Ruchi Agrawal Moneycontrol Research
Member nations of the Organization of the Petroleum Exporting Countries (OPEC) met on Friday to analyse and strategize the future course of oil production, amid a volatile geopolitical situation. The meeting highlighted the growing rift between the members and concluded with cloudy overall outcome and a plan to relax production cuts.
Despite strong opposition from Iran, Iraq and Venezuela, the group has announced that it will increase production by up to 1 million barrels of crude oil per day starting July 2018. This will be its first reversal of a production cut that has now been in force for the last 18 months.
However, there is still some uncertainty over how much share of the increased production each member country will pick up.
We believe the enhanced production from OPEC, along with rising US shale and Russian crude production, would reduce the supply side pressure on crude and help maintain the current softness in crude prices. The growing global demand would, however, provide support for prices.
What is the rift all about?
Amid rising geopolitical tensions, some OPEC nations have been fighting their own internal battles. The imposition of sanction on Iran by US is expected to remove some portion of Iranian oil from the global supply. Due to this, Iran fears losing out on market share to OPEC and non OPEC nations and this could seriously impact its budget.
With political-economic instability, hyperinflation and falling value of its currency, high crude prices come as a respite for Venezuela and any softening seriously impacts the already distorted budget of the country. Despite one of the largest oil reserves in the world, government has little resources to fund production operations thereby limiting the production capability.
Saudi Arabia on the other hand, with support from Russia and under pressure from US, is keen on grabbing the opportunity created by these constraints and expand market share and supports upping production.
Our expectation on crude price
We expect the production increase, along with enhanced flow of supplies from US shale, to reduce the supply side pressure on oil in the coming months. The price of crude has already softened and we expect the softness to continue and oil to hover near the $70 per barrel mark.
However, the global political scenario has been full of uncertainty. This coupled with an overall increasing demand for crude oil would set a floor for crude prices.
How could the decision impact Indian companies?
Softness in crude oil prices is positive for India's budget math, which had been under pressure because of higher oil prices until a few days ago. This would also cool off inflation a bit, and could impact the future course of policy decisions taken by RBI's monetary policy committee.
Lower crude prices come as a relief for oil marketing companies (OMCs) whose margins were under pressure for the past several months. We see realisations coming down for upstream oil companies, which had been the biggest beneficiaries of the increase in prices. However, companies like ONGC and Oil India would see some relief if the government increases its budgetary allocation for gas subsidies.
The reduction in crude prices would lead to some softening in gas prices as well, given the correlation between the two. This would come as a relief for gas downstream companies, whose margins came under pressure in recent months. Fertilizer, power and petrochemical companies, which use gas as a raw material, also stand to benefit with a reduction in gas prices.
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