Cheap Oil’s Biggest Winner

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By Eric Ramoutar.

In July of 2008, just before the financial crisis, crude oil hit a record $147 per barrel. Seven years and one recession later, most of the global economy has been rebuilt. Sure, Europe is still teetering on the brink of recession, but American growth is back up above 3% and most analysts are optimistic about 2015. That broad economic success, however, has not percolated into the oil market. In the last seven months, the price of one of the world’s most valuable resources has fallen, and fallen, and fallen some more. Oil now stands at less than a third of its peak in 2007—47 dollars per barrel—a price collapse that has far reaching impacts in every corner of the globe.

Why So Cheap?

The dramatic drop in crude oil prices is the product of a confluence of geopolitical and economic trends. First, oil supply in volatile producing regions has been remarkably resilient. Iraq’s oil production, for example, set a 35-year high last month. Moreover, traditional oil giants like Saudi Arabia and its Persian Gulf neighbors have opted to keep production high even as prices and profits tumble in an effort to choke off rising U.S. shale oil production.

Over-performance on the supply side has been coupled with diminishing demand in key regions. As Europe slides closer and closer to another recession, fewer and fewer Europeans are choosing to spend their money at the pump. Asia too, is seeing receding demand. Chinese growth has slowed to about 7%, which is still strong, but feeble compared to the double digit Chinese growth of the last decade. Tough economic times have bled into Japan as well, where questionable economic policies have failed to produce meaningful results. The compounding demand slump and supply boom have driven oil down to less than $50 per barrel for the first time since the deep recession of 2009.

The Hidden Winner: India

The vast majority of analysis has focused on the economic impact of cheap oil in developed, gas-guzzling nations. But this narrow focus misses an even more powerful development being felt primarily in India. Of course, Indian drivers and consumers will get some relief at the pump just as Americans, Chinese, and Europeans do, but, there are two advantages that India will experience that will not be felt in most of the developed world: cheaper food production and subsidy relief. 

More, Better, Cheaper Food

India remains the largest agrarian economy in the world, where agriculture represents a whopping 17.4% of national production, 11.5% more than the world average and 3.1% clear of Indonesia, their closest competitor.

The connection between oil prices and agricultural output may not be immediate obvious, but the Economist offers some keen analysis that highlights just how intertwined the two are. They point out that agriculture is actually more energy intensive than manufacturing is, and oil is used in facets of farming from fertilizer use to water acquisition. In fact, John Baffes, a Senior Agriculture Economist at the World Bank, notes that one dollar of farm output requires four to five times as much energy as a dollar of manufacturing output. Declining oil prices benefit those that lean on agriculture, and India tops that list.

What’s more is that Indian farmers typically live under crippling poverty. Indian cultivators generally have not adopted new agricultural technologies as quickly as other nations, and massive food subsidies have discouraged experimentation and investment on many farms. That has made the farming remarkably unproductive and relatively unprofitable. The poverty shackling these farmers could be mitigated to some extent by cheaper input costs and larger profit margins.

No More Free Fuel

Certainly, agriculture reliant economies are not the only ones that will benefit from cheap fuel, so too will nations that have been crushed under addictive and dangerous fuel subsidy regimes. The problem of fuel subsidies persists in the world’s largest economies and its developing ones alike, and India has not escaped the temptation to subsidize. New Delhi offers an annual 2.6 trillion rupee ($42.4 billion), a mammoth figure for an economy of its size.

When Narendra Modi took over the Indian Prime Ministership in May, 2014, many to his political right were clamoring for cuts to fuel subsidies. Subsidy reduction, or even elimination, would go a long way in helping Modi achieve two of his core economic goals: pruning government interference and rebuilding Indian infrastructure. If government is going to get out of industry, it needs to stop suppressing commodity prices, and if it is going to make an honest effort to improve India’s insufficiently sophisticated infrastructure, it needs money from somewhere.

But Modi was initially hesitant to slash subsidies, and for good reason; cutting subsides to make gas more expensive is hardly politically palatable. However, the global downturn in oil prices might give the new Prime Minister a much needed break. If Modi were to propose a subsidy cut now (as he did for diesel in October), the return to a price based solely on market forces would be much easier to swallow than it would have been, say, eight months ago. In fact, A Wall Street Journal report references Indian Oil Ministry officials predicting that every dollar drop in oil prices would allow India to cut $1 billion in fuel subsidies without passing on the pain to ordinary Indians.

Narendra Modi was elected to office to reform. For now, political realities have stymied some of his ambition, but this period of cheap oil may just be the window that Modi needs. Cheap oil alone will not make Mumbai look like Monte Carlo, but it is a start.




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