No room for complacency on oil front

Since 2008, Brent crude oil prices have been fluctuating, touching a high of $147 and low of $35 per barrel. What explains these wild swings, which at times change the directions of world economy?

You may or may not find a can of Pepsi or Coke in some countries. But there is no country in the world which has not been penetrated by petroleum products. Out of the 196 countries in the world, only 20 have surplus crude oil to export. To such exporters, a decline in oil price is bad news and to the rest of the world, which is home to more than 75 per cent of the global population, it’s good news. For India, there cannot be a better Diwali gift!

The price of any product is normally determined by what it costs to produce and transport to consumers plus a margin that is determined by the market.

And if it’s an essential product, its price spikes when consumers fear that it may not be available (as we saw in the case of the price of milk in Vizag post Hudhud). It is this constant fear factor, at times real and many times artificial and speculative, which has been swinging the oil prices in such a broad range.

When oil prices move up north, you can expect experts to say that prices are shooting up as “the US economy is recovering” or “the Chinese demand for oil is rising” or “Japan is set to import more oil” or “There is disruption to oil production in Syria” (which incidentally, at 385,000 barrels of oil production per day in 2010, contributes to only 0.4 per cent of world oil production).

And when oil prices plunge south, the arguments are conveniently reversed.

Make no mistake; it seems that this time, the reduction in price is real. It’s primarily driven by the fundamental surplus in oil supplies, powered by the North American Shale Revolution. The fact is the US, the world’s largest importer of crude oil, has increased its oil production by 50 per cent and reduced its import from the Organisation of Petroleum Exporting Countries (OPEC) by more than 30 per cent since 2008.

Unlike in other products, cost plays a limited role in determining oil prices. It is driven primarily by “expected shortage or surplus” and “its strategic impact to importers”.

The markets for any commodity are determined by its top sellers and buyers. The top five exporters of crude oil today are Saudi Arabia, Russia, the UAE, Kuwait and Iraq and top five importers are the US, China, Japan, India and South Korea.

The world needs around 90 million barrels per day (mbd) to keep its engines moving. The global oil market generally ignores the signals if volume of oil barrels added to or withdrawn from market, at any point in time, is less than a million barrels per day.

And the US today imports 5 million barrels less than what it used to in 2008.

The six countries that really matter today to the global oil market are Saudi Arabia, US and Russia from supply side and China, India and Japan from the demand side. The only thing that can stimulate a spike in oil price again is when more than a million barrels of production are cut or disrupted, and the market fears further disruptions and shortage in supplies in the near future.

Saudi Arabia can cut production and influence such a cut by its fellow members in OPEC. Whether OPEC will decide to cut its production or not, when it meets next month, will be debated widely. Even if OPEC decides to cut its production, as it did during the 1980s to prop up the oil price, whether the oil market will react the same way as earlier, is a big question mark.

Over four decades, oil market dynamics have changed. While global oil demand moved up to about 90 mbd from 55 mbd in 1973, OPEC continued to maintain its production at a steady rate of 30 mbd for the last 40 years. Its sole purpose is to hold oil prices from falling. OPEC continues to hold the largest share of global oil reserves and has the lowest per barrel production costs in the world.

But what it could not hold is its market share. OPEC’s share in global oil supply has fallen from 54 per cent in 1973 to less than 33 per cent today. Ultimately, it is the market share which determines the relevance of a player in a marketplace. The fear of losing it further will be the greatest deterrent to any OPEC debate on oil production cuts.

In the first 10 years of this century, China’s oil demand more than doubled and is expected soon to overtake the US as the world’s largest oil importer. Even now, China and India together import more oil than the US. Therefore, energy policy choices that China and India make, particularly in the transportation sector, as host to more than one-third the global population, will influence the direction of future global oil prices as never before.

The import of oil by China and India is essential to meet the ever growing demand for transportation fuel and energy in both countries. Whether one travels by air, sea, rail or road, petroleum products remain the sole fuel of choice. As long this dependency continues, oil prices will remain volatile and cyclical, derailing the economic progress of emerging economies.

But smart countries are those which focus on developing alternative transportation fuel options such as gas, ethanol, methanol and appropriate electric power, even while oil prices decline. China is ahead of India in its quest for alternative transportation fuel, opting for more and more flexi-fuel cars, which are run on a combination of compressed natural gas (CNG), diesel, ethanol, petrol and methanol

India consumes around 150 million tonnes of liquid petroleum products every year, with the top 11 States consuming 82 per cent of the petroleum products. Maharashtra, Gujarat, Tamil Nadu, UP and Rajasthan each consume more than 10 million tonnes of liquid petroleum products. Over 70 per cent of diesel consumption in India is by the transportation sector.

Buses, cars, even railways can, and must plan to switch to a flexi-fuel mix of gas, ethanol, methanol blend along with petrol and diesel, while encouraging electric-powered cars in select regions.

We must pursue this flexi-fuel goal even if gas were to be imported in the form of LNG and a premium price is required to be paid to increase domestic production of ethanol.

This will send a strong signal that India will depend less on imported oil, even as its demand for energy will continue to grow in tune with its economic growth. Higher oil prices and the resultant subsidies and fiscal deficits, appear to be the only speed-breakers on India’s road to accelerated growth.

Libya, Iran, Iraq, Syria, Yemen, Nigeria and Ukraine will continue to remain geopolitical hotspots with a potential impact on oil markets. However, their ability to create fear of oil shortages and trigger price spikes has weakened. And the market’s reaction to political upheavals is gradually getting moderated. Thanks to the shale revolution, no one talks about “Peak Oil”, and no one ever talked about “Peak Gas”.

Moving away from excessive dependence on oil as the sole source of transportation fuel is essential. This is a conscious choice each country, and in the context of India, each State needs to make and move.

The writer is a former CEO of Cairn India