Stock markets react to several factors, including economic, geopolitical, technological, and human.

One of the main factors they are responding to now is the pricing of crude oil. Since India imports over 80 per cent of its demand for crude oil, the rising price of crude translates into higher prices of petro products, which lead to higher inflation and a higher current account deficit, which causes currency depreciation.

This, in turn, affects the stock market, because foreign investors, who have invested in India in $, find their $ returns to be lower, given the fall in the INR. Foreign portfolio investors have so far pulled out $5 billion.

Yet the price of Brent crude had fallen from a high of $136/b in June 2008, to a low of $30/b in 2016. Thanks mainly to higher production of shale oil in the US, which went up from 5,000 barrels/day in 2008 to 8,831 in 2016.

This step-up in shale oil production in the US made it a major producer of crude oil and significantly reduced its oil dependency.

So, the question to ask is whether the US shale boom will continue to increase supply, thus bringing down prices of crude, or will it start tapering off, thus allowing OPEC to continue to dominate the market? If the former, India’s economy and stock markets would benefit. If the latter, we could witness turbulence.

Unlike traditional oil, shale oil is more capital-intensive. This is because the oil is found trapped in rocks, and to extract it the producer must horizontally drill. In traditional oil wells, the oil (like water) finds its own level, so it needs only one vertical drill to exploit the reserves.

To extract shale, several horizontal drills are required, entailing capital cost. This has to be funded. About 70+ per cent of shale is recovered in the first year, and thereafter the recovery tapers (long tail).

An excellent blog ‘Deep the Denial’ recently posted by Mike Shellman concludes that the capex undertaken by the shale industry has resulted in a debt of $285-300 billion and interest on long-term debt by the industry is $20 billion.

He concludes that the US shale oil industry is a giant Ponzi scheme, which will implode. The industry has produced negative cash flows. This is unsustainable. He estimates that 29 per cent of US shale production goes only to service its debt.

Another article, ‘The Coming Collapse of US Shale Oil Production’ analyses how shale oil production tapers off after the first year production and predicts that production of shale oil will fall faster than people estimate. For example, North Dakota Bakken production can fall from 1.1 million b/d to just 100,000 b/d by 2025, according to this article.

So also from other large shale oil basins like Permean and Eagle Ford. So, by 2025 US shale oil production can be expected to fall, according to this analysis, from 5 million to 1.3 million b/d.

If these analyses are correct, then production of traditional oil needs to increase.

Supply of this has been reduced due to other factors. Venezuela, which has the world’s largest reserves (more than Saudi Arabia) is a financial mess and because of it production is falling.

Iran has come under unilaterally (and illegally, without UN mandate) imposed US sanctions. These, and other countries, have caused a fall of over 2 million b/d in oil supply. Not enough is being invested by the oil companies to ensure enough production to meet rising demand from China, India and other countries.

It looks, therefore, that prices of crude oil will, again, rise.

Add to this the other factors of concern. The increased chances of a full-scale trade war, after the US increased tariffs yet again last week, on Chinese imports, being one. The chances of the US Fed hiking interest rates again, is another. This would lead to a further diversion of investment from equity to debt.

And, of course, the oncoming elections to the US Congress next week (a Republican victory would embolden Trump to be more aggressive); and in five States in India in November, followed by General Elections in 2019.

(The writer is India Head- Finance Asia/Haymarket. The views are personal.)

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