Supply-side factors—like Venezuela’s cuts and the possibility of US sanctions on Iran being brought back—are putting upward pressure on crude prices
A recent Kotak Institutional Equities report states that the worsening socio-economic conditions in Venezuela, a major crude oil exporter, has led to oil production in the country falling from 2 million barrels per day (mbpd) in August 2017 to 1.5 mbpd in March 2018. This, and other supply-side factors, are what likely explain crude prices shooting up from $63.83/barrel (Brent crude) on March 1, 2018, to $73.59 on April 25. Mexico has also cut production—from a supply baseline of 2.4 mbpd, the country has brought output down to 2.1 mbpd. OPEC has maintained its supply cuts—as opposed to raising production to offset the reduced production by Venezuela and Mexico. This has led to a 2.4 mbpd overall reduction in production in March 2018 while just 1.7 mbpd of cuts was agreed to by the member of the oil-nations consortium.
The outlook for oil prices, thanks to supply-side factors, is further dampened by the expectation that US president Donald Trump will not extend the waiver of sanctions against Iran, possibly resulting in supply cuts to the tune of ~1 mbpd. Crude supply to the world market is also under the threat of action by Libyan militants that will push up prices further. The other supply constraint is that “midstream pipelines connecting Canadian oil sands to Cushing (US WTI delivery point) and Permian basin to the US Gulf coast are both operating at near-full capacity utilisation” and the situation is unlikely get better until new projects get completed in 2019
This supply-demand imbalance has resulted in a world-wide deficit of oil production, which is expected to continue till the end of this year. This puts upward pressure on the price of crude oil, which is expected to settle at around ~$65/barrel, according to Kotak’s estimates.
However, the upside risks to the price of oil could be offset by increased drilling activity witnessed in the United States over the past few years, which is expected to rise further in the current year. India will be relying on this, and the easing of geo-political tensions, for the rapidly rising oil prices to cool off. Given the Petroleum Planning and Analysis Cell already projects India’s oil import bill to rise by 20% and cross the $100 billion mark this year, India’s best bet in the near term is that OPEC reconsiders its cuts. With India’s rising trade deficit—it rose by 85% in FY18—it surely cannot afford the oil import bill taking a toll on the rupee, bringing with it risks to inflation and the fiscal deficit.
By Yash Budhwar