Complacency on oil prices should not go on for long

Ardhendu Sen

The first of the missile showers over Kabul did not bring any relief to oil producers. Brent, which closed at $21 and 5 cents a barrel on October 5, 2001, was at $20 and 50 cents on October 9. Oil traders are obviously not expecting any disruption in oil supply on account of the war in Afghanistan. However, as an oil consumer, India cannot be complacent about the oil price, especially as the United States has warned that the war could be carried beyond Afghanistan. If this means that Iraq may have to be hit, we may well see a repetition of 1990-91 when the price shot up from $20 a barrel to over $40.

The US attack on Afghanistan came 24 days after the assault on the World Trade Centre. In contrast with the quick reaction of 1998, a lot of strategic thinking has gone into shaping the US response this time. The emphasis has been on building a global alliance and on formulating a strategy acceptable to a large number of countries, including Islamic countries. In this, the US seems to have largely succeeded. It is reasonable to expect that a large part of this strategising addressed the question of oil prices. Has the US been able to make sure that the oil price will not shoot up?

More than any diplomatic initiative, it is the slowdown in the US, European and Asian economies which will help in keeping the oil price down. After reaching a high level of $33 a barrel last year, the oil price has been softening this year. So much so that the Organisation of Petroleum Exporting Countries (Opec) decided in July to cut production by a million barrels a day with effect from September 1, 2001.

The Energy Information Administration of the US government reported in August that the market would be easy for the rest of the year, rising only by a dollar and a half per barrel when the winter sets in. The attacks on the US on September 11 took place in this background. Immediately following the attack, the oil price went up by $2 a barrel. This was caused by traders anticipating an immediate retaliation by the US. However, the retaliation did not come and the price started moving down within two days.

The attacks on September 11 severely depressed the oil market. Civil aviation was hit the hardest. In the US, the consumption of aviation fuel normally comes to 10 per cent of all petroleum products consumed. This consumption has now dropped by 25 per cent.
Gasoline consumption has also suffered in the US and in Europe with people staying away from long journeys. Refineries have cut back production and reduced inventories of both crude oil and products. Before September 11, the market was mildly over-supplied; now there is too much supply chasing too little demand.

Under more favourable circumstances, the Opec ministers’ meeting on September 26, would probably have decided on a further production cut. A production cut could be dangerous in a recessionary situation but Opec has only limited choice of instruments for propping up a falling price. Following September 11, a production cut would have looked like a vote for terrorism and expectedly, Opec decided to maintain the production level. On October 5, the price of the Opec basket of crude oils stayed below $22 a barrel for 10 consecutive days. Normally, this would bring an automatic cut of 500,000 barrels a day in Opec production. There has been no move so far toward activating this trigger.

The last time we saw oil being used as a weapon by oil producers was in 1973. Ever since then, US policy has tried to ensure that this does not happen again. The US has relied heavily on Saudi Arabia which has agreed to maintain an excess production capacity of two million barrels a day. This capacity can be brought into use in emergencies within three months or so. The US Energy Policy announced this year acknowledges this fact and apparently considers this to be sufficient. The policy does not, for instance, say that energy security requires that the Palestinian problem be solved or that major changes are called for in US policy toward West Asia. So long as the Saudis play ball, it is all right with the US.

The significant gap in the US game plan is that Iran has not been taken on board. Both Iran and Iraq now produce over two million barrels a day. In case of war spilling over to Iraq, the Iraqi capacity will no longer be available. In the event, any action by Iran or even the threat of such action could send the oil price rocketing. The damage would be done before Saudi Arabia or Russia or Mexico could make good the loss.

Over the longer term, Iran, with her vast gas reserves and proximity to Central Asia, is important for energy security for India and the whole world. The US sanction on Iran was unfortunately renewed in August for five more years. The developments in September have provided an opportunity for a rethink, and it would not be surprising if we see the sanction lifted by the time the present crisis runs its full course.

(The writer, an IAS officer, is Senior Fellow (Oil and Gas), Tata Energy Research Institute, New Delhi)