Oil prices have plummeted in the last 8 months from $115 a barrel in mid June’14 to below $60 a barrel in Feb’15. Why the drop in prices is so sharp? Why are many countries not rejoicing the drop in price than as expected? How long this slump in price would sustain? Are the reasons and rationality behind this continuing drop in price more of a political than economic one? What does it mean to India?
OPEC the acronym for Organization of Petroleum Exporting Countries produces more than 40% of the world’s oil consumption. It is spearheaded by the Middle East countries, mainly dominated by Saudi Arabia. The cartel decides on the production & supply of oil, although the prices are determined by the market forces. Focusing on the cause of this sudden slump in oil prices can be reasoned around many factors.
The first such factor is the huge drop in the oil imports made by United States, one of highest oil consuming countries in the world along with China and India. They were able to achieve self sufficiency and curb their oil imports because of the boom of Shale gas. Between 2005 and 2013 the number of oil wells drilled and fractured for the production of shale gas, increased from a meager 150 to more than 2000 wells which is 10 times higher than that of Saudi Arabia’s total oil wells. Although critics forecast the drop in prices would not be prevailed longer leading to their skepticism over the production costs of shale gas which is almost 90% higher than that of oil. I see this forecast too vague in nature, for technology has always played a vital role in bringing down the cost of production of any commodity for that matter. Taking cue from shale gas itself, the production cost for the same has dropped from $70 per barrel to $57 per barrel. I see no reason why this can’t drop further and I would love to gamble on the same. While the discovery and usage of shale gas has proved as a vital clog in the oil prices drop, other factors such as decreasing consumption of oil, fuel efficient vehicles and the rise in usage of renewable fuels such as solar and wind power has added to it woes.
Not many countries seem to be rejoicing the drop in oil prices afterall. Countries like Russia, Venezuela and Nigeria have not only lost a bitter battle due to slump in oil prices, but also given their current economic scenario this might just hit them hard towards a recessionary environment. It does seem like the current cycle has more to do on political front rather than economically. Given Saudi Arabia’s stubborn stance on not cutting down the production, it does seem like they are betting on their $900 billion cash reserve to save themselves some more time to get their strategic plan right on track. Their tactics not to cut down on production will throw other oil exploring countries out of business in selling it at such a lower price. Again the Saudi’s seems too mindful about their bitter experiences in 1970s, when a big leap in prices brought out new oil field investments leading to a decade long glut. In simple terms, let the prices fall and put the high cost producers out of business esp. Russia in particular, which would lead to higher prices sooner or later.
Along with China, India might well be one of the biggest beneficiaries in the cycle of oil price drop. Infact decreasing oil prices has come as a Midas touch to the Narendra Modi’s government. Although both business and consumer confidence are back in the Indian market almost after a decade, the price drop of oil could further strengthen the economic mood in the country. Firstly, India will look to cut into the huge diesel subsidies that are being offered. By reducing fuel, food and fertilizer subsidies it can save up to a massive $41 billion annually, which is roughly 2.5% of GDP. Since the government has been compensating the sellers of oil for their losses, deregulating the fuel prices would significantly cut down the current account deficit by a large margin. As oil import constitutes a lion share of our total import bill, there is every chance that our foreign exchange reserve will improve by leap and bounds. Inflation rate has dropped from 10.2% at the end of 2013 to 5% in January’15. For sure the Indian market wouldn’t have dreamt of, such a bigger stimulus to their economic growth and development coming in terms of a huge slump in oil prices.
For once it looks like; it’s only the ‘I’ that stands tall of the term BRICS coined by Jim O’Neil. It’s time for India to make hay while the sun shines.
Aravind
