With crude at a 7-month low, should India be celebrating?

With crude at a 7-month low, should India be celebrating?

A decade ago, any political turmoil in the West Asian region would have an immediate impact on the oil market. Now, despite growing tensions between Saudi Arabia and Qatar, Brent crude, the international benchmark, has fallen to as low as USD 45.62, its lowest level since November.

This was partially a reaction to increase in supply by Libya and Nigeria, both of which are exempt from the production cuts announced late last year. At that time, OPEC (Organisation of Petroleum Exporting Countries) and other non-OPEC producers such as Russia agreed to cut output by 1.8 million barrels a day for the first six months of 2017.

That deal had helped oil to claw back to levels of above USD 50 per barrel from lows below USD 30 witnessed in January 2016. In May, OPEC and other oil producers extended cuts into March next year in a further effort to increase prices, but the price of Brent crude continued to head downwards.

So what’s causing the persistent weakness – non-OPEC production or demand?

According to International Monetary Fund, supply factors have played a somewhat larger role than demand factors in driving down oil prices.

Oil production from countries outside the OPEC currently represent about 60 percent of world oil production. Key centres of non-OPEC production include North America, regions of the former Soviet Union, and the North Sea.

Oil prices are not only affected by actual non-OPEC production, but also by changes in expectations about future non-OPEC supply. Upward revisions in expectations of non-OPEC production contribute to downward pressure on oil prices.

READ  Teenager Stands Before Running Train To Complete Blue Whale Challenge, Dies

In recent times, the US shale industry has come back with a bang, thanks to oil prices moving back above USD 50 a barrel. The US Energy Information Administration sees output rising 300,000 barrels a day to 9.2m b/d in 2017 before adding a further 500,000 b/d next year.

Drilling in the Permian basin in Texas and New Mexico is once again expected to lead those gains, with output poised to rise by 71,000 barrels a day in June.

Those are big numbers but only tell half the story. The industry has squeezed down costs during the two-year downturn and executives are talking up efficiency and production gains that lead many to forecast an even bigger rebound. According to energy analysts, it would not be entirely inconceivable to see combined US and Canadian output rising by 1m b/d in 2017.

Stronger-than-expected North American production poses a serious threat to OPEC. The biggest short-term problem for OPEC is that U.S. inventories keep on rising.

Investors had lined up to back OPEC’s cuts, amassing the biggest ever bet on rising prices in the first two months of this year. But oil’s failure to break higher in 2017 meant that position was getting more expensive to defend. Traders say it is not surprising funds have started to scale back their positions — a move that probably accelerated after oil’s recent drop.

If the supply picture has many moving parts, demand should be easier to track, and may provide some comfort.

According to the IMF, lower oil prices should translate into higher spending and therefore support global growth. Although oil price gains and losses across producers and consumers sum to zero, the net effect on global activity is positive. The reasons are twofold: Simply put, the increase in spending by oil importers is likely to exceed the decline in spending by exporters, and lower production costs will stimulate supply in other sectors for which oil is an input. Thus a collapse in demand is unlikely.

READ  Coal India's April coal despatch grows 6% to 45 mn tonnes

While the rise of electric cars has led some big players in the industry to warn of oil demand tapering off after peaking in the near future, others are far more sceptical. Analysts at Morgan Stanley point out that the conventional global car fleet is increasing by 40 million a year, net of scrapping. That alone should account for about 600,000 b/d of growth, or half the 10-year average. Higher use in planes, freight and petrochemicals will also boost consumption.

EIA (US Energy Information Administration) forecasts the market to be in balance and predicts Brent spot prices to average USD 53/b in 2017 and USD 56/b in 2018.

What does it mean for India?

With crude constituting over 30 percent of total imports and around 70 percent of its current account deficit, the gains from a lower oil price are obvious. India’s current account deficit (CAD) has contracted from 4.8 per cent of GDP in 2012-13 to 0.7% in 2016-17 as the sharp contraction in trade deficit aided by decline in oil imports outweighed the decline in net invisible earnings.

According to economists, a 10 percent reduction in crude oil prices could reduce Consumer Price Index-based inflation by around 20 basis points (bps) and bring about a 30 bps rise in gross domestic product (GDP) growth. A USD 10 a barrel fall in oil prices reduces the country’s import bill and, hence, the current account deficit, by USD 10 bn or 0.48 per cent of GDP.

However, a sharp downward spiral in oil might not augur too well as the deflation in Gulf States could impact employment (seven million Indians are resident in the Gulf countries), remittances and exports to these countries.

READ  U.S. crude stocks rise, product inventories down EIA

In addition countries that run large sovereign funds like Norway, Saudi Arabia, Abu Dhabi, Qatar, or Kuwait would not see the kind of surpluses that they used to and will have less capital to send out, which could impact capital flows into India.

So it is neither low, nor high but a sustained stability in oil prices that India should look forward to, in order to reap structural benefits in the long run.

Source Link: CLICK HERE

Leave a Reply

Your email address will not be published.