For some time, it seemed that the rout of crude oil had finally ended. After falling from $115 a barrel last June to $45 at end January, Brent oil made a smart comeback and rose more than 40 per cent to $66 in mid-May.
Those bullish on oil were hopeful that crude oil would recoup more lost ground. But this optimism was short-lived, with Brent again falling to about $56 a barrel currently. Nearly a dollar was shaved off today after the Iran nuclear deal. Here’s what’s continuing to keep a cap on crude oil.
US shale and Saudi output
Mega oil producer Saudi Arabia is engaged in a high-stakes standoff with US shale oil producers. Among the key reasons for the rout in crude oil was the sharp rise in US shale oil output, aided by new technologies such as hydraulic fracking.
The US is among the world’s mega oil guzzlers, and the rapid growth in domestic output (and consequent decline in imports) was a game-changer for global crude prices. The traditional oil producing and exporting countries, many of which are part of the Organization of the Petroleum Exporting Countries (OPEC), found themselves facing a massive challenge.
The rally from February until mid-May suggested that the Saudi strategy was working and that US shale oil producers might have been priced out of the market. Indeed, there was a decrease in US crude oil inventory which, along with an increase in the number of idle rigs, suggested that supply in the country is slackening.
Cat-and-mouse game
But then, the sands keep shifting. As the crude oil price inched up towards $60-$65 levels, many shale oil producers in the US, who may have chosen to lie low, would have found it viable to make a comeback. So, many idled rigs and wells would have got cracking, and again exerted downward pressure on global oil prices.
Meanwhile, Saudi Arabia has shown no sign of backing off from its policy of keeping production at high levels to maintain market share. At its meeting on June 5, OPEC again decided to maintain production levels. Saudi Arabia’s output has in fact increased in recent months to record levels. The cat-and-mouse game is likely to continue.
The world’s economic superpower is unlikely to let go of the opportunity to secure its energy independence and add to its geo-political heft. Meanwhile, the entrenched incumbent oil exporters will fight for market share until they can. Supplies have also been increasing from countries such as Iraq and Libya, despite the ongoing strife there.
Iran is back
Years of negotiations have finally culminated in a nuclear deal between Iran and six major world powers. This will pave the way for lifting of sanctions against Iran and can significantly add to the global supply of crude oil in the years to come. Ergo: oversupply could increase and prices may come under further pressure.
Earlier in the year, the US Energy Information Administration had estimated that $5-15 a barrel could be shaved off oil prices in the short run, if and when the sanctions against Iran are lifted.
Tepid demand
There is more than adequate supply, on the one hand, and, on the other, global demand for crude oil remains weak. The economy of China, a massive oil importer, seems to be on shaky ground. Add to this the troubles in Greece and Europe, and demand pick-up is likely to stay weak in the near to medium term — hardly good news for oil prices.
Good for India
Now, oil producing countries and companies may be unhappy with the state of affairs, but for India which imports more than three-fourth of its needs, the crude oil rout has come as a godsend. The import bill has been cut significantly, and this has contributed to improvement in macro-economic indicators such as the current account deficit and inflation, which have reduced sharply.
The fall in crude oil also resulted in a sharp drop in fuel under-recoveries – which results from public sector oil marketing companies (OMCs) selling petroleum products below cost. Total under-recoveries nearly halved from almost ₹140,000 crore in fiscal 2013-14 to just over ₹72,000 crore in 2014-15. If current price trends hold, the figure should be much lower in 2015-16.
The dip in under-recoveries is good news, not just for the OMCs (Indian Oil, HPCL and BPCL), but also for the Centre and public sector upstream companies (ONGC and Oil India) and GAIL (India), which bear the chunk of under-recoveries through cash compensation and product discounts to the OMCs.
The sharp fall in crude oil prices gave the Government enough leeway to decontrol diesel prices late last year. This was among the most significant pricing reforms in the oil and gas sector, and slashed under-recoveries significantly. Now, under-recoveries remain only on domestic LPG and kerosene. Lower diesel and petrol prices also gave the government room to increase excise duties on the fuels, and add to the exchequer. Major oil importing countries including India will be hoping that the crude oil market remains bountifully supplied and prices stay subdued.