Can oil companies look away?
As crude oil prices are headed down, proper pricing is needed to align with market dynamics, analyses K. Raveendran.
28 Aug 2017 3:45 PM GMT
The elusive achhe din no longer holds out any promise; nor causes disappointment. We have become so used to the facts and tragedies of life that it no longer perturbs us. But suddenly there seems to be sufficient reason to feel optimistic about the possibility of some good days ahead, especially in the domain of petrol and fuel prices, which have been creeping up without our notice or attention. After the introduction of dynamic fuel prices, which involves the daily revision of retail prices on the basis of the prevailing international crude oil prices, petrol prices, for instance, have gone up by Rs 5.42 per litre in Delhi. It is a different matter that retail prices are higher compared to the days when crude oil prices were at the levels of $140 a barrel. Now crude oil costs a neat $100 lesser and faces the prospects of further falls.
The results of the latest OPEC meeting in Abu Dhabi are signalling further falls in petroleum prices and in retrospect, the Saudi-Russian deal last November has failed to stabilise the market as was expected with Brent/West Texas crude prices being 20 per cent below their 2017 peaks. Analysts feel that OPEC made a strategic mistake exempting Libya and Nigeria from its output cuts as both countries have flooded the physical crude market by more than 1 million barrels a day.
Iraqi compliance with the Vienna deal has been a joke at only 30 per cent. Kazakhstan actually raised output since last November. The US rig count has almost doubled since summer 2016 and the frackers of West Texas have produced 900,000 extra barrels a day since OPEC inked its historic deal in Vienna in November 2016. Saudi Arabia can no longer play the role of swing producer, or the role of the central bank of black gold it played in the Sheikh Yamani era, in the Age of Shale.
According to analysts, even a 1.8 million barrel a day output cut by OPEC, along with Russia, and other global oil producers has been insufficient to rebalance the world crude oil market. The North Korean geopolitical crisis has cast a shadow on Asian oil demand growth while prices have now fallen to below post-Vienna deal levels. In 2009, Saudi Arabia had engineered a 'shock and awe' 4 million barrels a day OPEC output cut, the biggest since Sheikh Abdullah Tariki and Juan Pablo Pérez Alfonzo founded the organisation in 1960. This was sufficient to lead to a major rise in crude oil prices from a post-Lehman low of $38 in the global recession of 2009 to as high as $115 in June 2014, the month this millennium's most traumatic oil price crash began. The world needs a credible Saudi brokered 3 million barrels a day oil cut and compliance by major producers like Iraq, Iran, Nigeria, Angola, and Algeria.
Global financial and political realities make such a 'shock and awe' OPEC deal impossible to negotiate and more difficult to enforce. The result? The global supply glut worsens. Speculators continue to sell crude oil futures in the financial pits of London, New York, Chicago and Singapore – and Brent crude once again falls to $40 a barrel. The velocity of US shale oil production is simply beyond the control of OPEC, which barely supplies one-third of global crude. Compliance with the last Vienna's output deal has been poor by some of the OPEC's biggest producers, notably Iraq. The Qatar crisis is yet another bearish data point for oil prices, say observers.
Analysts feel it is only a matter of time before Saudi Arabia and Russia conclude that there is no point in bearing the disproportionate political and financial burden of the Vienna deal. That will be the point when crude oil prices collapse, possibly down to the February 2016 lows of $28 a barrel. Meanwhile, the rise in US land drilling rig counts and supply elasticity of production promises another surge in US shale output.
The Energy Information Administration in Washington predicts that the US will produce 9.9 million barrels a day in 2018, the highest Uncle Sam ever produced. This surge in American output in 2018 means the odds of another oil price crash become almost certain and the strategy of relying on Saudi output cuts to stabilise the world oil market will no longer work. In any case, US producers are programmed to hedge their output any time prices approach $50 in the West Texas spot crude. Like gold in the 1990s, hedging by thousands of small producers almost guarantees a protracted bear market in crude oil. This is the reason why even the fall in US crude inventories has not been sufficient to boost prices in August. The surge in US gasoline storage is also an ominous sign as the US summer driving season is set to end after Labour Day in September. The collective net long position in West Texas crude oil futures could well unwind with a vengeance by October.
Non-OPEC output growth is another bearish data point for crude oil prices. The International Energy Agency's growth estimates for non-OPEC output, in 2017, is 1.073 million barrels a day. The US, Canada and Brazil are all ramping up output after fire related outages were resolved. Russia and Kazakhstan, desperate for petro-currency revenues, have both rejected deeper cuts. This increases the odds of another oil price crash.
Crude oil prices around the 30s cannot but have an impact on domestic retail prices, although they do not automatically imply a proportionate reduction in fuel prices for consumers. The price of the Indian basket of crude oil has risen by over 11 per cent from $45.42 per barrel in the last week of June to $50.51 per barrel this week. The corresponding rise in the petrol price works out to 8.5 per cent.
Indian fuel prices are very truthful to crude oil price rises but do not follow the same logic when it comes to falling crude prices, though it is not the fault of market dynamics. Our fuel pricing policy allows only a one-way movement. So, don't blame the market.
(The views expressed are strictly personal.)
Next Story
