By Amb D P Srivastava (Retd)

Before he departed for the Middle East (ME),  US President Joe Biden wrote in an Op-ed in the Washington Post on July 9 that he was concerned with mitigating the effect of the Ukraine war on oil prices. Moderating prices required increasing production.

The Saudi Crown Prince Mohammad Bin Salman in a meeting at Jeddah on July 15 mentioned that the Kingdom will increase its production to 13 million barrels per day (mbd) by 2027 from the current level of around 10.7 mbd. His statement gave no hint of the immediate course of action. The answer came on August 3 when OPEC+ announced an increase of 100,000 mbd in September. This was a rather meager increase and came with a lot of caveats. Nevertheless, it was a political gesture.

The Saudi Oil Minister’s statement threatening a possible cut in production by OPEC+ on August 22 has come as a shock against this background.

HRH Prince Abdul Aziz Bin Salman said in an interview with the Saudi Press Agency that OPEC+ has ‘the commitment, the flexibility, and the means to deal with the oil situation ‘including cutting production at any time and in different forms as has been clearly and repeatedly demonstrated in 2020 and 2021’. He hit out at the ‘flow of unsubstantiated stories about demand destruction, and the recurring news about the return of large volumes of supply’. He was challenging the assumption that fear of slow-down in the leading economies of the world has affected demand, or that an imminent revival of the Iran nuclear deal could increase supply. 

The oil prices moderated in early August. The Brent price came down from $ 103.97 (INR 8,325.03) on July 29 to $ 92.34 (INR7,393.80) on August 16 before going up again. On August 22 when the Saudi Oil Minister made his statement, Brent was trading at $ 95.81 (INR 7,671.65). There was also moderation of petrol prices at the pump in the US. Before President Biden’s visit, the nationwide average of petrol in the US had crossed $ 5 (INR 400.36) per gallon. This was above the comfort level of $ 4 (INR 320.29) per gallon. Hochstein, President Biden’s advisor on energy security noted that petrol prices have fallen to $ 4.16 (INR 333.10) per gallon. This is a welcome development for the Democratic Administration before the US Congressional elections in November. This has come about more due to fear of recession rather than policies or actions of OPEC+. Following the Saudi Oil Minister’s statement, Brent oil climbed to $ 102 (INR 8,167.29) per barrel. It has since settled down to $ 101 (INR 8,087.22) per barrel.

There are three factors driving up the oil prices – the restrictive production policy of OPEC+, geopolitical uncertainty, and the fall in investment in upstream exploration with mounting concern about climate change.  OPEC+ is a  grouping of OPEC and non-OPEC producers led by Russia. It had cut production by 9.7 million barrels per day following the outbreak of the pandemic. But its restrictive production policies pre-date the pandemic and have been followed since the group was formed in 2016. The cut in production during the pandemic has been gradually restored. But there is an important caveat. The increase in production has consistently lagged behind the increase in quota. This partly neutralizes the periodic increase. Though the grouping had announced a quota increase of 648,000 bpd for July the actual production remained  2.9 million bpd below the quota set by OPEC+.

The restrictive production policy of OPEC+ has earned its member states rich dividends. ARAMCO, Saudi National Oil Company earned $ 65 billion (INR 5,19,220 crore) in the first half of this year. According to the Russian Central Bank, Russia’s international reserves have reached $ 580.6 billion (INR 4,63,7832.8 crore). They have no incentive for breaking rank. The Saudi Oil Minister’s statement has been supported by UAE and a number of other OPEC + members. This has also created new equations in the M.E. Saudi Arabia and UAE voted with the West on the Ukraine issue in the UNGA, but are determined to maintain the unity of OPEC+ which includes Russia. Could the Saudi Oil Minister’s statement be linked to the possible revival of the Iran nuclear deal? The return of Iranian oil to the world market will soften prices, and force OPEC+ members to accept still smaller quotas to support the price threshold they want. But the issue may go beyond demand-supply or price calculation. Normally, Saudi statements are not so direct especially if they impinge on US interests. In this case, the demand for oil price moderation was raised by the visiting US President. 

The geopolitical situation in Europe and M.E. has also pushed up the oil prices. Before the sanctions, Iran exported 2.2 mbd of oil. Since then, its exports have come down to around 800,000 bpd. If the Iran nuclear deal is revived, it will bring at least an additional 1 million bpd of crude oil to the international market. This will help moderate the prices, but cannot compensate for the Russian exports which are much bigger in scale. Russia exports about 3 mbd of crude oil to the EU and 2 mbd to Asian destinations. The EU oil sanctions against Russia are to go into effect by the end of the year. This will affect supplies to the EU which will have to procure from elsewhere. In case the scope of sanctions is expanded to include shipping and marine insurance, this will also affect Russian exports to third countries.

Also Read: Biden’s dilemmas in the Middle East

The investment in oil extraction has shrunk from $ 749 billion (INR 5,98,3012 crore) in 2014 to $ 350 billion (INR 27,95,800 crore) in 2021. The trend initially due to low export prices has been reinforced by rising climate concerns. Unlike in the past, high oil prices are no longer leading to increased production. The OPEC + says that there is not much spare capacity available. Between February and May 2022, the US Shale production increased by a mere 0.3 mbd. The US Shale companies are returning money to shareholders or retiring debt to the shareholders. Despite the huge increase in earnings, ARAMCO has not substantially increased outlay for upstream exploration. 

India as a consuming country has an interest in the moderation of oil prices. Its annual oil import bill increases by more than Rs. 14,000 crores if the crude price increases by $ 1 (INR 80.07) per barrel. There has been a $ 29 (INR 2322.07) increase in the price of the Indian basket of crude since last year. The increase in crude import bill also means that the government has fewer resources to invest in clean energy. 

The flow of gas from Russia to the EU has been reduced to 20%. The gas prices in the EU have gone up from $ 26.52 (INR 2,123.50) per MMBTU on February 22 to $ 85.75 (INR 6,866.13) per MMBTU now. The high prices in the EU have already affected prices elsewhere. Asian LNG prices have gone up from $ 25.96 (INR 2,078.66) to $ 66.25 (INR 5,304.74) per MMBTU. Gas currently accounts for 6 % of India’s energy basket. But it is a bridging fuel to energy transition to a low carbon economy. The government’s target is to increase its share to 15% of the energy basket. In the immediate context, gas is a feedstock for Urea production. An increase in gas prices has already increased the import price of fertilizer. Through the urea prices have come down recently, they are still nearly double the prices a year ago.

A major escalation in oil prices will be inevitable If the EU oil sanctions are implemented by year-end, or deepened to include shipping and insurance. The LNG prices have already nearly tripled. There is an urgent need to diffuse geopolitical tensions to avoid the global economy from tipping into recession.

Author is a former Ambassador, and has served in Saudi Arabia, Libya and Iran. He was also Senior Advisor to OVL and Director, GAIL.

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