The impact of rising crude prices

By Larissa Fernand |  02-07-14 | 
 
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About the Author
Larissa Fernand is Senior Editor at Morningstar.in. Follow her on Twitter @larissafernand

The tremors of the situation in Iraq are already being felt in India.

The price increase across the nation is Rs 1.69 per litre on petrol and 50 paise on diesel. However, the exact impact of the hikes would differ in different cities due to local levies.

According to the Times of India, the rising crude oil price is also weighing heavy on the Indian polyester industry. The price of polyester yarn, the basic raw material for Surat’s man-made fabric, or MMF, has gone up. This is because Purified Terephthalic Acid, or PTA, a raw material to manufacture yarn chips, is derived from crude oil. This will naturally impact the finished fabric and materials.

India imports more than 75% of its oil requirements, making the economy extremely susceptible to a price hike. According to the U.S. Energy Information Administration, last year India was the fourth-largest energy consumer of crude oil and petroleum products after the U.S., China and Japan. It was also the fourth-largest net importer of the same products. Despite having large coal reserves and a healthy growth in natural gas production over the past two decades, India is increasingly dependent on imported fossil fuels. The gap between India’s oil demand and supply is widening, as demand reached nearly 3.7 million barrels per day (bbl/d) in 2013 compared to less than 1 million bbl/d of total liquids production.

Financial Times reveals that Barclays estimates a $10 per barrel rise in crude oil price would cost India a 0.5% in its growth rate. If crude prices continue to see an uptrend, India will have to deploy its foreign exchange reserves to pay the higher import bills. In such a case, a depreciating rupee and widening current account deficit will be back on the table.

According to Alan Higgins, CIO – UK, Coutts, the immediate impact on the global economy looks limited. Higgins shared his views on Morningstar UK which have been reproduced below.

With about 90% of the country’s oil production being based in southern Iraq, an ISIS intrusion in that direction would cause more uncertainty. However, we note that in recent cases of internal turmoil in oil-producing nations, such as Egypt and Libya, oil production resumed its flow after a brief interruption, and therefore it’s understandable that the market remains fairly sanguine about the current situation in Iraq.

Even if there were to be a more significant disruption to oil supplies, the U.S. has the capacity to act as supplier of last resort, given its ample “strategic reserves”, which could help keep oil prices reasonably stable.

The global economy could in any event cope with a gradual rise in oil prices, even if they were to go up 20% towards $140 per barrel. The Brent oil price rose to $120 during the Arab Spring in 2011, which had little impact on global growth and inflation. That said, the Arab Spring weighed on risk assets, such as equities, and the current situation in Iraq could similarly cause periodic bouts of risk aversion.

He concludes by saying that if oil prices were to rise dramatically, Japan, China and India would be most at risk given their dependence on oil imports.

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