Shale Oil

Why the Price of Petrol is Racing Towards Rs 100 Per Litre

If there are two things that get people of this country interested in economics, they are the price of onion and the price of petrol racing towards Rs 100 per kg or litre, respectively.  Currently, the price of petrol is racing towards Rs 100 per litre in large parts of the country. In fact, in some parts, it has already crossed that level.

So, what’s happening here? Let’s take a look at this pointwise.

1) Take a look at the following chart, which plots the average price of the Indian basket of crude oil since January 2020.

Source: Petroleum Planning and Analysis Cell.
*February price as of February 18, 2021.

What does the above chart tell us? It tells us that as the covid pandemic spread, the price of oil fell, falling to a low of $19.90 per barrel in April 2020. It has been rising since then. One simple reason for this lies in the fact that as the global economy recovers, its energy needs will go up accordingly and hence, the price of oil is going up as well.

The other reason has been the massive amount of money that Western central banks have printed through the beginning of 2020. Oil, as it had post 2008, has emerged as a hard asset of investment for many institutional and high-networth investors, leading to an increase in its price. As of February 18, the price of the Indian basket of crude oil stood at $63.65 per barrel, having risen by close to 220% during the current financial year.

2) Now let’s look at the average price of the Indian basket of crude oil over the years.

Source: Petroleum Planning and Analysis Cell.
* Up to January 2021.

What does the above chart tell us? It tells us that the Narendra Modi government has been very lucky when it comes to the price of oil, with the oil price on the whole being much lower than it was between 2009 and 2014.

In May 2014, when Modi took over as the prime minister, the price of oil averaged at $106.85 per barrel. By January 2016, it had fallen to $28.08 per barrel.

Even after that, the price of oil hasn’t touched the high levels it did before 2014, in the post financial crisis years, which also happened to be the second term of the Manmohan Singh government.

A major reason for this lies in the discovery of shale oil in the United States. In fact, as Daniel Yergin writes in The New Map – Energy, Climate and the Clash of Nations: “In the autumn of 2018, though it was hardly noted at the time, something historic occurred: The United States overtook both Russia and Saudi Arabia to regain its rank as the world’s largest oil producer, a position it had lost more than four decades earlier.” This has been a major reason in the lower price of oil over a longer term.

The question that then crops up is why hasn’t petrol price in India seen low levels? The answer lies in the fact that between 2014 and 2021, the taxes on petrol, in particular central government taxes have gone up dramatically.

In short, the central government has captured a bulk of the fall in oil prices. Now when the oil price has gone up over the course of this financial year, the high-price of petrol has started to pinch.

3) Take a look at the following table. It plots the price of petrol in Delhi as of February 16, 2021 and in March 2014.

Source: https://iocl.com/uploads/priceBuildup/PriceBuildup_petrol_Delhi_as_on_16_Feb-2021.pdf
and https://www.ppac.gov.in/WriteReadData/Reports/201409231239065062686Snapshot_IOGD_MAR.pdf.

The above table makes for a very interesting reading. As of February 16, the price of petrol charged to dealers was Rs 32.1. Over and above this, the central government charged an excise duty of Rs 32.90 per litre on petrol. Add to this a dealer commission of Rs 3.68 per litre, and we are looking at a total of Rs 68.68 per litre.

On this the Delhi state government charged a value added tax of 30% or Rs 20.61 per litre. This leads to a retail price of petrol of Rs 89.29 per litre. Given that the state government charges a tax in percentage terms, the higher the price of petrol goes, the more tax the state government earns. The vice versa is also true.

Let’s compare this to how things were in March 2014. The price of petrol charged to dealers was Rs 47.13 per litre, much lower than it is today. On this, the central government’s tax amounted to Rs 10.38 per litre. The dealer commission was Rs 2 per litre.

Adding all of this up, we got a total of Rs 59.51 per litre. On this, the Delhi state government charged a value added tax of 20%, which amounted to Rs 11.9 per litre and a retail selling price of petrol of Rs 71.41 per litre. Interestingly, the state government’s tax was more than that of the central government at that point of time.

4) The above calculations explain almost everything. In March 2014, the price of petrol at the dealer level was higher than it is now, but the retail selling price was lower. Both the central government and the state government have raised taxes since then.

The total taxes as a percentage of dealer price now works out to 167% of the dealer price. In March 2014, they were at 47.3%. It is these high taxes which also explain why petrol prices in India are higher than in many other countries.

Of course, a bulk of this raise has come due to a rise in taxes charged by the central government. As mentioned earlier, the central government has captured a bulk of the fall in price of oil.

5) The calculation shown here will vary from state to state, depending on the value added tax or sales tax charged by the state government and the price at which petrol is sold to the dealers. States which charge a higher value added tax than Delhi will see the price of petrol reaching Rs 100 per litre faster than Delhi, if the price of oil continues to rise.

6) Of course, the governments can bring down the price of petrol by cutting taxes. In fact, four state governments have cut taxes providing some relief to oil consumers. But any substantial relief can be provided only by the central government. The trouble is that tax collections have fallen this year. Only the collection of excise duty has gone up by 54% to Rs 2.39 lakh crore, thanks to the higher excise duty charged on petrol and diesel.

The interesting thing is that the excise duty earned from the petroleum sector has jumped from Rs 99,068 crore in 2014-15 to Rs 2.23 lakh crore in 2019-20. The government has become addicted to easy revenue from taxing petrol and diesel. This year its earnings will be even higher than in 2019-20.

7) The central government also fears that if it cuts the excise duty on petrol and diesel, the state governments can step in and increase their value added tax, given that like the centre, they are also struggling to earn taxes this year.

Also, what needs to be kept in mind here is that the central government doesn’t share a good bit of what it earns through the excise duty on petrol and diesel with the states. This is because a bulk of the excise duty is charged in the form of a cess, which the central government does not need to share with the states.

Let’s take the overall excise duty of Rs 32.90 per litre of petrol currently. Of this, the basic excise duty is Rs 1.40 per litre and the special additional excise duty is at Rs 11 per litre. The road and infrastructure cess is at Rs 18 per litre (also referred to as additional excise duty) and the agriculture and infrastructure development cess is at Rs 2.50 litre. Clearly, the cess has a heavier weight in the overall excise duty.

8) One reason offered for the high price of petrol is low atmanirbharta or that as a country we have to import more and more oil than we did in the past. In 2011-12, the import dependency was 75.9%. This jumped to 77.6% in 2013-14 and has been rising since. In April to December 2020, this has jumped to 85%.

The explanation offered on this has been that oil companies haven’t carried out enough exploration activities in the past. Let’s take a look at the numbers of ONGC, the government’s biggest oil production company (or upstream oil company, as it is technically referred to).

The total amount of money spent by the company on digging exploratory wells in 2019-20 stood at Rs 4,330.6 crore. This had stood at Rs 11,687.2 crore in 2013-14. Over the years, the amount of money spent by ONGC on exploration has come down dramatically. This explains to some extent why the crude oil production in India has fallen from 37.8 million tonnes in 2013-14 to 30.5 million tonnes in 2019-20, leading to a higher import dependency.

Of course, not all exploration leads to discovery of oil, nevertheless, at the same time unless you explore, how do you find oil.

The reason why ONGC’s spending on exploration has fallen is primarily because the company has taken on a whole lot of debt over the past few years to finance the acquisition of HPCL and a majority stake in Gujarat State Petroleum Corporation’s (GSPC) KG Basin gas block. The money that ONGC borrowed to finance the purchase of HPCL from the government was used by the government to finance the fiscal deficit. Fiscal deficit is the difference between what a company earns and what it spends.

The borrowing has led to the finance costs of the company going up from Rs 0.4 crore in 2013-14 to Rs 2,823.7 crore in 2019-20. The cash reserves of the company are down to Rs 968.2 crore as of March 2020 from Rs 10,798.9 crore as of March 2014.

All this explains why the price of petrol is racing towards Rs 100 per litre. At the cost of sounding very very very cliched, there is no free lunch in economics. Somebody’s got to bear the cost.

It will be interesting to see if the central government continues to hold on to the high excise duty on petrol and diesel (whatever I have said for petrol applies for diesel as well, with a different set of numbers) leading to  a high petrol and diesel price and lets these high rates feed into inflation in the process.

Keep watching this space.

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

oil
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 Prediction: “Take 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

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.
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.”
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 www.firstpost.com on Jan 15, 2015

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

Despite recent fall, oil prices will touch $100 per barrel again

light-diesel-oil-250x250Vivek Kaul

This column should complete the trilogy of columns on the price of crude oil. In yesterday’s column I had argued that it is difficult to predict which way the price of oil would go in the short-term, even though it seems that it will continue to remain low.
The more important question is which way the price of crude oil will go in the long term. While exact forecasting is risky business, the direction of the price rise can be predicted especially when structural factors are at work.
Nevertheless, before we get around to doing that, we first need to understand why is oil so important for the progress of human civilization. As Jeremy Grantham of GMO puts it in a newsletter titled The Beginning of the End of the Fossil Fuel Revolution (From Golden Goose to Cooked Goose: “The quality of modern life owes almost everything to the existence of fossil fuels, a massive store of dense energy that for 200 years had become steadily cheaper as a fraction of income. Under that stimulus, the global economy grew ever larger.”
By fossil fuels Grantham means coal and oil. But what is it that makes oil so important? Grantham explains it through an example of one of his sons who is a forester. Grantham talks about a situation where wood is needed for heating purposes and hence, trees need to be cut. This can be done by hiring local labour who will use their axes to cut trees, and paying them a respectable minimum wage of $15 an hour. The other option is to fill a chainsaw with a gallon of gas and use that to cut trees.
As Grantham writes: “One of my sons, a forester, tells me he could cut all day, 8 to 12 hours, with a single gallon of gasoline and be at least 20 times faster than strong men with axes and saws, or a total of 160 to 240 man hours of labor. For one gallon!”
If people had to be hired to do the same job around $2,400 (160 x $15) to $3600 (240 x $15) would have to be paid. That’s the value created by one gallon(or 3.79 litres) of gasoline(or what we call petrol in India) which costs around $3 in the United States.
This “surplus value” created by gasoline and other petroleum products were a major reason which helped usher in the industrial revolution in the Western world. Before the world discovered fossil fuels it was totally dependent on wood from trees for its energy requirements.
As Grantham writes in another newsletter titled Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever: “[Wood]…was necessary for producing the charcoal used in making steel, which in turn was critical to improving machinery – a key to progress. (It is now estimated that all of China’s wood production could not even produce 5% of its current steel output!) The wealth of Holland and Britain in particular depended on wooden sailing ships with tall, straight masts to the extent that access to suitable wood was a major item in foreign policy and foreign wars. Even more important, wood was also pretty much the sole producer of energy in Western Europe.”
Other than being used for making charcoal, wood was also used to power steam engines and for heating purposes. What this meant was that forests were rapidly cut down for wood which was required to produce energy. “Not surprisingly, a growing population and growing wealth put intolerable strains on the natural forests, which were quickly disappearing in Western Europe, especially in England, and had already been decimated in North Africa and the Near East. Wood availability was probably the most limiting factor on economic growth,” writes Grantham.
If the world had not discovered first coal and then oil, it would have run out of trees by around 1850, estimates Graham. And there would have been other impacts as well. “By 1900 wars would have been fought over forests, and the population – without oil-intensive agriculture, both for growing and transportation – would have peaked out probably well under two billion and our species would indeed have had its nose pushed up against the limits of food,” writes Grantham.
That is the importance that fossil fuels, in particular oil, have had on the human civilization over the last two hundred years. So, it is important that the world continues to have access to “cheap” oil. But will that be case?
As Niels C. Jensen writes in The Absolute Return Letter for January 2015 titled Pie in the Sky: “The world will still run out of cheap oil (cheap as in approx. $25 per barrel of production cost, as is currently the average production cost in the Middle East) over the next decade or so. It is hard to predict exactly when, because OPEC members are not the most informative people in the world.”
This, despite the fact that over the last six to seven years the world has managed to increase the production of shale oil. In the United States oil production has gone up by 4 million barrels per day to 9 million barrels per day and almost all of it has come through shale oil production.
Even with this, the future does not look very encouraging. And there is a reason for the same. As James K. Galbraith writes 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.”
Grantham goes into detail about the point that Galbraith makes. The process used to drill out shale oil is referred to as fracking. As Grantham points out: “The first two years of flow are basically all we get in fracking…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.”
Hence, shale oil will be what Jensen calls a “relatively short-lived phenomenon”. It is not replacing cheap traditional oil which is becoming more and more difficult to find. “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!,” writes Grantham.
Hence the oil industry in the “last 12 months” has replaced “only 4½ months’ worth of current production!” This, despite the boom in shale oil production.
What this clearly tells us is that the recent fall in the price of oil is at best a temporary phenomenon. Over the long term, oil prices can only go up. As Jensen puts it: “we will see the oil price at $100 again, and it won’t take many years, but it could be an extraordinarily bumpy ride.”
Meanwhile,watch this space.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 14, 2015

Oil in the 40s: Falling oil price has several negative effects as well

oil

Vivek Kaul

The price of brent crude oil fell by 5.65% yesterday (January 12, 2015) to close at $47.43 per barrel. Many experts who follow oil closely have talked about how a fall in the price of oil will be beneficial for the world at large. The logic is straightforward.
Most countries do not produce all the oil that they consume. Hence, they need to import oil. A fall in the price of oil means that these countries will pay a lower price for oil and in turn petroleum products like petrol, diesel etc.,will become cheaper. This means that citizens of these countries will have more money to spend on other things, which, in turn, will benefit businesses.
There are various estimates about how much this benefit will amount to for oil consuming countries. As Niels Jensen writes in The Absolute Return Letter for the month of November 2014, titled Snail Trail Vortex: “A $20-per-barrel drop in oil prices transfers $6-700 billion from oil producing nations to consumers worldwide or nearly 1% of world GDP. Assuming consumers will spend about half of that on consumption, which historically has been a fair assumption, the positive effect on GDP in consumer countries is c. 0.5%.”
Author Satyajit Das in a recent research note titled The Reverse Oil Shock makes a similar assessment, when he writes: “A US$ 40 fall in oil prices equates to an income transfer of around US$1.3 trillion (around 2 percent of global GDP) from oil producers to oil consumers. A sustained 10 percent cut in the oil price is generally assumed to increase global GDP by 0.20 percent per annum.”
The price of oil has fallen by around $60 per barrel since end of May 2014. Using the numbers provided by Jensen and Das, we can conclude that an income transfer of around $2 trillion will happen from oil producers to oil consumers.
This money when spent by citizens of oil consuming countries will lead to economic growth. This is a straightforward conclusion that can be drawn from this data to the condition that governments of oil consuming countries pass on the benefits of low oil prices to their citizens.
But this hasn’t happened everywhere in the world. As Das writes: “A number of governments, such as Indonesia and India, have taken the opportunity presented by low prices to reduce fuel subsidies. 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 Indian government has increased the excise duty on petrol and diesel thrice since October 2014, in order to shore up its revenues. There are several other negative effects of a low oil price. The world at large is still in the process of coming out of a huge debt binge and hence, will use the money saved from the low oil price to repay debt. As Das writes: “A significant overhang of debt, employment uncertainty and weak income growth may result in the transfer being saved or applied to reducing borrowings, reducing the boost to consumption and growth.”
Further, with falling oil prices the amount of money being spent on “energy exploration, development and production,” will come down. “One estimate puts the decrease in investment spending as a result of the fall in prices at almost US$1 trillion. This entails the deferral or cancellation of deep water, arctic oil, tar sands and shale projects as well as further investment in mature fields such as the North Sea projects, which require high prices to be economically viable,” writes Das.
This can’t be good for energy security over the long term. A newsreport suggests that there has already been a drop of  “almost 40% in new well permits issued across the United States in November.”
A major reason for a fall in oil prices has been the massive amount of shale oil being produced in the United States. Oil production in the United States has jumped by 4 million barrels per day since 2008. Almost all of this increase in production has come from an increase in production of shale oil.
Shale oil is expensive to produce and much of it is only viable if oil prices remain higher than $70 per barrel. As Jensen puts it: “A high percentage of the industry breaks even with an oil price in the $55-65 range…With an oil price around $50, oil producers could go belly up, left right and centre.” This can’t be good news for the United States because shale oil companies have been a major reason behind the job boom in the United States. And if they start shutting down, this will have an impact on job creation, which will in turn have an impact on consumer spending and US economic growth.
The United States is the shopping mall of the whole world and if consumer spending slows down, it will have an impact on many exports of many countries.
Further, the oil exporting countries are losing out because of lower oil prices. “Many oil producers are now fiscally profligate, using strong oil revenues to finance ambitious public spending programs or heavily subsidise domestic energy costs. Lower oil prices will force these governments to curtail programs and subsidies or increase debt, which might reduce the positive effects on growth,” writes Das.
These countries are now in a major problem. Saudi Arabia leads this pack and is now forecasting the biggest fiscal deficit in its history. Fiscal deficit is the difference between what a government earns and what it spends. The deficit for 2015 is expected to amount to $38.6 billion and was recently announced on state television. The Saudis can ride through this because they have a huge amount of foreign exchange reserves amounting to over $700 billion. Other oil exporters are not so lucky.
Nevertheless Saudi Arabia has plans to limit wage growth. As a Bloomberg report points out: “The Finance Ministry said the government will continue to invest in areas such as education and health care, while exerting “more efforts” to curb spending on wages and allowances, which make up about 50 percent of spending.” This can’t be good for global economic growth.
What all these points suggest is that there are many negative impacts of falling oil prices, which are not being highlighted at all.

The article originally appeared on www.firstpost.com on Jan 13, 2015

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