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 YOM KIPPUR WAR 6.5%-8.5% BONDS

1979-81 IRAN-IRAQ WAR

1990-91

1996-99

2002-05 IRAQII

EVENTS

GULF WAR DEMAND INDUCED PRICE SURGE 8%-9% 4.5%-6%

9%-11%13.5% INVESTOR MOVED TO ENERGY STOCKS(No
equity value)

LITTLE CONCERN

STOCK MARKET

Avg. STOCK Fluctuating PRICES HALVED OR Permanent net erosion of $600 bn CATER BONDS D’MARK GETTING STRONGER YEN & D’MARK BECOMES STRONG AND THEN WEAKENS

HIGH TECH STOCKS OVERSHADOW Skeptic ED HIGH OIL PRICES

YEN, DEUTSCHE & GERMAN CURRENCY MARK WEAKENED

YEN DOLLAR BECOMES DEPRECIA STRONG TES AND D’MARK 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 (inflationadjusted)
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 exporting Countries to net oil exporting countries Reduced industry output through higher costs of production Increased inflation via higher prices of imported goods and petroleum 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

barrels per year)

5000

Actual Production

95% Confidence Interval 2009

4000

3000

1985
Forecast Peak in Production

2000

1000

1996

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

r

L' L O Money

The demand for and supply of money M S' MS

Rate of interest

r2

r1

L
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

DOLLARS( only means of exchange

Oil Price Increases

More demand for dollars & 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 Global Demand

Slowdown in Global Demand

Oil Exporters

Invest
Finance oil importers CAD Lending Increase in the Fuel bills back to the consumer

Invest in Global Capital Markets

Push Down Bond Yields In Oil Importing Countries

Boosting the Asset Prices

Increase in Demand For Financial Assets

How might the flow of oil money affect theDollars Oil Traded in dollar?

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 Brazil China India South Korea Thailand TOTAL WORLD Of which European Union 25# OECD Former Soviet Union Other EMEs

1970-79** 1980-89 1990-99 2000 2001 2002 2003 2004 9.9 0.9 3.8 -1.3 2.2 -2.3 -3.7 2.5 16.9 2.2 7.0 12.9 0.9 6.9 7.7 15.4 4.9 6.3 6.3 5.6 1.3 3.9 1.9 5.6 14.1 6.1 10.3 2.3 0.3 2.1 0.8 -0.9 10.1 5.1 7.6 -1.3 -3.3 9.2 9.2 8.7 4.3 0.1 1.4 1.2 0.7 1.0 1.6 3.1 3.1 -1.3 1.0 -0.9 1.0 -0.7 0.6 0.7 3.4 -0.7 1.5 0.3 0.1 -0.1 1.3 1.0 6.1 0.2 -7.8 -3.7 -0.7 0.3 3.0 4.8 7.0 2.7 4.2 3.7 1.9 3.2 2.1 6.8

Subsidies on Major Petroleum Products (Rs. crore)

Kerosene (domestic use)
High-speed diesel LPG (domestic use) Total subsidies on petroleum oil and lubricant productsb Total central government subsidies Total subsidies Petroleum, oil, and lubricants subsidy as a percentage of total subsidy

1993/94 1996/97 1999/00 2000/01 2001/02 2002/03 2003/04a 2004/05a
3773 575 6596 12682 19278 34.22 6540 8090 18600 16125 26020 53.56 8151 5070 17714 24487 42201 41.98 7522 8845 23091 26838 49933 46.25 5310 11140 31207 42347 26.31 3018 6709 44618 51327 13.07 0 2783 4801 44709 49510 9.70 0 1465 2417 43517 45934 5.26

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

100 80 G ro w th ra te 60 40 20 1 99 019 92 19 93 19 97 1 99 119 94 1 99 519 96 19 98 1 99 92 00 020 01 20 02 20 03 0 -20 -40

94

95

99

01

00

91

03

92

93

96

97

98

02

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

04

Gro t Rat wh e 10 0 5 0 20 0 15 0 1 01 99 -9 19 1 2 9 -9 19 2-9 9 3 19 3-94 9 1 94 5 9 -9 1 56 99 -9 1 67 99 -9 19 7 8 9 -9 19 8-9 9 9 1 99 9 -00 2 00 1 0 -0 2 01 2 0 -0 2 23 00 -0 20 3-0 0 4
Year

0 -5 0

Growth rate of Investment of Petroleum Industry (In per cent per year)

Inve e stmnt

COMPARISON OF IMPACT ON INDIA & CHINA

Brent Oil Price and Growth Rate of Industrial Production
14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 50 30 20 10 1983 1985 1989 1995 1999 2001 1981 1987 1991 1993 1997 2003 0 $ pe Barre r l 40

% change

Industria Growth Ra l te

Bre Oil nt

Brent Oil Price and Growth Rate of GDP (current prices)
3 .0 0 0 growth ra te 2 .0 5 0 2 .0 0 0 1 .0 5 0 1 .0 0 0 5 0 .0 1981 1993 1999 2001 1983 1985 1987 1989 1991 1995 1997 2003 0 0 .0 4 5 4 0 3 5 3 0 2 5 2 0 1 5 1 0 5 0 US dolla pe ba l r r rre

INDIA

GDP

Brent Oil

30.00 g row th rate 25.00 20.00 15.00 10.00 5.00
198 1 19 83 1 985 198 9 19 91 19 95 20 01 1 993 19 97 1 999 20 03 1987

35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 Y ear GDP B rent O il

U S do ll ar per barrel

35.00

40.00

CHINA

0.00 -5.00 -10.00 -15.00

Brent Oil Price and Value of Merchandise Imports
b i ll io n s U S d o ll a r 1 0 0 .0 0 9 0 .0 0 8 0 .0 0 7 0 .0 0 6 0 .0 0 5 0 .0 0 4 0 .0 0 3 0 .0 0 2 0 .0 0 1 0 .0 0 1980 1982 1988 1992 1994 1998 2002 2004 1990 2000 1 98 6 1 99 6 1 98 4 0 .0 0

45 40 35 30 25 20 15 10 5 0

U S d o l l a r p e r b a rr e l

INDIA

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

1996

1998

2000

Year impo rt B rent O il

2004

2002

1992

1994

1988

1990

1980

1982

1986

1984

600.00 500.00 400.00 300.00 200.00 100.00 0.00

50.00 40.00 30.00 20.00 10.00 0.00

$U S dollar per bar rel

B illion U S D ollars

CHINA

Brent Oil Price and Trade Balance
20. 00 18. 00 16. 00 14. 00 12. 00 10. 00 8. 00 6. 00 4. 00 2. 00 0. 00

198 2

198 4

198 6

199 0

199 2

199 4

19 98

20 00

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

50 40 Billion Dollars 30 20 10 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 0 -10 -20

20 02

198 8

199 6

1980

40 35 30 25 20 15 10 5 0

U S do ll a r pe r ba rre l

B illio ns d olla r

INDIA

45.00 40.00 35.00 30.00 US dollar per barrel

.

25.00 20.00 15.00 10.00 5.00 0.00

CHINA

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 -0 .5 -1 .0 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

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!!!

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