Ever since President Donald Trump led a US walkout of the Iran nuclear deal, oil pundits have been busy writing elegant prose on how oil prices have been strengthening. They changed their previous price forecasts to predict higher prices
Oil prices have been heading northward since the beginning of the year partly influenced by geopolitical factors. There were fears of a decline in Iranian oil production in a market that was coming into supply/demand balance. But an analysis (Graph -1) of the movement of oil prices over 50 years reveals a different story. It shows that similar incidents of oil disruption have resulted in sky rocketing prices. Well this time it hasn’t happened!
Since the dawn of 2018, Brent oil price has gone up from $69 per barrel in January to $74/b in April. Since the announcement to pull out of Iran nuclear agreement 8 May, Brent reached a high of $80/b, and then came down. Despite knowing the risk of predicting oil prices, there are some forecasts of oil reaching $100/b by December 2018. Even such a triple digit oil prices do not imply any sky rocketing of prices like what happened in the 1970s. In 1973 because of the Arab oil embargo, oil prices went up by 300 per cent: from $3/b to $12/b and in 1978-79 after the start of Iran-Iraq war it went up to $36/b. It is comforting to know that oil prices will now not zoom if the experts are to be believed. But how reliable are they?
Better balance between supply and demand
According to IEA, world oil demand will increase by 1.5 million barrels per day (mmbd) while Non-OPEC oil supply will increase by 1.8 mmbd ( Table-1). If OPEC and its 10 non-OPEC partners led by Russia continue to adhere to their cut of 1.8 mmbd in oil production, then there will be better balance between world oil supply and demand.
IEA also expects the overhang of inventory built during the excess oil supplies in 2015 would have disappeared by the middle of this year. Because of significant reduction in Venezuela’s oil production, quota compliance of OPEC as of March 2018 has been around 163 per cent. This is remarkable. Historically OPEC has not been able to achieve any degree of quota compliance.
OPEC spare capacity according to IEA is less than 3.4 mmbd. As per Energy Information Administration (EIA) it is less than 2 mmbd and is predicted to go down in 2019 (see Graph 2). Most of the spare capacity is controlled by Saudi Arabia. Because of the expected IPO of their oil company Aramco, Saudis are interested in maintaining a high oil price.
It is a total guess at this time to estimate how much reduction in Iranian production will happen as a result of the new sanction to be reimposed by the US. It could be as low as 300,000 bd or more than one million bd. One can build a scenario of perfect storm.
Currently OPEC spare capacity is limited. World oil demand is continuing to increase. OECD oil inventory is less than the five year average. If there is small oil disruption in any OPEC or in non-OPEC member countries, it can have a huge impact on oil prices. But oil future market does not seem to anticipate such an eventuality. What a contrast from early 1970s when even a small disruption -real or potential- caused prices to sky rocket!
NDA was lucky in having low oil prices so far. They may run out of luck when they face the general elections in 2019. They wisely increased excise taxes and did not pass on the benefit of lower oil prices to consumers. There was not much protest from the opposition parties and economy did not suffer. However, should oil prices go above $100/b in 2019, NDA will be forced to ‘manipulate’ oil prices because of political compulsion as happened recently during the Karnataka election.
Public sector oil companies despite having autonomy (more than likely only on paper) failed to reflect higher oil prices and absorbed losses during Karnataka election. Will it be any different during parliamentary election of 2019? Let us not forget how UPA’s policy of forcing public sector oil companies to sell petrol and diesel below cost drove more efficient private sector companies to close down their stations.
It is prudent on the part of Modi’s government to draw up plans to face different pricing scenarios now when there is still some time to plan.
