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What factors have led to a surge in crude oil price?

The worse news is that things might get a lot worse here on - some analysts have predicted it to hit $100 by the next year.

twitter-logo BusinessToday.In   New Delhi     Last Updated: May 18, 2018  | 22:09 IST
What factors have led to a surge in crude oil price?

The bad news is that the benchmark Brent crude oil price breached the $80 a barrel level yesterday, for the first time since 2014. According to Reuters, this has pushed up Asia's oil bill to $1 trillion this year, about twice what it was during the market lull of 2015-2016. The worse news is that things might get a lot worse here on - some analysts have predicted it to hit $100 by the next year. So here's a look at the factors that are fuelling this spurt in oil prices.

Deliberately tightened supply

The Organization of the Petroleum Exporting Countries (OPEC) and its allies, including Russia, started to withhold output in January 2017 to reduce excessive global stockpiles that had depressed oil prices since 2014.
According to a recent survey by think tank S&P Global Platts, the 14-country bloc produced 32 million barrels per day (b/d) in April, a drop of 140,000 b/d drop from the previous month. In fact, the April figure is about 730,000 b/d below OPEC's notional ceiling, when every country's quota under its production cut agreement is added up.

Despite the surplus stock drying up, and despite consuming nations voicing concerns that the price rally might have gone too far and could now lead to demand destruction, OPEC has so far maintained that it saw no need to ease the output restrictions. OPEC is scheduled to meet on June 22 to review its oil production policy, and the outcome of the meeting will play a big role in determining which way oil prices are headed.

The Trump effect

US President's recent decision to re-impose sanctions on Iran has also impacted oil prices. Brent is reportedly up by more than 4 per cent since he announced abandoning the landmark UN-backed deal. It's still early days and the potential impact on Iran's oil exports, currently about 2.4 million b/dx, is yet uncertain. According to the International Energy Agency (IEA), when sanctions were imposed in 2012, Iran's exports fell by about 1.2 million b/d. "It is too soon to say what will happen this time, but we should examine whether other producers could step in to ensure an orderly flow of oil to the market and offset a disruption to Iranian exports. Neither Venezuela nor Mexico can raise output in the short term, but some of the 1.5 million b/d that have been cut by other producers under the Vienna Agreement might be available to keep markets well supplied," it added.

Furthermore, India's Oil Minister Dharmendra Pradhan recently tweeted that Saudi energy minister Khalid al Falih had assured him Riyadh and other producers would "ensure availability of adequate supplies to offset any potential shortfalls and ensure that prices remain reasonable". We will just have to wait and watch but rumours that Saudi Arabia wants oil prices to hit $100 a barrel are getting louder.

Venezuela's unplanned output decline

The South American country boasts the world's largest oil reserves of over 300 billion barrels, but it has been unable to stop a now six-year-long production decline. Venezuela's crude oil production fell nearly 13 per cent last year, according to OPEC figures, and things seem to have gotten worse this year.
S&P Global Platts claims that its production of 1.41 million b/d in April was a whopping 40 per cent drop in two years. It is also the lowest in the 30-year history of the Platts OPEC survey, aside from a 2002-03 strike that severely debilitated Venezuela's state oil company PDVSA. Venezuela has now reduced its production, the most among OPEC members since the output deal went into force in January 2017, surpassing Saudi Arabia. An oil ministry source told the think tank that production could fall by a further 200,000 b/d by December.

You can blame a combination of factors for this dismal state of affairs, ranging from a crippled economy to insufficient investments and brain drain. If the US decides to impose further sanctions on the country - the May 20 presidential elections could be a possible trigger - output could take a further hit. "The potential double supply shortfall represented by Iran and Venezuela could present a major challenge for producers to fend off sharp price rises and fill the gap, not just in terms of the number of barrels but also in terms of oil quality," said the IEA.

Other geopolitical risks

"The ongoing escalation of tensions between Saudi Arabia and Iran, continuing conflicts in Iraq, Libya, Syria and Yemen have significantly taken their toll on the region," Mitsubishi UFJ Financial Group told The Guardian. In April, Iraq reportedly saw its first decline in output since November. That apart, any escalation of proxy conflicts in the region - and the associated threat of blocking off the multiple choke points vital for oil trade flows - could rock the boat further.

Where are prices headed?

According to the Financial Express, Goldman Sachs projected an oil price hike to $83 a barrel, Morgan Stanley predicted oil hitting $90 a barrel soon, and not because of Iran and the OPEC production cut, while Bank of America Merrill Lynch said that crude oil could hit $100 a barrel by next year.
If that is not alarming enough, the report cited oil hedge fund manager Pierre Andurand claiming that prices hitting $300 a barrel is not impossible, given the reluctance of energy companies to invest in crude oil production.

What will be the impact on India?

Given that India is the world's third largest oil importer, such a hike will inflate the import bill and disrupt the fiscal position. According to a recent Goldman Sachs report, India's current account deficit will be around 2.4 per cent of GDP in 2018-19, up from its previous forecast of from 2.1 per cent. Moreover, as pointed out by Kotak Securities, a high deficit means the country has to sell rupees and buy dollars to pay its bills. This reduces the value of the rupee, which has already depreciated by around 5 per cent against the dollar this year.

In the bargain, the investment bank sees the RBI adopting a more hawkish stance its second bi-monthly monetary policy, to be announced on June 6.

With agency inputs

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