Saudi Arabia has hinted in a recent public discourse that it will cut down oil production in February 2021 to stabilise market prices. This is a unilateral action in an otherwise tense geo-political scenario, where Russia and Kazakhstan have declared they will increase their output, in a reluctance to cede market share to the United States. How did this situation emerge?
USA, Russia and Saudi Arabia are the leading oil producing countries of the world. There is a constant tussle between the countries to generate maximum profit by selling oil. An alternative to this is getting together and deciding oil sale price. It is due to this that the concept of OPEC (Organization of the Petroleum Exporting Countries) came up. This is an organisation of 13 countries, found as early as 1960, which gets together to regulate oil prices while ensuring fair amount of profit for all oil producers.
In December 2016, OPEC signed a deal with some non-oil producing countries, that they will increase oil production by 1 million barrels to regulate oil production, including countries like Mexico, Kazakhstan and Russia. This agreement was christened “OPEC+”, which saw an alliance between Saudi Arabia and Russia. Together, this was an alliance of 24 countries, controlling 55% of oil price. This had a profound impact on the world economy. However, USA was not a part of OPEC+, but a competitor.
However, the pandemic served as a twist on this geo-political scenario. With aviation and shipping on a halt, along with factories, schools, colleges, and businesses shutting down, and people are not moving out in general, has pushed the oil prices down. However, prices can remain stable if prices are reduced in tandem with the oil supply, which is exactly what OPEC did on 5th March 2020. However, Russia refused to comply, and took the opposite route of increasing their production. One may speculate why Russia did that, but experts believe it is to attacks the USA oil industry.
With the discovery of shale oil in USA, the country left Saudi Arabia and Russia way behind in oil production. With increase in shale supply, the price of oil went down. This means reduction in profit for everyone. OPEC decided to increase their production themselves, to reduce global oil prices. This would harm the American private companies, who are the main players in American oil sector. In Saudi Arabia etc it is the government supporting the oil companies, so they would survive, while USA would drown. However, this plan was not successful. Russia still wants to throw USA off the energy radar.
Impact of this decision: To some extent the Russian oil companies might be successful, especially with respect to small oil drilling companies of the same. This can be a nightmare for US shale companies. However, US government is planning to provide financial assistance to these oil drilling companies to prevent bankruptcy. Russia can tolerate losses, but only for a short term. In the long haul of thigs, targeting USA is not sustainable for Russia. In response to these growing tensions, Saudi Arabia had decided to increase production.
Amidst this geo-political tensions, small oil producing nations like Iran, Iraq, Argentina, Brazil, etc will suffer due to lack of profitability. For small economies that depend on oil to sustain themselves, this can prove to be disastrous. On the bright side, these countries may see this as an incentive to switch to renewables with ever fluctuating and uncertain oil prices. However, this is yet to be seen.
Off late Saudi Arabia slashed oil prices to 10 million barrels a day in 2020, while USA was producing 13 million barrels a day. The back and forth of oil production quantities and fluctuating prices is proving to be advantageous for oil importing countries, including India. For example, in 2018-19 India spent $112 billion to import oil, as per Petroleum Planning and Analysis Cell (PPAC), while it was $69 billion for 2019! This saves about $50 billion of forex for India. A cushion of high foreign exchange has a multitude of positive impacts, namely, increase in trade, economic stability, with sufficient cushion for import bills, along with strengthening of rupee against the dollar.
Further, when crude oil prices rise, the current account as well as fiscal account deficit shoots up. The opposite happens when oil prices decline, which is what is happening in the case of India and other oil importing ecomomies. The benefit passes to the common man through “trickle- down” effect if government reduces fuel prices. If this is executed, domestic economic activity will increase, having a plethora of positive changes, like increase in employment and investment. This also promotes inflow of FDI, which was at a staggering $284 billion during 2014-19.
Oil import also has a profound impact on inflation, because it is a very important commodity to meet domestic petrol and diesel needs. In addition, it is also a necessary raw material for several industries. An increase in the price of crude oil will lead to an increase in the cost of goods, the brunt of which is usually faced by the end consumer. This will result in Inflation and money supply issues in the market, along with a fewer contenders for bank loans
In addition, a decrease or increase of petrol import price has a profound impact on the Indian stock market. A lot of Indian companies bank on regulated and healthy oil prices. This includes companies manufacturing tyres, footwear, refineries, shipping, airline, and other freight companies. The profitability of these enterprises is adversely impacted due to higher input costs, which negatively impacts stock prices in the near term. On the other hand, oil exploration companies in India or any other oil importing country will benefit from a rise in oil prices.
From the environmental standpoint, it will have a negative impact, because the world over we are moving to electric/ battery operated vehicle. This can be seen in the Indian context, where Tesla has registered itself in Bangalore today. A decline is oil prices will only push the consumer to purchase oil further, provided the taxes on petrol and diesel are regulated. The companies recycling plastic would find it more profitable to generate new plastic items than recycling old ones, thus adding to environmental degradation. Thus, environmental benefits will have to be tied with economic incentives from MNCs to the common man.
Thus, the ongoing oil war has a profound impact on the economy and environment. We are yet to see what 2021 oil market has in store for India.