30-04-2018

A crude awakening could be in the offing

When the price of Brent crude oil dropped from $125/b in March 2012, to a low of $29.25 in January 2015, India, which imports some 80 per cent of its requirements, reaped a huge benefit. The government ought to have set aside a part of the enormous savings, to act as a cushion when crude oil prices start rising, as they inevitably do. It did not. Now that Brent crude has gone over $70, we are in for a crude awakening.

The forces which make crude oil prices yo-yo thus are several. The current rally is due to these factors. One, OPEC, under Saudi Arabia and with Russian help (Russia isn’t a part of OPEC), has managed to curtail output. Two, Venezuela, which has the world’s largest reserves, is in a horrible state and is unable to pump out oil. Three, Saudi, under Prince Mohammed Bin Salman, is trying to get crude oil up to $100 in order to be able to sell the Saudi Aramco IPO at a good price, and raise enough resources for the transformation of the country to one not entirely dependent on fossil fuels.

An article in Seeking Alpha talks about the likely further cuts to Venezuelan crude oil production, because the authorities have just arrested (ostensibly for extorting bribes) two employees of Chevron. Venezuelan state owned company, PDVSA, can’t pump out enough oil because of lack of resources and lack of people (the competent ones have gone to other countries; the US shale industry has a shortage) and production has dropped.

Venezuelan oil production is held up by international oil companies such as Chevron, which is a joint venture. The (assumedly fake) charge against Chevron would likely result in a further fall crude output. In the base scenario, the fall can be one million barrels per day (bpd) and in the worst case scenario it can be 1.55 million mbpd. It’s possible China may step in to take over some assets, but not certain, given the deteriorating conditions in the country. OPEC production is around 31 mbd.

Help from US

On the flip side, production of shale oil/gas from the US will rise with rising prices, dampening the increase. President Trump has already issued a warning to Saudi and Russia on this.

So, if Venezuelan production falls further, crude oil prices would go up further and, for India, that would result in: a) higher fiscal deficit; b) higher petrol/diesel prices contributing to inflation; c) rising interest rates. Deutsche Bank expects RBI to hike interest rates by 25 basis points in June.

Also, the US Fed is expected to have three more interest rate hikes, and as 10-year US Treasury yields have risen to over 3 per cent, we can expect some more FII outflows from the stock markets.

This is because the risk premium between the safe US T-Bills and the riskier equity exposure in emerging markets, has narrowed. What is keeping the Indian market propped up is increasing domestic flows from retail investors, who are moving savings from traditional bank deposits into equity markets, which have given great returns. In April, FIIs sold $2 billion in Indian equity and debt markets.

In view of this, some caution may be advocated, for the next few months. Global debt is at $164 trillion (>2X global GDP) and there is little scope for another rescue if there is a financial crisis.

Source: The Hindu Business Line

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