Shishir AsthanaMoneycontrol Research
The world’s oil producers have finally managed to work around their differences and reach a conclusion to cut oil production. Oil markets were anticipating an agreement, but the extent of the cut took everyone by surprise.
Rising oil inventory and stressed financials was the driving force that pushed the Organisation of Petroleum Exporting Countries (OPEC) to see reason in cutting production. The oil industry was literally running out of storage space and had to act fast on cutting production.
While analysts are expecting oil prices to trade in the USD 50-USD 60 per barrel mark, OPEC members are looking at a figure of USD 70. Venezuelan Oil Minister Eulogio del Pino said that within nine months, OPEC’s deal should bring inventories closer to normal levels and potentially lift crude prices as high as USD 70 a barrel.
For India, either case does not augur well. India is not only affected by rising oil prices but also by falling rupee against the dollar. These factors will add to the economic stress being felt due to demonetisation, even if that is a temporary phenomenon.
India imports oil at the rate of 4.29 million barrels per day. Every dollar rise in oil prices results in USD 128 million to the oil import bill every month or USD 1.54 billion every year. If crude oil touches USD 60 then oil import bill can rise by over USD 15 billion a year.
Import bill for FY15 was USD 113 billion and expectation for the current year is USD 65 billion. Though we still have only four months left in the present year FY17 could see oil import bill rise to USD 94 billion if price touches USD 60 and USD 110 billion if it touches USD 70. The sharp rise in oil import bill will impact Prime Minister Narendra Modi’s plan of passing on the benefit of demonetisation as a price of USD 70 for oil will increase the oil bill by Rs 3 lakh crore.
OPEC’s agreement to slash output, the first since 2008, will help narrow the supply-demand gap faster than expected. The group has decided to cut production by 1.2 million barrels per day to bring their production down to 32.5 million. More importantly, for the first time in 15 years Russia has agreed to participate in curbing production and has announced a 300,000 barrel per day cut.
The International Energy Agency (IEA) had warned that oil stockpiles, which were already at record levels, would expand for a third consecutive year in 2017 unless OPEC cut production. As per the agency’s estimates, they were at 300 million barrels of oil, enough to fill 150 supertankers. Most of the oil inventory is presently stored in these floating tanks.
There may be hope for India in the fact that OPEC tends to exceed its agreed quotas with some members routinely flouting agreements.
Oil prices have jumped by near 15 percent over the last fortnight, first in anticipation of the cut and then in response to the higher-than-anticipated cut, but many analysts are still apprehensive of the deal. This is because OPEC members do not have a history of adherence to production cuts.
Adam Longson, commodities analyst at Morgan Stanley, said that OPEC exceeded its quota by an average of 883,000 barrels a day from 2000-2008. Saudi Arabia was the only country in OPEC that more or less stuck to its production levels. Other analysts do not trust the Russians, Iran and Iraq to stick to their production numbers.
The key problem is OPEC does not have any power to enforce the production cuts, nor are there any penalties for those jumping the line. Further, the production cut is time-bound and will come up for reassessment in six months’ time.
To top it all, USA with its shale oil production has the potential to spoil the party. The latest production data shows that US production has touched 8.7 million barrels, nearly 1 million barrels lower than last year’s production level. Shale oil production has been a victim of the fall in oil prices as production cost for this form of oil is much higher than others.
Adding to the fear of higher production from USA is president elect Donald Trump’s policy of easing federal restrictions for oil production in the United States.
Analysts fear that a spike in oil prices would result in more rigs coming online in the USA, adding to the supply glut. USA shale oil has the capacity of exceeding the cut announced by OPEC and bringing oil prices lower.