Hardening of oil prices

Sushma Ramachandran

THE rising world oil prices have sparked concerns that the low price regime that has brought a bonanza to emerging economies like India may come to an end soon. Crude oil prices rose about 20 per cent in April to reach within the touching range of $50 per barrel, considerably higher than the $30 per barrel recorded just a few months ago. The phenomenally low prices had helped India, which is a big oil importer, to reduce its foreign exchange outgo on oil purchases. The enormous fuel subsidy bill has also been cut to size due to the steep fall in world oil prices over the last two years.

Fortunately, oil industry experts here do not expect the firming up of prices to continue for much longer. They maintain that world oil inventories are still very large and demand is not rising fast enough for a drawdown to take place on a significant scale as yet. As for international analysts, as usual there are widely differing predictions for the coming year. The investment bank Jefferies expects oversupply to flip into undersupply in the coming months. It is projecting a rise in non-OPEC output. Deutsche Bank and Commerzbank, on the other hand, feel the rally may not be sustainable for long as output from the OPEC is set to rise with production from Iran and Saudi Arabia likely to increase soon. Besides, the efforts to bring the cartel together to agree to a freeze on output have failed. As a result, production increases are expected shortly in several of the biggest producers like Saudi Arabia. Maintenance operations that had reduced supplies from the UAE are also likely to end leading to an increase in output from this major producer as well.

To understand the whole issue of crude oil pricing and the balance in world supplies and availability, one must look at the key element of shale oil. The recovery of oil from shale reserves in the US in a big way was the trigger for the decline in world oil prices over the last two years. The sudden availability of oil from domestic sources reduced demand from the biggest oil consumer, the US. In reaction to this development, OPEC producers, especially Saudi Arabia, decided not to adopt their normal strategy of curtailing output to maintain prices at higher levels. Instead, they allowed prices to float lower to rock-bottom levels in a bid to make it uneconomic for shale oil producers to continue operations. The fact is that existing shale oil producers have been able to continue producing at the current price levels. The low prices have only hit new fields which are not likely to go into production at the existing rates.  Reports from the US also suggest dramatic improvements in technology in shale oil production. It has been possible to improve output sharply from the same number of rigs and thus recoverable reserves become much higher. In addition, producers have adopted aggressive cost-cutting techniques which have enabled them to continue oil extraction even in the current low price regime. Technology thus has also played a spoiler for the oil cartel, OPEC, which used to control world markets with an iron hand not so long ago.

Even though crude oil prices have been climbing upwards in April, the month also recorded one of the biggest increases in oil output by the cartel. It rose to 32.64 million barrels per day in April from 32.47 million bpd in March, one of the highest levels in recent times. The largest hike is from Iran which is trying to reach the same production levels as prior to the imposition of the oil embargo. With world inventories still ruling high and demand slack, it looks as if the present price rally is a flash in the pan.

These developments are all good news for India. A country which has had an oil import bill of $147 billion in 2013-14 to $62 billion in the last fiscal, has been a big beneficiary of the crash in world markets. It has also been able to bring down its fuel subsidy bill from Rs 1.4 lakh crore two years ago to Rs 30,000 crore. It has not, however, passed on the full benefit of the fall in oil prices to consumers. There have been some cuts in the price of products like petrol, diesel and compressed natural gas, but it has not been to the extent of the decline in international rates. Even so, the decline in fuel prices has contributed to a moderation of inflation in the economy. In other words, the external environment in the area of oil has created a win-win situation for the government. 

Hardening of oil prices, however, could upset the apple cart for the exchequer at this stage. In fact, before the presentation of this year’s Budget, many economists had advised Finance Minister Arun Jaitley to keep to the fiscal deficit targets, simply because of the low oil prices were giving more buoyancy than ever before to revenue collections. The commentary was, if you can’t keep to the target this year, you will never be able to do it. 

In sharp contrast, the UPA government had to grapple with the highest-ever oil prices shooting up to over $100 per barrel. The enormous oil import bill and fuel subsidy burden made it difficult to keep the Budget in balance. 

In other words, oil prices are one of the keys to the health of the economy. But it is an external factor beyond anyone’s control. The only way in which the country can overcome this import dependence is to try and find more oil from its own geological reserves. A beginning has been made in the Budget by revamping the exploration licensing  programme to make it more investor-friendly. If the new approach turns out to be a success, it could well be the turning point for India to become more self-sufficient in the most critical commodity for the economy right now — energy in the form of hydrocarbons like crude oil and natural gas.