A few weeks after American missiles had taken out Syrian airfields. The price of the benchmark Brent crude rose the price of oil has crossed $80/barrel and the trend is upwards.

The markers were fuzzy. Traders were skeptical about the production agreement between OPEC and Russia to take out 1.8 mbd from the market and the robustness of demand.

In contemplating its policy response to a high oil price scenario, the government should draw upon the lessons of the past.

 

Points to study

 

• Background of speculation in crude oil market
• What is OPEC?
• What is the reason for rising crude oil price?
• What should Indian Government do in case of further rise in crude oil prices?

 

Background of speculation in crude oil market

 

The oil industry is full of economic booms and busts. As of October 2015, the industry is in a downturn, and the price of crude oil has dropped significantly.

 

Reasons for Sharp fall in Oil Prices in 2014-15

 

1. Organization of the Petroleum Exporting Countries

A leading factor in the sharp price drop of crude oil is that OPEC, a cartel of oil producers, is unwilling to stabilize the oil markets.

Prices of OPEC’s benchmark crude oil have fallen 50% since the organization decided against cutting production at a 2014 meeting in Vienna.

Of the participating countries in OPEC, Iran, Venezuela and Algeria have wanted to cut production to firm up prices. Saudi Arabia, the United Arab Emirates and other Gulf allies refuse to do so.

Iraq sits alone as the only OPEC country to not only maintain supply but actually increase it.

 

2. Oversupply of Crude Oil

 

Crude futures declined in late September 2015 given that the global oversupply is increasing oil stockpiles. Total oil production by year-end 2015 is expected to rise to over 9.35 million barrels per day, higher than the 9.3 million barrels per day forecasted in February 2015. This shows that not only is the market oversupplied, but supply is actually increasing.

Unrelated to futures, oil inventories have risen more than expected. The Energy Information Administration (EIA) reported on Sept. 30, 2015, that U.S. commercial crude oil including (Shale Oil) inventories rose by 4.5 million barrels from the previous week.

At almost 500 million barrels, U.S. crude oil inventories are at the highest level in at least the last 80 years, causing a decline in prices.

 

3. Declining Demand

 

While supply is increasing, demand for crude oil is decreasing. The economies of Europe and developing countries were weakening, which has caused the demand for fuel to lag.

China’s devaluation of its currency suggests its economy may be worse off than expected. With China being the world’s largest oil importer, this is a huge hit to global demand.

 

4. Iran Nuclear Deal

 

 

The Iran nuclear deal is a preliminary framework agreement reached between Iran and a group of world powers. The framework seeks to redesign, convert and reduce Iran’s nuclear facilities.

The U.S. nuclear deal with Iran allows more Iranian oil exports. The deal removes Western sanctions against Iran, and investors fear it will add to the world’s oversupply of oil.

Markets have already reacted to this news by decreasing the price of crude oil.

 

Reasons for increasing prices

1. Production agreement between OPEC and Russia to take out 1.8 mbd from the market
2. The collapse of The Venezuelan oil industry
3. Turmoil in the Middle East

• Domestic chaos in Libya
• Islamic State militancy in Syria and Iraq
• Houthi Rebellion in Yemen

4. US Exit from Iran nuclear deal (JCPOA)
5. Robust oil demand in China and India

 

The combined impact of tightened supply, higher demand and reduced inventory is a favourable environment for high prices of crude oil

 

How will rise in crude oil prices affect India?

 

 

If prices continue to rise, the government may have to roll back a part of the tax hike on petroleum products. This will adversely affect the fiscal math and the ability of the government to push capital

expenditure.

Private consumption could also get affected because of higher fuel bills.

Companies that benefited from lower oil prices may also see margin erosion as passing higher input cost to the consumer could be difficult at this stage.

Impacts on inflation

With a weightage of only 2.4% in headline CPI, the adverse impact will entirely depend on the extent to which higher crude oil prices are passed on to the consumers. Considering the general election next year, it is difficult to envisage a significant hike in retail fuel prices, and thus, the direct impact on CPI inflation is likely to remain muted.

Solutions

The government has effectively three options.

1. It can continue with the current market-related pricing system but nudge the companies to move prices incrementally and imperceptibly.

2. It can reduce the indirect taxes on petroleum products and forego its commitment to limit the fiscal deficit to 3 per cent of the GDP.

3. It could contemplate a variant of the old (and discredited) system of fixed returns with companies paying into an account (call it the “price stabilisation account”) as and when returns/margins exceed a predetermined cap and drawing down from the account when returns/margins fall below a stipulated minimum.

Miscellaneous Facts

 

Organization of the Petroleum Exporting Countries

Organization of the Petroleum Exporting Countries is an intergovernmental organization of 14 nations as of February 2018, founded in 1960 headquartered Vienna, Austria
An estimated 44 percent of global oil production and 73 percent of the world’s “proven” oil reserves, giving OPEC a major influence on global oil prices
Algeria ,Angola, Ecuador, Equatorial Guinea, Gabon ,Iran ,Iraq , Kuwait , Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, Venezuela ,
Trick To memorize OPEC members :- AQUA EVIL SKIN (Algeria, Qatar, UAE,Angola,Ecuador,Venezuela,IRAN,Libya, Saudi Arabia , Kuwait, Iraq, Nigeria)

 

Shale Oil

Shale oil is unconventional oil produced from oil shale rock fragments.

The resulting oil (Kerogen) can be used immediately as a fuel or upgraded to meet refinery feedstock specifications by adding hydrogen and removing impurities such as sulfur and nitrogen.

The refined products can be used for the same purposes as those derived from crude oil.

What is fracking?

 

Fracking is the process of drilling down into the earth before a high-pressure water mixture is directed at the rock to release the gas inside.
Water, sand and chemicals are injected into the rock at high pressure which allows the gas to flow out to the head of the well.

The process can be carried out vertically or, more commonly, by Drilling horizontally to the rock layer and can create new pathways to release gas or can be used to extend existing channels.

The term fracking refers to how the rock is fractured apart by the high-pressure mixture.

4. Types of Crude Oils

(a). Sweet and Brent Crude Oil

Sweet crude oil contains less than 0.5% Sulphur, while sour crude contains more than 0.5%. Sweet crude oil has a sweet aroma because of less sulphur. The low quantity of sulphur makes it more suitable / easier to produce gasoline that is why sweet crude oil is expensive. Presence of sulphur makes it toxic and also the production of gasoline is expensive. Brent Crude Oil is a sweet crude oil mainly produced in Nothe rth Sea. It is largest of the several key classifications of crude oil comprising of Ekofisk, Brent Crude, Forties, Brent Sweet Light Crude and Oseberg. It is also known as London Brent, Brent petroleum and Brent Blend.

(b). Sour Crude Oil and the Gulf War Syndrome

Due to high sulphur content, the Sour Crude oil can be toxic and corrosive, particularly when it contains high levels of hydrogen sulfide (H2S)

5. Doctor test

Doctor test is the name of a qualitative method of detecting undesirable sulfur compounds in petroleum distillates, that is, of determining whether oil is “sour oil ” or “sweet oil”.

 

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