Updated: Nov 9, 2019
Oil is a commodity and tends to see larger fluctuations in price than more stable investments such as stocks and bonds. Investors bet on the future of oil prices through a financial instrument, oil futures in which they agree on a contract basis, to buy or sell oil at a set date in the future. When delivery dates approach, they close out existing contracts and sell new ones for future delivery of the same oil. The oil never moves out of storage. If the forward market is in "contango"—the forward price is higher than the current spot price—the strategy is very successful.
Brent crude oil spot prices averaged $63 per barrel in September, up $4/b from August and down $16/b from the September 2018 average. Brent spot prices began September at $61/b and increased to $68/b after attacks on major Saudi Arabian oil infrastructure disrupted the country’s crude oil production. However, Brent spot prices have subsequently fallen, reaching $58/b on October 4, as Saudi Arabia restored the shut-in production and concerns about oil demand based on the condition of the global economy rose.
The front-month futures price for Brent crude oil settled at $57.71 per barrel on October 3, 2019, a decrease of 55 cents/b from September 3. The front-month futures price for West Texas Intermediate (WTI) crude oil, decreased by $1.49/b during the same period, settling at $52.45/b on October 3.
Global Demand Scenario
The oil market focus recently has been on the demand side as growth weakens amidst uncertainty around the global economy.
OPEC now expects the world oil demand to grow by 1.02Mn barrels per day (mb/d), which is 0.08 mb/d lower than last month’s projection in 2019 due to weaker-than-expected data displayed during 1H19 (January- June) by various global demand centres and slower economic growth projections for the remainder of the year. Both OECD and non-OECD demand growth forecasts have been revised lower, by 0.03 mb/d and 0.05 mb/d, respectively. World oil demand growth in 2019 is now pegged at 1.02 mb/d, with total global consumption at 99.84 mb/d.
OPEC has also revised world oil demand forecast for 2020 which is projected it to increase by 1.08 mb/d (cut by 0.06 mb/d from the previous month’s assessment). World oil demand growth in 2020 is now anticipated to reach 100.92 mb/d.
Along with OPEC, EIA too has revised its demand outlook for the remaining 2019. Global oil demand growth has been revised downwards to 0.9 mb/d which is 0.1 mb/d lower than the August forecast. Demand has been revised due to low GDP forecasts and lack of demand from OECD countries.
According to BP, global oil demand is expected to grow by less than 1 mb/d in 2019 as consumption slows. Mounting trade tensions between the United States and China and increased signs of global economic recession are also set to weigh on oil refining margins. IEA on the other hand has stayed put their 2019 and 2020 global oil demand growth forecasts at 1.1 mb/d and 1.3 mb/d respectively but has noted that the demand growth in the first 6 months of this year came in at just 0.5 mb/d.
Demand Scenario in Indian Oil Market
In the current financial year India has imported 4.5 mb/d (April-July) of crude oil which is 0.1mb/d less as compared with our import levels in the same corresponding period in the previous financial year. The compliance of US sanctions on Iran, May 2019 onwards has led to a decline in India’s imports. Iran was India’s third largest crude oil supplier. Despite the decline of crude imports which is supposed to be considered favourable for the Indian economy, import dependency based on consumption has increased from it being 83.4% to 84.9%. Fall in crude imports has led to the domino effect of decline in the country’s crude consumption and increase in the overall imports of petroleum products. Crude oil processed by Indian refineries has declined by 2.3% and the overall imports of petroleum products have increased by 22.5%. There has been a sharp increase in petrol and diesel imports by 298% and 363.5% as well in order to make up for the subdued refining activities.
According to the oil ministry, crude oil imports from the OPEC decreased to 78% of total imports during first 4 months of FY20 compared with 83.2% during the corresponding period a year ago. On the other hand, India’s crude oil imports from the US have increased by 213% in the same time frame.
Oil prices transforming global geopolitics
Crude oil prices react to geopolitical events and other unplanned supply disruptions. However, global oil supplies exceeded the demand by 0.9 mbpd in 1HFY19 thereby creating an oil glut which is holding down the prices. In November 2018, the US government imposed sanctions on Iran’s energy sector including petroleum. However, waivers were granted to eight nations; including India for 6 months which expired on May 2019. As countries reduce importing from Iran, global oil demand is likely to increase as Iran is the fifth-largest producer of crude oil, contributing to 5 percent of world crude oil production; and sixth largest oil exporter, accounting for slightly less than 5 percent to global exports.
How does US sanctions on Iran affect India?
Iran is India’s third largest oil supplier after Iraq and Saudi Arabia. Favourable terms of trade with Iran, which comprises 60-day trade credit, discount on freight and insurance and payment in rupee terms of 45 percent of total supply from Iran, makes it an important strategic trading partner for India. The rupee payment mechanism with Iran also helped India save its foreign exchange.
There has been a decline in India’s crude oil production in recent years. Along with rising demand, this has contributed to increasing India’s import dependency to 83.7 percent in FY19 (P) from 80.6 percent in FY16. Not only due to US sanctions on Iran (10.6 percent) but also on Venezuela (7.6 percent), India will have to consider alternatives to source crude oil for more than 18 percent of import requirements, which would impact its import bill. Further, it will be expensive to change the configuration of state-run refineries, currently equipped to process oil from Iran, to other grades.
Oil is also the cornerstone of India-Venezuela ties. The export of crude petroleum oil from Venezuela accounted for 98.54 percent of all India-Venezuela trade in 2017–18. The region’s Orinoco Oil belt is rich in heavy crude which poses an advantage to Indian refiners that can turn a profit converting heavy crude to finished products like gasoline or diesel and sell it on the open market. Also, importing from Venezuela is a part of Government’s diversification policy. Naturally, the Middle East is the most important source of oil; in 2007, more than 75% of the imports came from this region. However, dependency on one region is a risky proposition and hence the Indian Government started looking for procuring oil from Latin American countries like Venezuela, Mexico, Brazil and African countries like Nigeria and Angola. Hence, a synergy developed between India and Venezuela based on the partnership of equal benefits; for India, it meant getting heavy crude at less prices as compared to Brent and for Venezuela; it gave access to large new markets. However, the current turmoil faced by the nation after the re-election of President Nicolas Maduro has created political discontent giving rise to hyperinflation, power cuts etc. Sanctions against Venezuelan crude would mean the U.S. is restricting flows from two OPEC countries, leading to a sharp supply outage and trade disruption in the global markets. Already the supply from Libya and Nigeria has curtailed and the OPEC+ production cuts have come into effect since the beginning of the year.
How does Venezuela crisis affect India?
Any increase in oil prices is always going to be a cause of concern for India considering we import more than 80% of our oil requirements.
Impact is to be felt in terms of trade deficit, on the markets, Indian basket of crude oil prices and exchange rate.
Crude oil and its products have a weight of 10.4% in the WPI. Of this crude oil and natural gas have a weight of 2.4% and mineral oils around 8%. With the exception of LPG and kerosene (with combined weight of 0.83%), the rest would be driven by market forces. Therefore, any increase in the price of crude oil would tend to impact the WPI inflation number commensurately. In terms of the CPI, fuel related items have a weight of nearly 2.7-2.8% directly.
Will oil spill over?
While the new Government decides to import oil from alternative source, 2 scenarios of increase in oil prices could play out in the near future which will consequently impact trade deficit, rupee and inflation.
Crude oil plays an important role in the manufacturing and worldwide distribution of numerous products ranging from food to electronics. When rising fuel costs are passed on to consumers, it can drive up inflation and reduce the purchasing power of wages. Gasoline and heating oil (which are derived from crude) are essential expenses for many households, so when prices spike there is less money available to spend on other goods and services. For these reasons, high oil prices have long been blamed for driving down GDP growth, and low prices have sometimes provided an economic boost.