Crude prices may fall in 2014: Will govt open up oil market?

Crude prices may fall in 2014: Will govt open up oil market?

Oil sector pundits have already given their prediction for 2014. Almost all of them forecast lower oil prices. Majority of them are predicting only a small drop of $2 to $5 per barrel from 2013 Brent oil price of $108.64 per barrel. This was a small decline from $111 per barrel in 2011 and 2012.

However, there is a small minority of experts who predict a larger drop of more than $10 to $20 per barrel. But factors like high OPEC surplus capacity, Non-OPEC crude oil production increase, adequate oil inventory, desire on the part of some OPEC members to produce more than their quota etc show that oil prices could fall below $50 per barrel like during 2009. However, it is rare to find any expert predicting such a drop. 

Has the government of India done any scenario planning to develop plan of action to face different pricing possibilities? This year being the election year, such an analysis may help the new government to implement the most appropriate pricing policy should oil prices fall. 

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 1.7 mmbd is more than enough to meet this demand. This will put pressure on OPEC to reduce their production. 

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 who had production problems in 2013 may be able to overcome them this year.

It is possible to develop a scenario where Libya, Iraq, Iran, Nigeria and Venezuela may be able to collectively increase their production to more than 3 mmbd in 2014. Because of the US and EU ban on importing oil from Iran, its production has declined to around 2.7 mmbd from the prior sanction period of 3.7 mmbd. Since there is a distinct possibility of trade sanctions against Iran being removed as a result of nuclear agreement, Iran’s export may go up as much as 1.0 mmbd. Because of the continuing unrest in Libya, its production has fallen to 0.4 mmbd from its recent high of 1.4 mmbd. Thus, Libya can also increase its export by 1.0 mmbd. Other three countries with civic unrest - Iraq, Venezuela and Nigeria - could add as much as 0.6 to 0.9 mmbd.  

OPEC had agreed on a quota of 30 mmbd in its last meeting. Even that will result in over-supplied oil market. In addition to this problem, if the above mentioned OPEC members were to increase their production, then OPEC can support the price if other members are prepared to reduce their production. In the past, it was mostly Saudi Arabia which has acted as the swing producer. It is a billion dollar question whether Saudi Arabia is willing to play that role.

Playing swing role

Libya, Iraq and Iran have informed OPEC that they may not abide by their quotas because of their lower oil production in recent years. Also there is a huge overhang of OPEC surplus capacity exceeding 6.38 mmbd. One of the significant reasons for the oil price drop in 2009 was a huge OPEC surplus capacity. 

Saudi Arabia needs a price of $100/b to meet its budget needs. However, it may refuse to play the swing role beyond a certain minimum level of production. It is worth recalling the drop in oil price below a single digit in 1986 when Saudis decided to give up its swing role. 

It is true that each member will be a loser if they collectively exceed the 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 that OPEC managed to support a price higher than the marginal cost of crude oil since 2011. 

There are several estimates of marginal cost by different experts. In a surplus crude oil market like the one discussed above, with OPEC losing control, prices can drop to marginal cost of crude oil. According to the Centre for Global Energy Studies (CGES), one-third of 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 and royalty while 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. 

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 parties are in power, decision should be made to liberalise the oil sector. UPA lost such an opportunity in 2009. 

Such a policy based on sound economic principle will support the government to really help the poor as a result of having far more access to funds. It is worth reminding that oil sector subsidies which are either diverted to generate black money or mostly help the rich account for 80 per cent of income tax revenues collected. Substantial savings resulting from eliminating the energy sector subsidies can be allocated to sectors like education, health, water etc to promote inclusive growth.

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