 -4.8 10.5 8.0
Expenditure 11.4 31.2 30.5 -6.1 5.8 8.0
Profit after interest and depreciation -16.8 20.1 27.5 17.4 70.8 7.4
Profit after interest, depreciation and tax 14.5 16.3 22.5 8.4 79.2 7.0

100
80
G ro w th ra te

60
40
20
0
1 99 0-

19 92 -

19 93 -

19 97 -
1 99 1-

19 94 -

1 99 5-

19 96 -

19 98 -

1 99 9-

2 00 0-

20 01 -

20 02 -

20 03 -
-20
94

95

99

01
00
91

03
92

93

96

97

98

02

04
-40

Ye ar

E xpend iture p rof it after int, de pre ciation an d tax

 GrowthRate

0
50

-50
100
150
200
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
Year

Investment 1997-98
1998-99
(In per cent per year)

1999-00
2000-01
2001-02
2002-03
Growth rate of Investment of Petroleum Industry

2003-04
COMPARISON OF IMPACT ON
INDIA & CHINA
Brent Oil Price and Growth Rate of Industrial Production

14.00 50
12.00
40

$ per Barrel
% change

10.00
8.00 30
6.00 20
4.00
10
2.00
0.00 0
1983

1985

1989

1995

1999

2001
1981

1987

1991

1993

1997

2003
Industrial Growth Rate Brent Oil
Brent Oil Price and Growth Rate of GDP (current prices)

US dollar per barrel

30.00 45
40
25.00
growth rate

35
20.00 30
25 INDIA
15.00
20
10.00 15
10
5.00
5
0.00 0
1981

1993

1999

2001
1983

1985

1987

1989

1991

1995

1997

2003
GDP Brent Oil

35.00 40.00

U S do ll ar per barrel
30.00 35.00
25.00
g row th rate

30.00
20.00
25.00 CHINA
15.00
10.00 20.00
5.00 15.00
0.00
198 1

19 83

1 985

198 9

19 91

19 95

20 01
1 993

19 97

1 999

20 03
1987

10.00
-5.00
-10.00 5.00

-15.00 0.00
Y ear

GDP B rent O il
 Brent Oil Price and Value of Merchandise Imports

U S d o l l a r p e r b a rr e l
45
b i ll io n s U S d o ll a r

1 0 0 .0 0
9 0 .0 0 40
8 0 .0 0 35
7 0 .0 0
30
6 0 .0 0
25
5 0 .0 0
20
4 0 .0 0
15 INDIA
3 0 .0 0
2 0 .0 0 10
1 0 .0 0 5
0 .0 0 0
1980

1982

1988

1992

1994

1998

2002

2004
1990

2000
1 98 6

1 99 6
1 98 4

Ye a r
I m p o rt B re n t O i l

$U S dollar per bar rel

B illion U S D ollars

600.00 50.00
500.00 40.00
400.00
30.00
300.00 CHINA
20.00
200.00
100.00 10.00
0.00 0.00
1996

1998

2000

2004
2002
1992

1994
1988

1990
1980

1982

1986
1984

Year

impo rt B rent O il
 Brent Oil Price and Trade Balance

U S do ll a r pe r ba rre l
20. 00 40
B illio ns d olla r

18. 00 35
16. 00
14. 00
30
12. 00 25
10. 00 20
8. 00 15
6. 00
4. 00
10
5
INDIA
2. 00
0. 00 0
198 2

198 4

198 6

199 0

199 2

199 4

19 98

20 00

20 02
198 8

199 6
1980

Y ea r
tr a de ba lan c e B r en t O il

50 45.00

US dollar per barrel

40 40.00
35.00
Billion Dollars

30
30.00
20
CHINA
. 25.00
10 20.00
15.00
0
1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004
10.00
-10 5.00
-20 0.00
Year

trade balance Brent Oil

Correlation between Changes in Crude Oil Price and Inflation Rate and
Industrial Output in India

1 .5

1 .0

0 .5

0 .0
1 9 9 5Q 4

1 9 98 Q 1

2001Q1

2001Q4

2 0 0 2Q 3

2 0 04 Q 1

2 0 04 Q 4
1 9 9 6Q 3

1 9 97 Q 2

1 99 8 Q 4

1 99 9 Q 3

2 0 0 3Q 2
20 0 0 Q 2
-0 .5

-1 .0

In f l V s B re nt IIP gr V s B re n t
ADB PROJECTION
VAR MODEL
VAR FUNCTIONS
VAR EQUATION
SIMULATION ANALYSIS
WITHIN SAMPLE ANALYSIS
OUT OF SAMPLE ANALYSIS
Questions
???
Thank You!!!