The double-edged sword of cheap oil

In anticipation of its sanctions being lifted after signing the nuclear deal with the P5+1 group of countries, Iran has offered 70 oil and gas projects comprising 52 production and 18 exploratory projects, both in onshore and offshore areas. Iran hopes to get investments worth $30 billion. Is Iran being unrealistically optimistic when there is so much gloom in the oil-producing world?

Similar hope is visible in the Indian government’s recent announcement of its new licensing policy to encourage investment in its oil and gas sector. The government has brought about ease of doing business for companies engaged with this sector.

Changes have been brought about in the way the acreage allotted to companies for oil exploration or prices are determined of gas, for instance. Going by the current scenario of depressed oil prices, this is unlikely to help India in its efforts to increase oil and gas reliance.

It is not just India that may struggle to get investor attention, even Iran — whose offer looks quite attractive as it departs from the earlier practice of signing buy-back agreements now offers attractive incentives — may suffer.

With the collapse of oil prices and refusal of Saudi Arabia and Russia to restrict their supplies, oil companies are busy trying to trim their losses by shutting down oilrigs and offloading oilmen. There has been a 20 per cent decline in investments in the oil sector that has resulted in job losses of around 300,000 worldwide.

Countries such as Brazil, Nigeria and Angola are in the doldrums. The situation in Venezuela is so grave that there have been food riots in the capital, Caracas, and elsewhere. The country is on the threshold of jettisoning the socialist government — come the elections.

Since the high in June 2014, oil prices have fallen by 60 per cent. Goldman Sachs, OPEC and IEA predict a further fall in prices in the short term. There is also confusion over the impact of global oil inventory of 3 billion barrels on oil prices and investments in the coming months.

The Paris-based IEA in its latest report says that the turnaround in oil price will come with the falling investments in unviable fields where extraction is expensive, leading to consequent reduction of oil production. Countries outside of OPEC will cut down production by 600,000 barrels per day, says the IEA.

There is no guarantee that IEA’s prediction will play out correctly. The major reason is that there is a manifest paradigm shift in the way oil prices are determined. Till the shale oil boom took place in the US, pricing was premised on “peak oil” and how fossil fuel was presented as a dwindling commodity. The discovery of shale oil and the speed at which it is available in the market have changed the perception about oil being a finite source.

This is a troubling thought for the world’s largest producer, Saudi Arabia, and other members of the OPEC. The Saudis, who have always determined oil prices, are expectedly troubled by the prospects of increased supplies from the US and its enemy Iran.

Many experts believe that the fall in oil prices are due to the Saudi attempt to kill the US shale oil and gas industry — they have succeeded somewhat — and also to hurt Iran and Russia whose economies depend on the price of oil.

Russia that is fighting a war in Syria and Ukraine needs oil to be sold at $100 per barrel to fund its military and development efforts. Iran that has been cash strapped due to debilitating western sanctions would also be happy with high oil price regime, but Saudi Arabia is unlikely to oblige.

Saudis have rejected suggestions from Venezuela, Algeria and other countries to reduce its supply to stabilise the prices at a level that it helps them fund their development. Saudis have just done the opposite. They are enlarging their market by giving discounts and have done away with the Asian premium that they would charge from countries like China and India till some time back.

Earlier in November, Russians and Saudis have had a meeting to manage oil supplies to ensure that it does not cede the oil market to anyone. Both the countries are producing oil furiously.

Russian intervention in Syria is ostensibly to fight the Islamic State and protect its ally Bashar al-Assad, but it has also given them an opportunity to target the factors that are bringing down oil prices. Media outlets close to the Russian government have spoken of individuals close to Turkey government that are raising funds for the IS and also creating an environment for low oil prices. Russians have targeted the trucks carrying oil from Syria into Turkey.

Evidence was presented by the Russian government spokesmen to show how the IS smuggling trails have been degraded by their Air force. Moscow benefits if fuel prices rise by curbing IS oil smuggling. For every dollar rise in its price, Russians could benefit by $1 billion. So a lot of things that Russia is doing in Syria makes political and economic sense.

From this standpoint the Iranian oil would find it difficult to recapture its old market including that in India.

In these circumstances India has to take a call on how it should deal with this new reality. Cheap oil will discourage investment so there is little hope of the new licensing policy yielding any results. India’s public sector companies, ONGC and OIL, will pump oil at $37 per barrel, which is lower than the prevailing global prices of $45-odd per barrel.

Anything below this will make them and producers in other countries — including the shale business — unviable. The Indian strategy has to work towards energy security, which takes into cognisance India’s own reserves, commitment to renewables and the external environment from where it proposes to source fuel.

This is complicated business, but Indian government could look at getting a clear idea of what resides in its 28 sedimentary basins. Till now oil and gas is produced only from only seven basins. There is a case, therefore, for public sector companies to invest in the long term to ascertain what we can extract at what price. Cheaper oil allows us to invest in resources abroad wisely without getting singed by wrong choices.

These are interesting times where the US is becoming self reliant in oil and gas and India and China have emerged as its big importer from West Asia.

Both the Asian countries are expected to play a big role in stabilising the region. Wisely, they have kept to themselves realising that being neutral promises a better deal than taking sides. These equations could change as fires rage around near the oil wells in the region.

The writer is the editor of Hardnews