The global oil supply decisions by the Organization of the Petroleum Exporting Countries and its allies led by Russia, or OPEC+, have typically always had a significant impact on oil price movements. However, the Reserve Bank of India (RBI) in its June 2023 bulletin has revealed that India's domestic crude oil basket, equity prices of oil and gas sector firms and sovereign bond yields witness high volatility during the oil output decisions by OPEC+.
The economic impact of global oil supply have important implications for India – a net importer of crude oil – to deliver price stability. Moreover, the oil supply-related news shocks cause a sustained increase in consumer prices and reduce the domestic output - for a short duration. Oil prices and financial markets typically tend to be more volatile around OPEC meetings and exhibit significantly abnormal returns after the oil producing cartel announce reduction in its global production quota, according to RBI's bulletin.
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How have OPEC+ decisions affected oil prices?
OPEC meeting outcomes as well as economic and geopolitical events impacts analysts' expectations in the crude oil market. On March 6, 2020, OPEC countries failed to strike a deal with their allies led by Russia on oil production cuts. At that time, markets expected an imminent price war within oil exporting countries. Consequently, oil futures went down across all tenors on the next trading day, i.e., March 9, 2020.
Similarly, when the World Health Organisation (WHO) declared COVID-19 as a global pandemic on March 11, 2020, market participants expected lower demand for crude only in the near future but negligible impact over the medium term. Reflecting this sentiment, on the very next day, futures price went down sharply for short-term contracts but only marginally in the case of longer term contracts.
In the OPEC meeting held on July 18, 2021, the OPEC and non- OPEC allies reached an agreement to boost oil supply by September 2022 as prices had climbed to the highest levels in more than two years. This led to an immediate decline in crude futures across all tenors
Finally, in February 2022, the implications of the Russia-Ukraine war were visible on crude oil prices as Brent crude oil hit a price of $125 per barrel in March 2022 - the highest since 2012 and almost six-folds above the bottom observed during April 2020. This gave way to an energy-induced cost- push inflation across the globe and oil prices have been volatile since then.
In April 2023, OPEC announced oil production cuts of around 1.16 million barrels per day (bpd) in a surprise decision, which led to oil prices immediately surging over 8 per cent to $83.95 a barrel. In March, benchmark Brent crude fell to $72 per barrel - the lowest in 15 months, due to the collapse of major global banks including Silicon Valley Bank (SVB) and Credit Suisse.
Earlier this month, OPEC+ decided to reduce the overall production targets from 2024 by a further total of 1.4 million barrels per day (bpd) in its latest meeting. Although, Saudi Arabia, OPEC cartel's dominant member, will make deep production cuts of 1 million bpd starting from July, as part of a broader output-limiting OPEC+ deal as the group faces flagging oil prices and a looming supply glut. The rest of the OPEC producers agreed to extend earlier cuts in supply through the end of 2024.
OPEC’s share in world oil production has been declining in recent years. In fact, OPEC’s share in global oil production has dropped from 42.3 per cent in 2012 to 36.2 per cent in 2020 as per data from the US Energy Information Administration (EIA). OPEC’s share in total global oil production is estimated to gradually rise from 36.8 per cent in 2021 to 42.2 per cent by 2050.
How have OPEC+ decisions impacted global economy?
The global oil supply, global demand for oil and expectations about future oil market conditions are fundamental drivers of oil price movements. In the context of global oil supply, conventional supply shocks are interpreted as sudden disruptions in the current supply of crude oil that gets reflected in an instantaneous fall in oil supply, an increase in oil price and a reduction in inventories.
From a medium-term policy perspective, oil price shocks are particularly important as they tend to have a stagflationary impact on the economy, said RBI's bulletin. Oil supply shocks shift the production and prices of oil in different paths, whereas an oil demand shock shifts the oil production and oil prices in the same direction, according to RBI. The oil supply and demand shocks account for 50 and 35 per cent of total oil price changes, respectively.
‘’If a surprise OPEC announcement leads oil market participants to expect a production shortfall in the future, they will build up inventories today to cover up for lesser oil production tomorrow. Thus, the reaction of oil inventories is the differentiating feature between oil supply news shocks and traditional oil supply shocks,'' said RBI in its bulletin.
Moreover, a drop in oil prices driven by positive supply shocks boosts economic activity in advanced economies, while dampening activity in emerging markets. Oil price shocks have discrete macroeconomic consequences and the overall macroeconomic effects of oil price shocks in the US are more similar to the Euro area than to that of China.
For oil importing countries, such as India, the increases in global oil prices directly impact domestic prices by increasing the price of imported goods and indirectly through increasing transportation costs. It also burdens the current account deficit (CAD) and pressurises the exchange rate. On the other hand, for exporting countries such as Russia, Saudi Arabia and others, oil price increases add to their export revenue thereby lifting their economic output.
Global inflation rose from 4.7 per cent in 2021 to 8.7 per cent in 2022. Although it is expected to decline to 7.0 per cent in 2023, it will still remain above the level seen in 2021. Since then, central banks across the globe have promptly reacted to the inflationary surge by hiking their policy rates and scaling back their accommodative policies to combat inflation.
Also Read: Domestic crude oil production at 2.5 MMT in May, imports increase 2%: PPAC
How have OPEC+ decisions impacted Indian economy?
India’s crude oil consumption has increased seven times accounting for about 5 per cent of world’s total crude oil consumption. India is the fourth-largest global energy consumer behind China, the United States and the European Union. India is slated to overtake the European Union as the world’s third-largest energy consumer by 2030 according to the India Energy Outlook 2021, published by the International Energy Agency (IEA).
India’s oil demand is expected to rise by 74 per cent to 8.7 Mb/d by 2040 under the existing scenario. The natural gas requirement is projected to more than triple to 201 billion cubic meters (IEA, 2021). The country's energy outlook suggests that the price of crude oil and other energy sources will have significant bearing on major financial and macroeconomic variables.
Economic indicators such as consumer prices in India and domestic output, along with key financial indicators such as INR, bond yields, and stock prices have shown movements to OPEC+ oil supply decisions.
While domestic currency appreciates against the US dollar on the impact of oil supply shock, surprise changes in expectations about future oil supply are expected to lead to an increase in oil inventories raising the domestic demand for US dollars to purchase available crude oil in the market. This leads to a depreciation of the domestic currency (INR) over time as seen in the medium-term response of exchange rate to oil supply news shocks.
At the same time, there is a persistent increase in domestic consumer prices in response to an oil supply news shock. The sustained increase in prices is expected to lead to a lower aggregate demand as households and firms are left with less disposable incomes to spend on non-energy goods.
Moreover, surprise changes in oil prices can also influence the price and wage-setting in the economy by altering the inflation expectations of firms and households, and so, domestic economic activity falls on impact of such a shock. However, the impact is felt only for a short duration as it reverts to mean quickly.
Lastly, while the immediate reaction of monetary policy is seen to be accommodative on impact perhaps to cushion the short-term fall in economic activity, monetary policy is gradually tightened to counter the increase in prices. So, the impulse response analysis underlines the cost-push effect of oil supply surprises – causing an increase in consumer prices and a fall in economic output – on the Indian economy.
RBI concludes that not only do financial markets react to supply-related announcements by the OPEC, domestic output falls and consumer prices increase as a result of oil supply news shocks.
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Updated: 23 Jun 2023, 10:17 PM IST
Friday, 23 June 2023
Higher CPI, volatile stocks and yields: RBI explains how OPEC decisions impact Indian economy | Mint
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