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Exploring the Unexplored

In this week's FinMail we explore the fields of Crude Oil and it's impact on an Economy. We also understand how everything gets affected by Crude Oil.

The Story:

Crude Oil has been in the news lately due to its rising prices. With the economies opening up after the ease of pandemic, it is pretty evident that Crude Oil's demand would push up. And as we know, with rising demand, there's also a rise in prices.

Last week, on June 22, Brent Crude Oil Futures for August rose 0.4% to $75.19/barrel for the first time since April 2019. The Brent Crude Oil prices have crossed the $75 mark again after 2 years.

Remember when Crude Oil Prices turned negative for the first time in history during May 2020? Yes, the WTI Crude Index went to as low as -40$/barrel in May 2020.

Wait, Hold on! First, we were talking about Brent and now about WTI? Yes, if you didn't know, there are different indices for different crude oil. Don't you worry, why are we here if we don't clear your confusion?

Why is Crude so important?

And why it is a headache for each country when crude prices rise?

How does one commodity affect the whole economy?

We are going to cover everything and explore all of your doubt fields and drill them out in this FinMail so let's just start right away.

Why is Crude so damn Important?

We see petrol and diesel price hikes or even it's price cuts making the headlines on news every now and then. It is considered extremely important for any nation to either import or export crude oil at the best price possible for them.

Keep aside everything, the world has even witnessed superpowers creating political tensions (and that's not even a new thing) and a war-like situation for the black gold. A small price to pay for salvation! Well, why? Let's understand.

Crude Oil has taken its place as a raw material in almost every economical activity. It is because Crude Oil goes in Energy Production, it goes in transporting every essential item, raw materials, and human capital, oil is also used as raw material in paints, tires, plastics, etc. and also it plays an integral part in the war and strategical activities. So basically it has its presence in almost all activity. And that's why it is also called "Black Gold" because it is the most precious thing. Remove Crude Oil from the equation and the world would come to a standstill.

Now imagine, if you had reserves buried deep, full of black gold. You would be more powerful and also rich, Wallah Wallah! Let's take a look at some top countries that export crude oil. United States, Saudi Arabia, Russia, Canada, Iraq, China, UAE, Brazil, Iran & Kuwait.

These countries are spread across the globe and thus the quality of the crude oil also varies from region to region. Also, some countries are located near to each other, geographically and politically as well. So there exists a Union or Group of nations that work together cooperatively with the purpose to keep the supply and therefore its price stable. One such union that has been throughout years is OPEC - Organisation of Petroleum Exporting Countries. OPEC was founded in September 1960 by 5 countries namely Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. Now it currently has 13 countries as its member.

Now that we have understood the unions of Oil Producing Nations, let us understand various benchmarks that are there in Crude Oil.

Benchmark of Crude Oil

Crude Oil is a type of fossil fuel that is obtained from the bottom of the earth. And these fuel reserves can be found out throughout the globe. Hence, there are different varieties of crude oils that are available in different regions. And hence these different varieties of crude oils are priced differently according to their quality and other factors. Take for instance, mangoes, we have Haphoos Mangoes, Ratnagiri Mangoes, Tota Mangoes, Kesar Mangoes etc. These mangoes are priced differently according to their quality and sweetness. So in a similar manner, we have different crude oils from different regions. These crude oils are given benchmarks according to their quality. Currently, we have majorly 3 Benchmarks that are acceptable globally which are:

1. WTI - West Texas Intermediate

2. Brent Blend

3. Dubai Crude

There are other benchmarks as well but these are the main 3 benchmarks. And also amongst these three only two, WTI and Brent are majorly used and among them, Brent is used as a benchmark for almost 2/3 of the supply. Benchmarks are used mainly because there are variety and grades of crude oil available and using a benchmark will help the buyers, as well as the sellers, get a reference for their sale/purchase.

Crude Oil differs in its quality, sulfur content, sweetness, thickness, and transportation and as a result, there is a price difference between WTI and Brent. In India, we import crude oil mostly from the Middle Eastern Countries and we follow the Brent Crude Index for our purchases.

Crude Oil and Its Impact on Indian Economy

India is the third-largest consumer of Crude Oil and we import almost 80% crude oil and the remaining 20% need is fulfilled by our local Crude Oil Production. In FY2020, India imported crude oil worth ₹7,17,000 Crores which stands at more than 3% of our GDP which is a massive portion and just by looking at these figures we can get an idea of the pressure it will have on our Import Bill if the Crude Oil prices increase just by $10-15 per barrel.

Increasing Crude Oil Prices would make our Import Bill larger and with exports remaining the same, it would increase our Current Account Deficit. We would have to pay more and more from our forex reserves. It will also have an effect on the International value of INR whereby the currency will depreciate against other currencies.

Passing on the effect:

The prices of petrol and diesel would also rise, of course. Now, with rising petrol prices, the government would come under pressure on whether to pass on the rising cost to the end customer or sustain them within themselves. If you remember, we did not see a daily change in petrol and diesel prices a few years ago, and the prices were updated once a week or once a month. So during that time, governments used to take a hit on them and sustain the daily volatility themselves. But now the governments are passing the daily changes on the customers themselves. So we see daily changes nowadays.

So, passing on the price rise to customers will mean that there would be fewer savings, it will also lead to higher inflation which will make all the other goods costlier as well. To control the price rise, RBI would need to raise the Interest Rates, and thus making borrowings costlier. It would impact the overall progress and profitability of the industries.

Government taking the hit:

If the government takes a hit on itself and pays all the price above a certain level, it would have an impact on the government treasury. Expenditures would increase and with the same revenue, the deficit in the budget would also widen. This will mean the government will either have to borrow more or mint (print) more money. This will also have a negative impact as the government would have to pay them more in the future. And of course, more and more borrowing & printing money would impact our Credit Rating & inflation as well.

So in and out, there's no good way of rising crude oil prices, it's just that if the government takes the hit on itself, they can postpone the negative effects on the economy.

Impact on the End Consumer

Direct - Increasing Crude Oil Prices would push up the Petrol and Diesel Prices. Increase in Fuel Expenses, Transportation cost will increase. (Air, Rail and Road Travel)

Indirect - As we looked, crude plays an important part in the economy and it is a raw material or a product that is involved in every activity. So with an increase in crude oil prices, production costs would also go up. Take for instance, your favorite Pulse Candy would no longer be profitable in ₹1 because with increasing Petrol/Diesel Price, its transportation cost (from ordering raw material to your nearest store) has also been increased. So, in this way every item would get costly as transporting them gets costly, affecting the overall price of goods and services.

The way out:

This is the reason why many oil-importing countries all over the world are working towards developing a sustainable economy to reduce its dependence on Crude Oil. Shifting towards green energy would help the economy reduce its import bills and save some money for other progressive activities as well. This we talked about what an economy or a nation can do to tackle the crude oil prices. Now let's take a look at what we as an individual can do to tackle the crude oil price rise.

How you can profit from rising Crude Oil Prices?

The answer is simple, be an Investor. Invest in the sectors and companies that get benefitted from the rising crude oil prices. Take, for instance, oil exploration/producer companies, if the crude oil price rise, they would get benefitted the most. Owning a part of it would definitely help you as well, right? There are also Futures Contracts of Crude Oil available on which any investor can bet on (way too tricky). If you believe that crude oil prices will rise, buy out a futures contract and you would also earn from the difference. The point is to be a benefactor rather than the sufferer. But this totally depends on your analyzing and research skills. You have to be informed enough about the trends in the sector and accordingly take any positions. And also, always consult a Financial Advisor and Invest according to your risk.

So that is it for this week's FinMail. Keep learning and stay safe.


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