This week, the price of Brent crude oil crossed $65 a barrel. From about $45 a barrel in end-June, oil prices have shot up more than 40 per cent. This sharp rally will have the government worried. India imports more than 80 per cent of its crude oil and the oil import bill for the year is likely to be much higher than estimated. This could strain government finances and weaken the rupee. Consumers, already upset at rising petrol and diesel prices, may have to brace for further price hikes.
The government, facing public backlash, cut excise duty on petrol and diesel a couple of months back to keep prices under check. But there are limits to this, with the exchequer already under pressure. So, the burden of higher crude oil prices could fall on consumers too. Higher oil prices could also peg up inflation, with petroleum products having a weight of about 8 per cent in the wholesale price index. Ergo: costlier oil has not-so-nice implications for us Indians.
So, on November 30, Indian policy-makers would have been closely tracking a key meeting in Vienna, hoping for a favourable outcome. That was not to be. The crucial OPEC meeting decided to continue with oil output cuts, in force from January 2017, beyond March next year until December 2018. The decision had the buy-in of some major non-OPEC countries too, which agreed to continue with the output cuts.
The output cuts had helped halt oil’s rout that commenced in mid-2014 and aided this year’s rally. The extension of these cuts is meant to provide further support to crude oil prices by squeezing supplies. Since the November 30 OPEC meeting, Brent crude has gained nearly $3 a barrel.
Oil exporter cartel
What is OPEC and why is it important?
OPEC, short for Organisation of Petroleum Exporting Countries, is a cartel of oil exporting nations. It was founded in 1960 in Baghdad with four major West Asian producers — Saudi Arabia, Iran, Iraq and Kuwait — and Venezuela as its founding members. The goal was to reclaim control of the global oil market from seven major international oil companies, known as the Seven Sisters. With some other oil exporting countries joining in over the years, OPEC today has 14 members. In addition to the founding members, the group comprises the UAE, Qatar, Nigeria, Libya, Gabon, Ecuador, Angola, Algeria and Equatorial Guinea.
But it is the Saudis who call the shots in the cartel, thanks to Saudi Arabia’s much higher production and exports compared with other member countries. It accounts for over 30 per cent of OPEC’s production, followed by Iraq and Iran (12-13 per cent) and UAE and Kuwait (8-9 per cent).
OPEC aims to coordinate the petroleum policies of its member-countries, which increase or decrease oil production in tandem to try to achieve desired supply levels and prices. This is based on a unanimous vote. That’s often complicated, though, with rivalries and internal contradictions within OPEC.
Saudi Arabia and Iran have been arch-rivals competing for geo-political dominance in West Asia for a long time. Relations between the Saudis and the Qataris are strained now, and Venezuela is in deep financial trouble. In the past, Iraq and Iran fought a multi-year war in the 1980s. Despite these conflicting pulls, OPEC members have managed to further their collective economic interest pretty well over the years. From low single-digits in the 1960s, oil prices gained manifold over the years, trading above $100 a barrel for much of 2011 to 2014, even as production cost was in low double-digits for many members including Saudi Arabia.
For long, OPEC was the prime mover in the global oil market. It could turn on and off the oil taps to control global prices. This dominant position was also used by the cartel to drive political goals. For instance, OPEC’s embargo in 1973 to protest the support of Western countries for Israel in the Arab-Israeli conflict saw oil prices quadruple from $3 to $12 a barrel.
OPEC – shale tussle
OPEC still remains a major force, accounting for more than 40 per cent of the world’s oil supply. But unlike earlier years, it is no longer the only show in town. This decade, the cartel came up against a formidable competitor — the US shale oil industry.
Technologies such as horizontal drilling and fracturing have enabled shale oil exploration on a massive scale in the US, the world’s largest oil consuming country. This huge expansion in shale oil output upended the dynamics of the global oil industry and precipitated the rout of oil.
Since mid-2014, oil prices more than halved, even going under $40 a barrel in late 2015 and early 2016. When the crash was underway, OPEC, instead of cutting production to support prices, initially adopted a strategy of maintaining output; this was meant to out-price US shale oil producers and wrest market share. The strategy only exacerbated the price rout but did not quite achieve the objective of bringing the US shale oil industry to its knees. Some did exit the market, but US shale as a whole has managed to hold on.
Change in strategy
Eventually, when low oil prices burnt a hole in the pockets of OPEC members themselves, the strategy was changed. Late last year, OPEC teamed with major non-OPEC producers such as Russia to cut production by 1.8 million barrels of oil a day, about 2 per cent of global production. OPEC alone cutting output may not have buoyed prices enough. Mega producers such as Russia, which are not part of OPEC, now command significant influence in the market.
The OPEC-major non-OPEC producers tie-up to cut output seems to have helped, even if with a lag. As piled-up oil inventories reduced, the oil price rout has given way to a rally this year. Improving demand conditions lent a helping hand. So did hurricanes in the US and the Saudi palace intrigues this year.
The extension of the output cuts in the November 30 meeting was along expected lines. One, many OPEC countries need high oil prices to balance their budgets. Next, high oil prices are imperative for the success of Saudi Aramco’s mega initial public offer (IPO) that is expected next year. This IPO is one of the building blocks of the plan of Prince Mohammed bin Salman, the power behind the kingdom’s throne, to make over the Saudi economy.
Even so, the output cut extension was not a total given. Russian oil companies were reportedly reluctant, given their apprehension of a sharp return of US shale oil at higher prices. Besides, Russia is less dependent on oil revenues than many OPEC countries. The Russians were also reportedly concerned about the appreciation of the rouble from higher oil prices; this could impact their prospects for other exports. So, the Russian go-ahead for the output cut extension may have been driven more by political considerations than by economic drivers. There are reports that the Russians may play hardball in the review meeting in June next year.
The oil price crash since 2014 benefited India significantly. While the country has been on the back-foot over the past few months due to the sharp price rally, there is hope that prices will not go up too much from current levels. US shale oil should come back to the market in a big way to take advantage of higher prices, resulting in a cap on prices. Reports say that there has already been a rise in US drilling activity that points to an expected rise in production. That’s something India will be hoping and rooting for.