Market rout: India should take advantage of falling crude oil prices

Topics Saudi Arabia | Investors | Liquidity

In late 2014, Saudi Arabia blocked calls from the Organization of the Petroleum Exporting Countries (Opec) to reduce production. Since the shale revolution and idea of oil being displaced by electric vehicles, people were worried that 'peak oil' was being replaced by 'peak use for oil' theory, and therefore Saudi Arabia did not want to give up market share by lowering production. Instead, they wanted to let the markets rebalance. They were also hoping that the rebalancing will reduce prices, making shale production unsustainable, and make them kings of the oil world again. 

However, shale oil proved to be very resilient and survived that phase forcing Opec and Russia to announce production cuts in late 2016 to support prices. This helped oil prices recover to some extent and made financials of all these countries more stable. However, this further encouraged shale production and US oil production grew by almost 50% in three years, taking away market share from Opec and Russia. 

Over the last few quarters, as demand faltered - first because of trade war and now because of the coronavirus outbreak - everyone expected Russia and Opec to continue with the cuts they had agreed earlier and potentially increase those to keep the market from becoming oversupplied. However, this time Opec and Russia had a very different view. Russia wanted to extend the existing cuts, whereas Opec wanted to increase the cuts to support the prices. They were not able to find a mid-path and the deal fell apart, leading to even the existing cuts being rolled back. In fact, Saudi Arabia has launched a full-fledged price war on the back of this, with its minister saying he will keep everyone wondering on oil production, with suggestions that it could ramp up production by 1-2 mbpd (million barrels per day), and Saudi has dropped prices of Arab Light by $6 so that it can quickly corner the market share.

This is happening at a time when shale producers in the US are in a bit of a spot as well. Easy liquidity available earlier is drying up, debt is piling up, debt repayments are due and a lot of investors are looking for profitability and not just production growth. This is making the shale producers more conservative in their approach. So the decision by Opec + Russia could not be worse timing for shale. This environment may make it very difficult for shale producers and could lead to bankruptcies 0and consolidation in the industry. There is probably a geopolitical play in this as well. Off-late the US has used energy as a tool in a lot of its negotiations with China, India, Europe etc., and Russia may be trying to circumvent that.

 However, the aggressive stance taken by Saudi may have taken everyone including Russia by surprise, and this may bring the two parties back to the negotiating table, else for next 3-6 months the oil markets will be in a lot of pain. Venezuela and Iran, already struggling because of sanctions may see a further hit, Canada and the US could see potential job losses in the energy sector and a lot of West Asian countries' budgets will be turned upside down by this. In the meantime, India should assume this is a short-term phenomenon, try and stock up on oil and take advantage of the low prices while it can.

The writer is vice-president (technology, energy and, commodities) Publicis Sapient

Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel