The world market witnessed one of the largest oil price declines following the oil price collapse in 2014; there was a 70% drop in oil prices between mid-2014 and early 2016. The oil prices recovered to some extent in 2017 after the OPEC and non-OPEC allies agreed to limit crude oil production at the end of 2016. Since then, oil prices have steadily increased and are at their highest level, 64.7 USD per barrel, since 2015.
Figure 1 Average annual OPEC crude oil price from 2014 to April, 2018 (in US dollars per barrel)
Source: Statista 2018
Reasons for global surge in oil prices
1. Demand and supply theory:
Supply: Generally, the increase in oil price is a result of OPEC’s influence on oil prices; OPEC controls 40% of the world’s supply of oil. OPEC was the major cause of cheap oil post-2014 as it refused to cut oil production, leading to a decrease in oil prices. The oil prices recovered to some extent in 2017 because:
- The OPEC and non-OPEC allies agreed to limit crude oil production till the end of 2018
- Oil producing countries like Venezuela, Libya and Nigeria are dealing with socioeconomic crisis leading to constrain in supply
- War in Yemen and Syria
- US withdrawal from Iran nuclear deal and increased sanctions
Demand: High demand for petroleum products from countries such as China, India, South Korea and Japan have led to a surge in oil prices in recent years.
2. Dollar value:
Most oil-exporting countries peg their currencies to the dollar. Therefore, a 25% rise in the dollar offsets a 25% drop in oil prices. The dollar’s value has been falling since December 2016. In early 2017, hedge funds began shorting dollar as Europe’s economy improved. As the value of the Euro rose, that of the US dollar fell. By April 11, 2018, value of USD had fallen to 89.53 from 102.95 in December 11, 2016.
3. Depreciation of Indian rupee:
Depreciation in the Indian rupee is also adding to rising costs of crude oil. While international crude prices jumped 45% in dollar terms last year, the spike was by 49% in rupee terms.[i] Moreover, the current trend of consistent foreign capital outflow from the domestic equity market has further weakened the Indian rupee.
Impact on Nepali Economy
1. Imports and General reserve
Since the Nepali currency is pegged to the Indian currency, the depreciating Indian currency has had a direct impact on increasing oil prices in Nepal. The lower value of Nepali currency will make imports expensive because Nepali traders have to hand over extra rupees to buy dollars in order to settle import bills. According to Nepal Rastra Bank (NRB)’s data for the first eight months 2017/18, growth in merchandise imports remained elevated at 22.1% to NPR 767.36 billion as compared to an increase of 44.2% in the same period the previous year. Similarly, total trade deficit widened 23.0% to NPR 713.93 billion in the first eight months of 2017/18. A high cost of import will widen the trade deficit, causing depletion in foreign reserves and leading to high levels of inflation.
The rise in import bills will be reflected in the final prices of retail goods and services. Hence, the inflation will increase as the imports become scarcer. Specifically, the rise in cost of petroleum imports will either have a negative effect on the balance sheet of Nepal Oil Corporation (NOC) or increase prices of petroleum fuel in the domestic market. The outcome will depend on whether the government opts for price rationalization or absorption of costs in terms of subsidies. It might then have spill over effects on transport and retail prices. According to NRB’s data for eight months of 2017/18, Nepal imported petroleum products worth NPR 100.60 billion, food and live animals worth NPR 97.05 billion and vehicles and spare parts worth NPR 84.91 billion.
3. Tight Liquidity
As the formal banking system is already facing tight liquidity, these developments would further dampen the money supply and Nepal’s growth trajectory would also make exports more expensive. The growth in deposit has been lower at 13.0% relative to credit off-take at 17.4% in mid-March 2018. This trend reflects tighter financial conditions.
On the other hand, a weak Nepali rupee benefits people in Nepal who receive remittance from those working abroad. Exporters might also benefit from a weak currency. Likewise, income from tourism will also gradually increase as foreigners can spend more following appreciation of the dollar.