The oil slump and beyond

Yesteryear’s seemingly fictional forecast “US$30 per oil barrel” has become a reality. The oil industry, today, with its history of booms and busts, has been overstrained by an “irrational” low, from a record high of US$147 a barrel in July 2008. This cannot even pay off the production cost of brown fields leaving aside non-conventional shale oil. And, nearly US$400 billion oil investments are put on hold; nearly two-thirds of drilling rigs are de-hired and an estimated 2,50,000 workforce is slashed.

In addition to pricing gloom, ever since the first oil well drilled in Pennsylvania in 1859, the oil industry has been enduring several disheartening conjectures on sustainability of petroleum resources. The Hubbert bell curve replicates a typical reservoir development profile of an oil field and thereby postulates the “peak oil” theory. As a corollary, there has been envisioning of a transition towards renewable energy. However, the investments in renewable energy, so far by E&P companies, have less prospective business elements than compulsive elements owing to environmental obligations and green social responsibilities. Moreover, the bigger question is whether the technology alone can improve the bottom-line of non-conventional and renewable energy sources. The renewable energy strategy will be the biggest dilemma for the oil industry in future.

Then, is it a paradigm shift from the paranoia of peak oil to an oil drenched economy? Certainly, the oil industry has been passing through tough times forcing companies to delay development projects and shelving their production costs; although, no production cut is visible yet. The prospective oil reserve bases to pursue marginal and non-conventional development projects have become contingent. This slump emerged at a time when one needs oil pricing to capitalize the brown fields, non-conventional resources and to incentivize renewable green energy for climate change targets.

There has been concoction of elucidations to this slump, typically in line with geopolitical elements, national demands and wild price war with conspiracy theories. Undoubtedly, the geo-political elements always play a major role in energy market. There have been weak demands from the European countries and China due to slow economic growth. Again, there is an oversupply situation due to surging production from US shale oil and moderately favourable geo-politics. The shale oil exploration has increased US crude production by over 70 percent since 2008 pushing out Saudi, Nigerian and Algerian oil to competing Asian markets. The OPEC has been pumping crude oil without volume reductions and this strategy has been viewed as a deliberate step to make shale oil exploration uncompetitive in the United States. Although, the shale oil production is not competitive below US$60 per barrel; the producers are still pumping oil, at least, to pay off debts. Again, Iran has re-entered the export market after lifting of sanctions. Canadian and Iraqi oil exports are rising year after year.

Russian economy, with oil and gas accounting for 70% of export incomes, loses about US$2 billion for every dollar fall in the oil price. Despite this, every major oil producer is speaking the same line, “If we cut, the importer countries will increase their production and this will mean a loss of our niche market”. Venezuela, one of the world’s largest oil exporters, had troubled economy even before the current oil slump, maintains the same line. World’s second-largest crude producer, Saudi Arabia is rather more cautious based on historical learning from 80s that badly affected the Saudi economy. Although Saudi Arabia needs oil prices to be around US$85 in the longer term, with comfortable reserve fund of some US$750 billion, it can withstand lower prices for some time. Other OPEC countries, the United Arab Emirates and Kuwait have also considerable foreign currency reserves. However, Iran, Iraq and Nigeria are constrained by greater domestic budgetary demands from oil exports.

The oil bankruptcies and sovereign defaults may have immediate impacts on global economy. Except US, other major developed economies including Japan and European Union are struggling in stagnation. Except India, most of the emerging market economies like Brazil, Indonesia, Nigeria, South Africa and Russia are already under depression. The lower oil prices won’t fully nullify the consequences of a slowing Chinese economy viewed as a prime cause for the current oil slump.

However, the falling oil price is certainly a blessing for India as it has direct bearing on macro-economic fundamentals. The recent slump could ease the subsidy cuts and increased taxes on oil in “turning a carbon subsidy regime into one of carbon taxation”. India imports nearly 80% of its total oil needs and it accounts for one third of its total imports. A fall of one-dollar in the price of oil saves about Rs 40 billion of import bill. Again, a fall in oil prices by US$10 per barrel helps reduce the current account deficit by US$9.2 billion and push up the GDP growth by 0.3 percent. If the oil prices stay low, the cost of India’s fuel subsidies and “under-recoveries” by PSU oil companies could fall by US$2.5 billion this year.

The fiscal policies should be governed by the economics of natural resources that demands abolishing state subsidies and the oil market should account for the externalities. However, the fiscal prudence shown recently by the Indian government may be a mere coincidence. Why are not petrol and diesel prices moving in the same proportion as falling crude oil prices? The excise duty from petroleum products that is 25-45% of overall excise duty is a key source of government revenues in India. The government has raised excise duty on oil to swab the gains from downstream entities as the expectations are not in favour of a sharp fall in petrol/diesel prices. It can be seen as the leveraging of the falling crude oil prices for long-term fiscal stability.

Again, India is the sixth largest exporter of petroleum products and earns $60 billion annually and the global oil slump may affect the exporters. However, it may be an incentive for private refiners like Reliance and Essar to consider re-entry to the domestic retail marketing. The major downside is slowing down of the upstream sector and the next auction of the New Exploration Licensing Policy (NELP) may not receive a considerable response.

The incredible history of human prosperity has been the evolution and factoring of petroleum resources as the basic drivers of growth. The factored international oil price is a strenuous resultant of geopolitics and the rationale of market economics. And, irrespective of transitory demand destructing phases, environmental concerns or sustainability worries due to its finite nature; petroleum will continue to play a larger role in our lives not just in immediate future.

  • Indrajit Borah (The Eastern Today)

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