Crude oil anchored to $100

Though supplies are comfortable, output can be pared if oil sinks below this price

In a little over two months, the price of crude oil (Brent) has slipped from $115 a barrel to near $100 a barrel, a 14-month low. This is thanks, in large part, to the perceived change in geopolitical conditions which had pushed up prices in the first place. In mid-June, the rapid advance of the Islamic State of Iraq and Syria (ISIS) had raised the spectre of supply shocks from Iraq, the second largest oil producer among the OPEC nations. This resulted in the price of Brent shooting up from $108 a barrel to $115 a barrel in quick time.

But then, with the realisation that the major oil producing fields and ports in the southern part of Iraq were not at imminent risk of being overrun by the ISIS, prices started moderating. The pace of the moderation has accelerated over the last few days with the tide of the war seemingly turning — in a significant reversal, the Kurdish peshmerga forces, with the help of US air strikes, wrested back control of a key dam in Mosul from the ISIS.

Another important factor which led to the price decline is the sharp rise in crude oil output in Libya, another major producer. Despite continuing political troubles, the country’s oil production last week jumped to 5,50,000 barrels per day (bpd) from 4,00,000 bpd in the week prior. Also, oil exports have restarted or are expected to resume from key terminals Ras Lanuf and Al-Sidra. News of some easing of tensions between Russia and Ukraine too helped keep a cap on prices.

On the demand side, lower requirement of crude oil from refineries in Europe and Asia due to slower economic growth contributed to the price softening.

Besides, US crude oil production in July rising to 8.5 million bpd in July — the highest monthly level since April 1987 — added to the pressure on global crude oil prices. From an average of 7.5 million bpd in 2013, US crude oil output is expected to rise to 8.5 million bpd in 2014 and further to 9.3 million bpd in 2015. This will translate into significant decline in the country’s dependence on petroleum products imports, from an average of 33 per cent in 2013 to 22 per cent in 2015. The US is currently the world’s second largest crude oil importer after China.

Crude oil contracts are currently in contango — this is indicative of higher expected supplies in the market relative to demand. With the US now joining the fight against the ISIS, oil production in Iraq should continue smoothly and could even rise in the coming months. In Libya, there is still significant potential for output to grow with the country’s production capacity at 1.6 million barrels a day, more than double what it is producing today. Besides, production disruptions in other major oil producing countries have reduced. Meanwhile, the Paris-based International Energy Agency has cut its oil demand forecast for 2014 due to a weaker global economic outlook than expected earlier.

Outlook

So, over the next few months, crude oil prices may not see significant recovery from current levels. That said, the price of Brent slipping below $100 a barrel may be unlikely, since this could trigger production cuts by the OPEC countries, including Saudi Arabia.

Weak crude oil prices bode well for India, which depends on imports for almost 80 per cent of its requirement. Under-recoveries due to sale of fuels (LPG, kerosene and diesel) at less than cost could be lower than originally estimated, if the rupee does not weaken further. Currently, under-recoveries on diesel have been almost neutralised, thanks to monthly price hikes.

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