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Open up the oil market
There is the chance of oil prices falling below $50 per barrel. The new government should have the courage to liberalise the oil market?

Such a wise policy based on sound economic principles will reduce oil sector subsidies and generate huge revenues.

According to the latest oil market report of International Energy Agency (IEA), oil demand will increase in 2014 by about 1.2 million barrels per day (mmbd). Non-OPEC production increase of 1.9 mmbd is more than enough to meet this demand. This will put pressure on OPEC to reduce their production below their quota of 30 mmbd.

The world oil demand has been going up during the last three years. Luckily for OPEC, non-OPEC production increase has been either modest or it was able to enforce the quota on its members. However, OPEC may not be lucky in 2014. Some of its member countries, which had production problems in 2013, may be able to overcome them this year.

 

Scope for increase...

Libya, Iraq, Iran, Nigeria and Venezuela may be able to collectively increase their production by more than 3 mmbd in 2014 from their current production. Iran’s production has declined to around 2.7 mmbd from the prior sanction period of 3.7 mmbd. But with trade sanctions likely to be removed, Iran’s export may go up as much as 1.0 mmbd. Libya can also increase its export by 1.0 mmbd from its current low production. Other three countries with civic unrest - Iraq, Venezuela and Nigeria - could add as much as 0.6 to 0.9 mmbd.

It is true that each member will be a loser if collectively they exceed quota bringing down the price. It is only because more than 50 per cent of the surplus capacity in the past was controlled by Saudi Arabia, OPEC managed to support a price higher than the marginal cost of crude oil since 2011.

 

Estimates on – price of $50/b

According to the Center for Global Energy Studies (CGES), one third of the world crude oil costs less than $10 per barrel and nearly 90 per cent costs less than $20/b. According to CGES, most conventional oil does not cost more than $30/b excluding taxes, royalty. The Canadian sand oil costs are less than $50/b. These cost estimates support a lower price of around $50/b if OPEC fails to control oil production.

At the other extreme, Sanford Bernstein, a Wall Street research company, estimates that the marginal cost of production has gone up from $30/b in 2002 to $104/b in 2012 while cash costs have gone up from $9.70/b to $44.20/b. These numbers also support the argument that crude prices can fall below 50/b. One may argue that it can remain low only for a short period because of higher full cost. However, oil history has shown that when prices fall and cash flow of oil companies is hurt they manage to improve operational efficiency to bring down the marginal cost.

Another oil consultant company, Cambridge Energy Research Associates, has estimated that the marginal full cost of oil production varies from a low of around $20/b in Saudi Arabia to a high of above $80/b for oil from Canadian sands. These estimates also support the argument that when the crude oil prices fall they are unlikely to remain at a low level for a long time. However, it needs to be stressed that it will be difficult or impossible to estimate what will really be the marginal cost based on the recent world oil history.

When oil companies have high cashflows as a result of higher oil prices, they spend most of it to look for oil. However, when and if oil prices fall, they can manage to control costs and still find and produce oil at lower cost.

Based on the above discussion, there is some probability that crude oil prices may drop below $50/b and stay at that level for some time before recovering to the current level of $ 100/b. When such a drop takes place, irrespective of which party is in power, the oil market should be liberalised. UPA lost such an opportunity in 2009.

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