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The battle to set oil prices

The logo of the OPEC (Organization of the Petroleum Exporting Countries)

The logo of the OPEC (Organization of the Petroleum Exporting Countries)   | Photo Credit: AFP

Russia’s move to reject production cuts is driven by its strategy of denying market share to U.S. shale producers

The global economy, grappling with the COVID-19 pandemic, is now facing an energy war, with crude oil prices crashing in the international market. Crude oil prices tanked, as the Organisation of the Petroleum Exporting Countries (OPEC) and its alliance partners failed to reach any consensus on cutting back production to levels that would enable prices to remain stable. The U.S., as the largest oil producer today, has stayed away from the OPEC-plus arrangement, hoping that production cuts by OPEC-plus countries will help it increase its market share.

Russia refused any production cuts, unleashing an energy war with Saudi Arabia. There has been a spectacular fall of around 30% in crude oil prices. The International Energy Agency (IEA) has scaled down global demand for oil, a move not taken by the energy watchdog since 2009. Demand for oil had already weakened owing to the global economic slowdown, and this weakening has become more pronounced due to the COVID-19 pandemic, which has hit China’s economy and reduced consumption by the world’s largest importer.

Russia’s decision to reject any production cuts is driven directly by its strategy of denying market share to American shale oil producers. The latter rely on higher prices in the range of $50-$60 to remain profitable because of higher production costs. At $31 per barrel, not more than five American shale oil producers can remain profitable.

Sanctions on Rosneft

Russia also remains resentful of sanctions imposed on Rosneft, which is building the gas pipeline project Nord Stream 2 across the Baltic Sea, carrying Siberian gas to Germany, a major consumer. This pipeline was delayed due to opposition from Denmark’s environmental activists and could not be completed before the U.S. sanctions kicked in. Moscow has accused Washington of using geopolitical tools for commercial reasons.

Russia had promised to retaliate at a time of its own choosing. The energy war over prices is Russia’s revenge, to cripple the American shale oil industry. President Donald Trump has scrambled to put together a rescue package for the shale oil companies. Russia is also signaling to Saudi Arabia that its American patrons can do little to protect its oil interests and it would be prudent for Saudi Arabia to reach some understanding with Russia. Both Saudi Arabia and Russia depend heavily on oil revenues — upwards of 80% of export revenues accrue from crude oil. Both are also fighting to retain market share. It has been reported that Saudi Arabia has agreed to supply crude oil at lower rates to refiners in India and China, two primary customers, but refused to supply to other refiners in Asia. This will impact on India’s oil procurement from the U.S..

Benefit to importing countries

Lower crude oil prices are not necessarily bad news for oil importing countries like India, which is the world’s third-largest importer of crude oil and the fourth largest importer of LNG. There are, however, collateral adverse consequences like the battering of the stock markets worldwide. The global economy, already impacted by President Donald Trump’s trade war with China and other countries, including India, and the COVID-19 pandemic, may find lower energy costs helpful in overall growth.

From a high of $147 per barrel in 2008, crude oil prices have fallen to around $24 per barrel and may even go further southwards. India, with 80% of its energy requirements met by imports from the international market, stands to save ₹10,700 crores for every $1 drop in prices. While this may help manage the current account deficit, fiscal deficit and inflation, there are non-oil related collateral factors that can cause countervailing adverse economic impact.

There is no doubt that India will benefit from lower oil prices, if the cost of fuel at the pump is passed on to consumers. It will reduce transportation costs and boost demand. The consumer, however, may not benefit much since the government may choose to use this financial windfall for other purposes, like bailing out banks which have been hollowed out by NPAs to leading Indian companies.

Can Russia and Saudi Arabia sustain the energy war for long? Unlikely. Saudi Arabia’s production cost is the cheapest in the world and it can ramp up production to around 12 million barrels a day. By offering discounts, it can undercut other producers, including Russia. Domestic considerations also matter.

Meanwhile, oil importing countries, like India, can enjoy a breather and cushion the adverse impact of COVID-19 and other factors.

The author is a former Ambassador and Secretary in the Ministry of External Affairs. Views are personal

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Printable version | May 30, 2020 8:55:38 AM | https://www.thehindu.com/opinion/op-ed/the-battle-to-set-oil-prices/article31230648.ece

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