… This FICCI Research Team’s Economic insights series continues from the first post: “Oil Production Agreement by OPEC and Non-OPEC countries”
OPEC’s Oil production cut announcement’s Impact on oil prices
Following the announcement of the proposed output cut on November 30, 2016, Brent oil prices spiked to over US$ 50 per barrel and further to US$ 55.72 per barrel on 13 December 2016. On similar occasions in the past in years 2008, 2001 and 1998, when OPEC announced production cuts, oil prices had reacted in a similar fashion, rallying in following weeks and months.
In 1998, Asian Economic crisis and higher OPEC production led to a sharp fall in oil prices, following which OPEC curtailed its output level in mid-1998. Though initially prices of oil dropped, they recovered beginning 1999 and with further production cut prices rose to over US$ 20 per barrel. Similarly in 2001, a weakened US economy and increases in non-OPEC production put downward pressure on prices. In response OPEC once again entered into a series of reductions in member quotas cutting 3.5 million barrels by September 1, 2001. However, in the wake of the terror attacks of September 11, 2001 oil prices plummeted. OPEC undertook further production cuts in early 2002, which had the desired impact and oil prices moved into the US $ 25 per barrel range.
In 2008, the falling petroleum demand which was an outfall of US recession, hit prices hard with prices dropping to US$ 40 per barrel. OPEC undertook production cuts in January 2009, and prices rose steadily supported with rise in Asian demand for oil. This time around also, prices are expected to go up, once the production cut is implemented in January 2017.
According to estimates of various financial institutions, crude oil prices will be around US$ 52-60 per barrel in 2017.
Oil surplus to turn into oil deficit scenario
The rise in oil prices is expected to be supported by decline in global oil inventories and a possible deficit scenario in 2017. Demand for oil is expected to be higher than supply pledged by the countries and this is expected to bring down the global stockpiles by the second half of 2017 and aid in rebalancing the oil market. According to estimates by the International Energy Agency (IEA), if the production cuts are adhered to by the OPEC and non-OPEC producers, then the oil market is likely to wipe out stocks and move into deficit in the first half of 2017. This should aid in pushing up prices. The underinvestment in the sector in recent years also possibly adds to the upward potential to prices. However, lack of strong demand drivers for crude oil could undo the impact of the cut. The US Energy Information Administration (EIA) though expects global liquid fuels consumption to increase in 2017 to 96.99 million bpd from an estimated 95.43 million bpd in 2016.
Impact of higher oil prices
The oil exporting countries stand to benefit immensely with an increase in prices, however oil-importing countries, including India, would have to bear the brunt in case international crude oil prices increase substantially.
OPEC’s oil production cut: Impact on India
India is one of the largest importers of crude oil and around 80% of the crude oil requirement of the country is met through imports. India has benefitted immensely from the low oil price regime over the last two years. However, with expected rise in oil prices, India faces a higher oil bill in the immediate future with impact on the fiscal balance and government finances. The international crude oil price of Indian Basket has risen from a low of US$ 28.08 per barrel in January 2016 to US$ 49.25 per barrel as of October 2016. Following the agreement on production curtailment, the crude oil price of the Indian basket has further risen to US$ 52.35 per barrel as of 16 December 2016.
In 2015-16, though oil imports in quantity terms rose by 7.7%, the import bill was lower by almost 40% (in Rupee terms) due to the drop in international oil prices. In 2016-17, however, the price of Indian Basket crude has already shot up by around 43% since March 2016, this would definitely lead to massive increase in the oil import bill implying widening external deficits. The import bill would also be strongly influenced by the changes in exchange rate (strengthening of the US Dollar).
Retail fuel prices are also set to rise. Since the beginning of 2016, prices of petrol have risen by around Rs. 5 per litre, while that of diesel have risen by around Rs. 7-10 per litre. Earlier, the entire benefit of the drop in international crude oil prices was not transferred to retail prices of fuels. The impact could be visible in the inflation numbers also. Easing of inflation in recent times was largely due to the correction in the heavily weighted food prices inspite of the upward rise in fuel prices/costs.
In addition to government finances, corporate profitability would also reel under pressure as gross margins would be adversely impacted by rising commodity prices. Prices of crude-oil derived products, which serve as intermediates to various industries would also increase adding to cost pressures for companies.
Next: Factors affecting the success of Oil Production agreement