Shale vs crude: Why oil prices are on a free fall even as Opec members suffer

The latest price of the Indian basket for crude oil was at $35.72 per barrel. It has fallen by 16% over the last one month and by 33% since end December 2014.
Yesterday, the Brent crude oil was selling at $37-38 per barrel. Lower quality oil is selling at even below $30 per barrel. As Amrbose Evans-Prtichard writes in The Telegraph: “Basra heavy crude from Iraq is quoted at $26 in Asia, and poor grades from Western Canada fetch as little as $22. Iran’s high-sulphur Foroozan is selling at $31.”

What has led such low levels of oil price? Over the last one year, the Organization of the Petroleum Exporting Countries(OPEC), an oil cartel of some of the biggest oil producing countries in the world, has been flooding the market with oil in order to make the shale oil being pumped in the United States, unviable. Pumping shale oil is an expensive process and is not viable at lower oil price levels.

In fact, the oil ministers of the OPEC countries met in early December and they pretty much decided to continue doing things the way they have been up until now, over the last one year. In the past, any likely slowdown in oil prices was met with oil production cuts within the OPEC. That hasn’t happened over the last one year and isn’t happening now either.

As the International Energy Agency(IEA) points out in its monthly oil report for December 2015: “OPEC’s decision to scrap its official production ceiling and keep the taps open is a de facto acknowledgment of current oil market reality. The exporter group has effectively been pumping at will since Saudi Arabia convinced fellow members a year ago to refrain from supply cuts and defend market share against a relentless rise in non-OPEC supply.”

The rise in the supply of non-OPEC oil has primarily happened on account shale oil being pumped in the United States and to some extent in Canada, over the last few years. In order to make companies pumping shale oil unviable, OPEC has been relentlessly pumping oil. As the IEA monthly report points out: “OPEC supply since June has been running at an average 31.7 million barrels per day, with Saudi Arabia and Iraq – the group’s largest producers – pumping at or near record rates. Riyadh has held supply above 10 million barrels per day since March to satisfy demand at home and abroad while Iraq, including the Kurdistan Regional Government (KRG), is doing its level best to keep production above the 4 million barrels per day mark first breached in June.”

Also, as oil prices have fallen, OPEC and non-OPEC oil producing countries have had to pump more and more oil, in order to ensure that their governments have some money going around to spend. As the Russian finance Anton Siluanov told Ambrose. “There is no defined policy by the OPEC countries: it is everyone for himself, all trying to recapture markets, and it leads to the dumping that is going on.”

Further, sanctions against Iran are likely to be lifted early next year and more oil will then hit the international oil market. The Financial Times quotes an oil trader as saying: “It seems the Iranians are fulfilling the requirements for the lifting of sanctions faster than expected.” said one London-based oil trader.

The IEA monthly report expects the extra oil from Iran to add 300 million barrels to the already swelling oil inventories. In fact, the November 2015 oil report of the IEA had put the total global stockpiles of oil at 3 billion barrels.

So how long will this last? Given the number of factors that impact the price of oil, predicting which way it will head, has always been tricky business.  As Philip Tetlock and Dan Gardner write in Superforecasting—The Art and Science of PredictionTake the price of oil, long a graveyard topic for forecasting reputations. The number of factors that can drive the price up or down is huge—from frackers in the United States to jihadists in Libya to battery designers in Silicon Valley—and the number of factors that can influence those factors is even bigger.”

Nevertheless, it seems that one year down the line the Saudi strategy of driving down the price of oil, in order to drive down non-OPEC oil production seems to be working. As the IEA oil report points out: “There is evidence the Saudi-led strategy is starting to work. Lower prices are clearly taking a toll on non-OPEC supply, with annual growth shrinking below 0.3 million barrels per day in November from 2.2 million barrels per day at the start of the year. A 0.6 million barrels per day decline is expected in 2016, as US light tight oil – the driver of non-OPEC growth – shifts into contraction.”

Also, it is worth pointing out here that oil exporting countries are having a tough time balancing their budgets. The fiscal deficit of Saudi Arabia has touched 20% of its gross domestic product (GDP). Fiscal deficit is the difference between what a government spends and what it earns. As Evans-Pritchard puts it: “Opec revenues have collapsed from $1.2 trillion a year in 2012 to nearer $400 billion next year.”

Hence, it is safe to say that the OPEC strategy of driving down the price of oil is hurting the member countries. Given this, the price of oil cannot be at such low levels for much long. But at least in the short run, the oil price will continue to stay low.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on December 15, 2015

Why oil prices have fallen below $40 per barrel

light-diesel-oil-250x250A few months back I wrote a series of columns on oil. In these columns, I maintained that it is very difficult to predict the price of oil over the long term, given that there are way too many factors involved, other than just demand for and supply of the commodity. At the same time I said that in the short-term the price of oil will continue to go down. And that is precisely what has happened.

Data from the Petroleum Planning and Analysis Cell (PPAC) tells us that as on December 8, 2015, the price of the Indian basket of crude oil stood at $ 37.34 per barrel. In fact, during the course of this week, oil prices have touched a seven year low.

What is happening here? The Organization of the Petroleum Exporting Countries (OPEC), an oil cartel of some of the biggest oil producers in the world, met last Friday on December 4, 2015.

The statement released by OPEC after the meeting as usual was very general in nature. It said: “emphasizing its commitment to ensuring a long-term stable and balanced oil market for both producers and consumers, the Conference [i.e. OPEC] agreed that Member Countries should continue to closely monitor developments in the coming months.”

What does this “really” mean? In the past, the OPEC has adjusted its oil production depending on oil demand. If the demand was high, it increased production so as to ensure that oil prices did not go up too much. This was done in order to ensure that other forms of energy did not become viable. If the demand was low, it cut production in order to ensure that oil prices did not fall too much.

In the last one year, OPEC has abandoned this strategy primarily on account of all the oil that is being produced by the shale oil companies in the United States. As shale oil started to hit the market, the OPEC countries started to lose market share. Hence, they decided not to cut production any further, and try and maintain market share, even if that meant low oil prices.

The major producers within the OPEC (the likes of Saudi Arabia, Kuwait and Iraq) produce oil at anywhere between $9 to $20 a barrel. It costs anywhere between $29 to $90 per barrel to produce shale oil, as per the International Energy Agency (IEA).

Hence, the idea was to engineer low oil prices and in the process make shale oil unviable and help OPEC countries maintain their market share. Nevertheless, despite low oil prices, the US shale oil industry is not shutting down at the rate it was expected to, when the price of oil started to fall, around a year back.
And this explains why OPEC continues to produce oil full blast. It wants to kill the US shale oil industry. Further, what the OPEC’s statement released last Friday really means is that the cartel will maintain its production at over 31.5 million barrels per day. In fact, members of the OPEC have always known to cheat on the side and produce more than their allocated quotas. Hence, the daily production is likely to be more than 31.5 million barrels per day.

As the newsagency Bloomberg reported: “There’s as much as 2 million barrels of oversupply in the market, and OPEC’s meeting on Friday means “everyone does what they want,” Iran’s Oil Minister Bijan Namdar Zanganeh said in Vienna on Dec. 4.”

Take a look at the following two charts from the International Energy Agency. One is a chart showing the World Oil Supply. And the other shows World Oil Demand.

world oil supply


world oil demand


As per the chart, the World Oil Supply during the period July to September 2015 was at 96.9 million barrels per day. The demand on the other hand was lower than the supply at 96.35 million barrels per day.

The OPEC oil supply during the period July to September 2015, went up in comparison to the period April to June 2015. The OPEC production between April to June 2015 was at 31.5 million barrels per day. Over the next three months it jumped to 31.74 million barrels per day. Hence, OPEC contributed significantly to the jump in global oil supply.
opec crude oil supply

In fact, the production of OPEC is likely to increase in the months to come as the sanctions on Iran are lifted and the country is allowed to export more oil.

Over and above this, the global oil inventory is at a record high. As a recent IEA report points out: “Stockpiles of oil at a record 3 billion barrels are providing world markets with a degree of comfort. This massive cushion has inflated even as the global oil market adjusts to $50/bbl oil. Demand growth has risen to a five-year high…with India galloping to its fastest pace in more than a decade. But gains in demand have been outpaced by vigorous production from OPEC and resilient non-OPEC supply – with Russian output at a post-Soviet record and likely to remain robust in 2016 as well. The net result is brimming crude oil stocks that offer an unprecedented buffer against geopolitical shocks or unexpected supply disruption.”

As the report further points out: “The stock overhang that first developed in the US on the back of soaring North American crude production, has now spread across the OECD. Since the second quarter, inventories in Asia Oceania have swollen by more than 20 million barrels. In Europe, record high Russian output and rising deliveries from major Middle East exporters are filling the tanks.”

What this clearly means is that oil prices are likely to stay low over the next few months. Further, the forecast is for a fairly mild winter in Europe as well as North America. This means that the demand for diesel, which is the fuel of choice for heating in Europe as well as North East America, is unlikely to go up at a rapid rate. The stockpiles of diesel are at a five-year high.

The column originally appeared on The Daily Reckoning on December 10, 2015

Oil price may touch a new low of $31 per barrel by March 2015

oilVivek Kaul

I wanted to write this column last week but just got a little too involved with the three pieces that I ended up writing on Indian real estate.
As I write this column, the price of brent crude oil is around $48.8 per barrel. This price is expected to fall further over the next two months, for the simple reason that oil inventories all over the world have shot up dramatically.
In a research note titled
How Low Will Oil Price Go and dated January 6, 2015, analysts at Bank of America-Merrill Lynch explain this phenomenon. The question is why do inventories build? “Inventories typically build because supply exceeds demand in any given market. But in some markets like oil or gas, storage capacity is a finite number and price declines can accelerate as inventories build.”
In another research note titled
Oil price undershoot; Compelling value emerging and dated January 16, the Bank of America-Merrill Lynch analysts note that: “Inventories all over the world are building at a very fast rate. In fact, we have moved up our storage numbers and now expect OECD (Organisation for Economic Co-operation and Development) inventory levels to reach 2,830 million barrels in 2Q15, 180 million barrels above last year.”
Interestingly, oil inventory levels in the United States are at an 80 year high for this time of the ear.
Numbers released by the Energy Information Administration(EIA) of the United States on January 16, 2015, shows that oil inventories in the country stood at 397.853 million barrels. Thus the oil inventories “are at the highest level for this time of the year in at least the last 80 years,” the EIA said in the release.
Typically in the past, as supply would increase the Organization of the Petroleum Exporting Countries (OPEC) would cut production and that would prevent a fall in oil price. Nevertheless that hasn’t happened this time around. In fact, Ali al-Naimi, the oil minister of Saudi Arabia,
said in a December interview that:It is not in the interest of Opec producers to cut their production, whatever the price is…Whether it goes down to $20, $40, $50, $60, it is irrelevant.”
The Saudi Arabia led OPEC has essentially been driving down the price of oil to make it unviable for US shale oil firms to keep producing oil. As Niels C. Jensen writes in 
The Absolute Return Letter for January 2015 titled Pie in the Sky: “In effect, OPEC is trying to destroy the economics of this industry, which admittedly requires quite high oil prices to remain profitable. Only 4% of total U.S. shale production breaks even at $80 or higher. A high percentage of the industry breaks even with an oil price in the $55-65 range.”
Due this OPEC oil production has not been cut and oil inventory levels world over have been shooting up. As land-based inventories start to fill up, the oil inventory will move to ships. “In fact, we see floating storage coming into play over the coming months with roughly 55 million barrels building on ships by the end of 2Q15, as land-based inventories across North America, Europe, and Asia fill up. But even floating storage is limited by its very nature. If crude vessels fill up, shipping rates will spike, and that is unlikely to help any oil producer in the world,” write the Bank of America-Merrill Lynch analysts.
Taking all these factors into account the Bank of America-Merrill Lynch analysts predict that by March 31, 2015, the price of brent crude is oil all set to fall to $31 per barrel. The question though is where will oil prices go from there. That is where things get rather interesting and as I have written in the past, it is very difficult to start predicting oil prices in the short term.
The answer to where oil prices are headed in the short=term probably lies in trying to understand how will oil supply shape up in the months to come. The non-OPEC oil suppliers need to cut oil supply by at least one million barrels per day to restore some sort of equilibrium in the oil market. But how good are the chances of something like that happening?
The Bank of America Merrill Lynch analysts point out that the cash cost of non OPEC producers comes at around $40 per barrel and given that oil prices need to stay below that for a while to get them to start cutting supply. “Many producers are well hedged, face very low cash costs, are partially protected by falling domestic currencies or tax breaks, or are notoriously slow to react,” write the analysts.
Oil companies in Brazil need $23 per barrel to cover their cash cost. Russian producers are well protected because of a huge fall in the value of the rouble against the dollar and have cash costs of around $9-15 per barrel. In case of the major oil companies ,the cash costs range anywhere between $20 to $42 per barrel. Only oil produced in the North Sea has an average cost of around $48 per barrel, which is around the current brent crude oil price.
Hence, non OPEC oil can still continue to produce oil for a while, leading to higher inventories. Given this, Saudi Arabia remains the joker in the pack and depending on which way it goes will decide the way oil prices head in the short term.
From the political posturing that Saudi Arabia has indulged in, it looks highly unlikely that OPEC will cut oil production any time soon, even though the country is losing a lot of revenue by keeping the market oversupplied.
As Brahim Razgallah of JP Morgan writes in a research report titled
Saudi 2015 Budget: More than meets the eye and dated January 9, 2015: “All else equal, every $10 per barrel fall in the average oil price widens the fiscal deficit by 4.1%-pts of GDP.” Fiscal deficit is the difference between what a government earns and what it spends.
This deficit is likely to be financed through borrowing. The public debt of Saudi Arabia stands at a rather minuscule 1.9% and hence, it can easily borrow its way out of trouble. Over and above this, the country also has a huge amount of foreign exchange reserves amounting to $734 billion accumulated over the years by selling oil. This money can also be accessed.
Razgallah of JP Morgan believes that: “The 2015 budget deficit will mainly be financed by domestic resources, in our view, with public debt likely to reverse its downtrend from 1.9% of GDP in 2014. We believe the government is unlikely to draw on its external savings (97% of GDP) unless oil price weakness lasts a few years.”
Given this, the way Saudi Arabia behaves in the time to come will decide which way oil-prices head in the short term. And that remains difficult to predict.

(The article originally appeared on as a part of The Daily Reckoning on Jan 27, 2015) 

Oil and dollar: Why Obama’s love for Taj lost out to Saudi King’s death


Barack and Michelle Obama were supposed to be in Agra on January 27, 2015, visiting the Taj Mahal. Instead they will now be going to Saudi Arabia to pay respects to  King Salman bin Abdulaziz, the recently crowned King of Saudi Arabia and the family of the late King Abdullah bin Abdulaziz, who died on January 23. Bloomberg reports that keeping with religious tradition, Abdullah was was quickly and quietly buried on the day he died.
A newsreport in The Indian Express points out that the “Supreme Court had earlier directed all visitors to the Taj Mahal to disembark at the Shilpgram complex, 500 metres away, and board an electric vehicle to the entry gate.” This was deemed to be a security risk by the Secret Service that guards President Obama and hence, the visit was cancelled.
This reason has since been denied by the White House. A more plausible reason lies in the shared history of Saudi Arabia and the United States. As Adam Smith (George Goodman writing under a pseudonym) writes in Paper Money: “In 1928, the Standard Oil Company of California, Socal, had failed to find oil in Mexico, Ecuador, the Philippines, and Alaska. As a last resort, it bought concession from Gulf on the island of Bahrain, twenty miles off the coast of Saudi Arabia, and found some oil. Socal sought out Harry St. John Philby, a local Ford dealer…who was a friend of the Saudi finance minister, Sheikh Abdullah Sulaiman…For 35,000 gold sovereigns, Socal got the concession for Saudi Arabia. Sheikh Abdullah Sulaiman counted the coins himself. Socal’s Damman Number 7 struck oil at 4,727 feet in 1937.”
This is how Saudi Arabia’s journey as an oil producer started. The United States was the world’s largest producer of oil at that point of time, but its obsession with the automobile had led to a swift decline in its domestic reserves.
President Franklin D. Roosevelt realized that a regular supply of oil was very important for America’s well-being. Immediately after attending the Yalta conference in February 1945, Roosevelt travelled quietly to the USS Quincy, a ship anchored in the Red Sea. Here he met King Ibn Sa’ud of Saudi Arabia, the country which was by then home to the largest oil reserves in the world. Ian Carson and V.V. Vaitheeswaran point this out in their 2007 book, Zoom—The Global Race to Fuel the Car of the Future.
Car production had come to a standstill in the United States during the course of the Second World War. Automobile factories became busy producing planes, tanks, and trucks for the War. Renewed demand was expected to come in after the end of the War. Hence, the country needed to secure another source for an assured supply of oil.
So, in return for access to the Saudi Arabian oil reserves, King Ibn Sa’ud was promised full American military support to the ruling clan of Sa’ud. It is important to remember that the American security guarantee made by President Roosevelt was extended not to the people of Saudi Arabia nor to the government of Saudi Arabia but to the ruling clan of Al Sa’uds.
Over the years, Saudi Arabia further returned the favour by ensuring that Organization of the Petroleum Exporting Countries (OPEC) continued to price oil in terms of dollars despite the fact that it was losing value against other currencies, especially in the 1970s.
Attempts were made by other members of the OPEC to price oil in a basket of currencies, but Saudi Arabia did not agree to it. This ensured that oil continued to be the international reserve and trading currency. Most countries in the world did not produce oil and hence, needed dollars to buy oil. This meant that they had to sell their exports in dollars in order to earn the dollars to buy oil.
If Saudi Arabia and OPEC had decided to abandon the dollar, it would have meant that the demand for the dollar would have come crashing down, as countries would no longer need dollars to pay for oil. Hence, oil will continue to be priced in dollars as long as Al Sa’uds continue to rule Saudi Arabia because they have the security guarantee from the United States.
Further, Saudi Arabia remains a close ally of the United States despite the fact that the late Osama bin Laden was a Saudi by birth. Osama was the son of Mohammed bin Awad bin Laden and his tenth wife, Hamida al-Attas. The senior bin Laden was a construction magnate who was believed to have had close ties with the Saudi Royal family.
Since 2008, a lot of shale oil has been discovered in the United States and the production of oil in the United States has gone up by four million barrels per day to nine millions barrels per day, with almost all of the increase coming from increased production of shale oil. This is only a million barrels per day lower than the daily oil production of Saudi Arabia.
Given this, why does the United States still need to continue humouring Saudi Arabia? It is now producing enough oil on its own. James K. Galbraith has an answer for it in The End of Normal: “There is no doubt that shale is having a strong effect on the American economic picture at present…But the outlook for sustained shale…production over a long time horizon remains uncertain, for a simple reason: the wells have not existed long enough for us to know with confidence how long they will last. We don’t know that they won’t; but also we don’t know that they will. Time will tell, but there is the unpleasant possibility that when it does, the shale gas miracle will end.”
Jeremy Grantham of GMO goes into further detail in a newsletter titled The Beginning of the End of the Fossil Fuel Revolution (From Golden Goose to Cooked Goose: “The first two years of flow are basically all we get in racking…Because fracking reserves basically run off in two years and can be exploited very quickly indeed by the enterprising U.S. industry, such reserves could be viewed as much closer to oil storage reserves than a good, traditional field that flows for 30 to 60 years.” The process used to drill out shale oil is referred to as fracking.
Hence, shale-oil might turn out to be a short-term phenomenon. As of now shale oil is not going to replace cheap traditional oil, which is becoming more and more difficult to find. As Grantham points out: “Last year for example, despite spending nearly $700 billion globally – up from $250 billion in 2005 – the oil industry found just 4½ months’ worth of current oil production levels, a 50-year low!”
It is worth remembering that the United States consumes 25 percent of the world’s daily production of oil and half of its daily production of petrol, or what Americans call gasoline. The fact that it is using way too much oil becomes even more obvious given that it has only five percent of the world’s population. Given this, it still needs Saudi Arabia.
Hence, the Obamas need to go to Saudi Arabia and offer their condolences on King Abdullah’s death as soon as possible. The Taj Mahal will have to wait.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The article originally appeared on as on Jan 26, 2015 

Falling oil prices: Modi and Jaitley should be thanking Saudi Arabia

narendra_modiVivek Kaul

Urjit Patel, one of the deputy governors of the Reserve Bank of India (RBI), recently explained the benefits of the dramatic fall in crude oil price for India. As he put it: The dramatic fall in oil prices is a boon for us. It saves, on an annualised basis, around US$ 50 billion, roughly, one-third of our annual gross POL (petroleum, oil and lubricants) imports of about US$ 160 billion. This is on a back-of-the-envelope, top-line basis. Of course, there will be leakages and other set-offs. But our external situation undoubtedly improves. The welcome development enhances our disposable income (which will increase consumer demand for other goods and services), reduce input cost of our businesses (which will increase margins and help to enthuse investment demand), and aid government finances by reducing the energy subsidy burden in the budget.”
This paragraph needs a detailed discussion. On May 26, 2014, the day Narendra Modi took oath as the prime minister of India, the price of the Indian basket of crude oil stood at $108.56 per barrel. Since then the price of the Indian basket has fallen dramatically and on January 13, 2015, it stood at $ 43.48 per barrel.

Hence, the oil price has fallen by nearly 60% since the Modi government came to power. This, as Patel puts it, has led to a dramatic fall in our oil import bill. He goes on to say that it also increases our disposable income, which in turn will increase consumer demand.
The logic here is very straightforward—people will spend a lesser amount of money to buy oil products, and the money thus saved would be spent on other goods and services. Nevertheless, things aren’t exactly like that. The government hasn’t passed on the entire fall in the price of oil to the end consumer.
As mentioned above the price of the Indian basket of crude oil has fallen by 60% since May end. Nevertheless, petrol prices haven’t fallen by 60%. In Mumbai, the petrol price has fallen by around 14% since April 2014. The same logic stands true for diesel as well.
This has happened because the government has increased the excise duty on petrol and diesel thrice since October 2014, in order to shore up its revenues. The tax growth had been assumed to grow at 16.9% at the time the budget was presented, whereas the actual growth in tax collections between April to November 2014 has been around one-fourth of that at 4.3%.
Analysts Chetan Ahya and Upasana Chachra of Morgan Stanley estimate that the Modi government will collect nearly Rs 14,600 crore between December 2014 and March 2015 through the higher excise duty on petrol and diesel.
What this tells us is that the major benefit of the fall in oil price has gone to the government and has not led to the disposable income of the citizens going up majorly as suggested by Patel. I don’t see this increase in disposable income being big good enough to lead to an increase in the consumption of goods and services.
As author Satyajit Das points out in a recent research note titled
Reverse Oil Shock: “While positive for public finances and economic efficiency, the diversion of the benefits from consumers to the government is contractionary, reducing the effect on growth.”
The index of industrial production (IIP) data suggests the same. IIP is a measure of the industrial activity in the country. When looked at from the use based point of view, for the period April to November 2014, the consumer goods number was down by 5.7% and the consumer durables number was down by 15.7%, in comparison to the same period last year.
Patel then talks about falling oil prices reducing the input cost of our businesses. This, he goes on to say, will increase margins and help to enthuse investment demand. Again this sounds very logical, but it does not take into account the biggest problem facing Indian businesses today, which is excessive leverage (i.e. very high debt).
In the Mid Year Economic Analysis, the Chief Economic Adviser to the finance ministry Arvind Subramanian pointed out: “Over-indebtedness in the corporate sector with median debt-equity ratios at 70 percent is amongst the highest in the world. The ripples from the corporate sector have extended to the banking sector where restructured assets are estimated at about 11-12 percent of total assets. Displaying risk aversion, the banking sector is increasingly unable and unwilling to lend to the real sector.” This has led to a situation where banks aren’t interested in lending and corporates aren’t interesting in investing.
Hence, while a fall in oil price will help corporates, it can’t be a major driver in corporate investment picking up.
Now that brings us to Patel’s final point which is that a fall in oil prices will “ aid government finances by reducing the energy subsidy burden in the budget”. In this case the answer is slightly complicated.
In the budget presented by Arun Jaitley in July 2014, it was assumed that the total oil subsidies for this financial year would work out to Rs 63,426.95 crore. Jaitley was assuming a low number to start with, given that Rs 35,000 crore of oil subsidies hadn’t been paid for in the last financial year.
Hence, Jaitley only had around Rs 28,400 crore to play around with in the oil subsidy account.
With a massive fall in the price of crude oil, the oil marketing companies are no longer suffering any under-recoveries on the sale of petrol and diesel. Nevertheless, they do suffer under-recoveries on the sale of domestic cooking gas and kerosene.
Data released by the Petroleum Planning
and Analysis Cell (PPAC) shows that in case of PDS(public distribution system) kerosene and cooking gas, the under-recoveries for the month of January 2015 will be Rs 19.46 per litre and Rs 235.91 per cylinder respectively.
The oil marketing companies need to be compensated for these under-recoveries. In fact, the under-recoveries for the first six months of this financial year were Rs 51,110 crore. This number is already higher than the Rs 28,400 crore that was left in the oil subsidy account. Given this, there can’t be any cut in oil subsidies that were budgeted for.
Nevertheless, as explained earlier, the government has raised excise duty on petrol and diesel thrice since October 2014, in order to shore up its revenues. And that would not have been possible if the oil price had not fallen.
Also, Modi and Jaitley should consider themselves lucky that the crude oil price has crashed by 60% since they came to power. If that had not been the case, then the amount allocated by Jaitely towards oil subsidies would have been wholly inadequate. This would have pushed up the fiscal deficit of the government. Fiscal deficit is the difference between what a government earns and what it spends. In fact, the fiscal deficit of the government is already at 99% of its annual target for the period between April to November 2014. This number has also been achieved only after a massive fall in oil prices.
Given this, Modi and Jaitley need to thank the Saudi Arabia led Organization for the Petroleum Exporting Countries(OPEC) which hasn’t cut production despite falling oil prices. This has driven down the crude oil price even further.
Saudi Arabia is doing this in order to ensure that it does not lose its market share in the global oil market. At the same time, it is trying to make things difficult for shale oil firms in the United States, which have suddenly started producing a lot of oil over the last few years.
Niels C. Jensen writes in The Absolute Return Letter for January 2015 titled Pie in the Sky: “In effect, OPEC is trying to destroy the economics of this industry, which admittedly requires quite high oil prices to remain profitable. Only 4% of total U.S. shale production breaks even at $80 or higher. A high percentage of the industry breaks even with an oil price in the $55-65 range.”
In the past, the Saudi Arabia led OPEC had cut production in times of falling oil prices. But that has not happened this time around. In January 2014, the nations in the Persian Gulf were pumping out 23.41 million barrels of oil per day. By September 2014, this number had remained more or less constant at 23.49 millions barrels of oil per day, despite falling crude oil prices.
n fact,
an AP newsreport points out that the energy minister of the United Arab Emirates, a member of OPEC, said yesterday that “there are no plans for OPEC to curb production to shore up falling crude prices, and instead put the onus on shale oil drillers for oversupplying the market.”
Nevertheless, it needs to be pointed out that the difference between supply and demand for oil is not huge. As Das writes: “The structure of the oil market entails fine margins between demand and supply. The current oversupply is around 2 million barrels a day.”
Data from the Energy Information Administration of the United States points out that the average daily production of crude oil between January and September 2014 stood at 77.17 barrels per day. In comparison to this, the difference between the oil supply and demand works out to 2.6% (2 million barrels expressed as a percentage of 77.17 barrels) of total global production.
Despite this small gap, oil prices have fallen by close to 60% since May. As Jensen points out: “even modest changes in the balance between supply and demand can have a dramatic impact on price, provided demand for, and supply of, the commodity in question is inelastic, and that is precisely the case as far as oil is concerned.”

The column appeared originally on on Jan 15, 2015

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)