Commodity Analysis

Crude prices can skid again

Anand Kalyanaraman | Updated on January 23, 2018 Published on May 17, 2015



As oil prices rise, many idle rigs and wells will restart production

Is the rout in crude oil finally over? The more than 40 per cent rise in the price of Brent oil — from about $45 a barrel in late January to $64 now — tempts one to think so. But it may be premature to conclude that oil has found its feet again.

The rally, which picked up pace from end-March, has been driven primarily by two factors. One, there was a decrease in US crude oil inventory along with a continuing increase in the number of idle rigs in the country. This suggested that supply is slackening in the world’s mega oil guzzler, and that deep-pocketed producer Saudi Arabia, which is engaged in a high-stakes standoff with US shale oil producers, has managed to out-price competition. Saudi Arabia’s refusal to cut production levels had exacerbated crude oil’s fall last year. The Saudi strategy was to maintain market share through low prices, while making it unviable for many US shale oil producers to continue drilling. Next, geo-political tensions with Saudi military intervention in Yemen and protestors’ blockade of a port in Libya raised fears of supply disruptions. Worries that the supply situation could be tight in the second half of the year has seen crude oil recouping some lost ground.

But both the above factors may not have the expected impact. As crude oil price approaches $65-70 levels, many shale oil producers in the US, who have chosen to lie low for the time being, will likely find it viable to make a comeback.

So, many rigs and wells which have been idled could get cracking. As output rises, oil prices could again come under pressure.

Supply shocks unlikely

Also, tensions in West Asia don’t necessarily translate into oil supply shocks. For instance, despite the rampage by the ISIS in Iraq last year, oil supply from the country increased. So did supplies from Libya despite the continuing strife there.

Indeed, counter-intuitively, the rout of crude oil happened at a time of great turmoil in the major oil producing regions of the world. Weak demand due to frail global economic conditions and increasing shale supply, as also higher output from West Asia, put crude oil on a slippery slope.

The real possibility of significant increases in supplies from Iran, if sanctions against the country are lifted, may also add to the over-supply situation in crude oil and squeeze prices.

The US Energy Information Administration estimates that $5-15 a barrel could be shaved off oil prices in the short run if and when the sanctions against Iran are lifted.

Saudi Arabia, meanwhile, is showing no sign of backing off from its policy of keeping production at high levels to maintain market share — its output has increased in recent months.

And in the run-up to the crucial meeting of the OPEC on June 5, it is keeping its cards close to its chest.

In a recent interview with CNBC, the Saudi oil minister Ali Al-Naimi stated that no one could set the price of oil, it was a matter of divine dispensation.

Showing the way

Major oil importing countries including India would be hoping that Providence keeps the market bountifully supplied and prices subdued.

A sharp spike in prices could send the budget projections of subdued fuel subsidies for 2016 awry and re-ignite inflation which has been on a downtrend over the last year.

Also, the proposed stake sales in major oil companies such as ONGC and Indian Oil could be jeopardised, if the subsidy burden shoots up.

The government, though, could draw reassurance from the prognosis of major oil producing companies, which project that the commodity’s prices will remain subdued.

In the recent March quarter, Vedanta took a massive ₹19,180-crore charge for impairment of goodwill generated on the acquisition of oil producer Cairn India. This, it said, was necessitated by the steep decline in the price of crude oil.

Its cash flow calculations are now based on oil price of $60 a barrel in 2015-2016, increasing to $84 a barrel only by 2020, and an escalation of 3 per cent annually thereafter.

If crude oil prices do follow this trajectory, India will not have much to worry about for some time to come.

Published on May 17, 2015
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