Oil prices will remain range-bound around US$60-65 through 2018
Irrespective of geopolitical uncertainties, output cuts and production outages crude oil prices are likely to remain in the range of US$60-65/barrel through 2018. Data for 2017 are yet to be released, but a survey of analysts reveals that oil prices will end at between US$55 and US$57/barrel in 2017, which is US$5 to $8 up from 2016.
The price of oil collapsed from near $120/ barrel in June 2014 to around $40-45/barrel due to weak demand, excess supply, a strong dollar and booming U.S. shale production in 2015-16. OPEC’s reluctance to cut output was also seen as a key reason behind the fall. But, the oil cartel soon moved to curb production — along with other oil-producing nations — in late 2016.
In November 2016 the 14-member OPEC agreed to shave off 1.2 million barrels a day from its output to relieve a global supply glut and prop up prices. A few days later Russia and nine other crude producers also decided to cutback 558,000/barrels/day in their production.
The move helped to contain the sharp nosedive of prices and slowly reverse the trend. Encouraged by the response the 24 oil producers again decided in late November 2017 to extend production cuts to the end of 2018. But supply overhang still persists and keeps the market heating up like the one in 2013-14.
Factors helping to firm up oil prices are improvement in the global economic growth, strong OPEC countries’ commitment to stick to their individual quotas, geopolitical tensions and accidental outages OPEC’s output cuts have been greatly aided by Saudi Arabia and Venezuela, which have trimmed more than what was required of them. The result has been a decline in global crude inventories, which has contributed to increased oil prices in recent months.
Golman Sachs is confident that the OPEC-led commitment to extend production cuts will support prices through 2018. It has lifted its Brent crude price (the international benchmark for oil prices) forecast for 2018 to US$62/barrel from US$58/barrel and WTI (West Texas Intermediate) projection to US$57.50/ barrel from US$55/barrel.
The global credit rating agency Moody’s Investor Service predicts crude oil prices to remain the price bands of US$40-60 in the medium term, despite the extension of OPEC-non-OPEC output cuts. Recent higher oil prices, it says, have been supported by expected global economic growth and production restraint by major producing countries, as well as greater geopolitical risk. But risks to prices, as seen in mid-2017, still persist, including reduced consumption at higher prices and increased supply,” Moody’s said in its global report on oil price outlook. It added that prices in the upper half of the oil price-band ($40-$60) will encourage increased supply as countries reduce compliance with their production quotas and will support increased US production.
The agency says the US’s shale industry has come roaring back since OPEC had announced its production cut move in November 2016 to prop up prices and reduce global inventories. US’ drilling efficiencies since then have improved complementing the more than doubling of the rig count. The country’s rig count has doubled to 900 rigs in November 2017 from 380 rigs in May 2016.
U S crude output rose to 9.48 million barrel per day (bpd) in September, up 290,000 bpd from August and near the record 9.63 million bpd last seen in 2015. It was also the biggest month-on-month gain in five years.
Also, U S crude is increasingly making itself felt in Asia, with vessel-tracking data showing about 135,000 bpd of exports in the first 10 months of the year which was believed to have to have risen to 242,000 bpd in November and 379,000 bpd in December.
“US shale producers are paying increasing attention to capital discipline and return-focused performance, but with prices rising and the ability to hedge and lock in favorable returns, we believe that US shale production will continue to grow as prices rise, increasing global production and keeping a lid on prices,” Moody’s said.
However, OPEC’s and Russia’s efforts to rebalance markets and prop up prices are being undermined by rising production in the United States, which does not participate in the deal to cut. U.S. crude production hit 9.79 million bpd last week, its highest since the early 1970s, the only time American production breached 10 million bpd. This brings U.S. output close to that of top producers Saudi Arabia and Russia, which pump around 10 and 11 million bpd.
Impact on India
The rising US production has reined in a substantial rise in crude oil prices, but risks of higher prices cannot be ruled out totally. Gulf oil producers, who have seen many of their development projects stalled in the wake of depressed oil prices, would like prices to rise. Saudi Arabia, for instance, will need oil prices to be at $70/barrel for fiscal break-even in 2018, according to the International Monetary Fund. Then, unforeseen political turmoil in tension-prone areas, like the Middle East, could disrupt oil supplies. In December 2017 prices hovered around US$63-65/barrel. There is no cause for serious concern arising from resurgent oil prices for India for now, as the country’s macroeconomic heath remains strong. But policymakers would be well-advised to remain vigilant. India witnessed reaped good dividend when oil prices fell by over 50% between 2014 and 2015. As Sajjid Z. Chinoy, chief India economist at J P Morgan, has shown, the windfall for the government was to the tune of 0.9% of the gross domestic product (GDP) in terms of lower subsidy outgo and higher tax collection, which helped boost public investments. Households and private enterprises also benefited.
However, higher oil prices could have the opposite effect and impede economic recovery in the coming quarters. They could have implications for growth, inflation, currency, current account deficit and fiscal deficit. According to a recent note by Nomura, every $10 increase in oil price increases consumer price inflation by 0.6-0.7 percentage point. It also estimates that a similar rise worsens India’s current account balance by 0.4% of the GDP. Reduction in excise duty on petrol and diesel by Re1 per litre lowers collection to the tune of 0.08% of the GDP. Since the government raised excise duty when prices were falling, it could come under pressure to reverse the hike if prices continue to rise.
The latest monetary policy report of the Reserve Bank of India (RBI) shows that for baseline forecasts, the central bank has assumed the price of the Indian crude basket to average around US$55/barrel in the second half of the current fiscal. If oil prices move up to US$65/barrel, inflation could go up by 30 basis points for the fiscal and the real gross value-added growth could be lower by 15 basis points. The Indian crude basket was at US$62.4/barrel on 8 November. Expectation of higher inflation will reduce the chance of a potential rate cut and could affect market sentiment. Bond yields have gone up in recent weeks. Higher oil prices will also affect corporate India’s profit margins and could delay the much awaited earnings revival. A relatively less favourable macro outlook and a decline in profit margins would affect the equity market where stocks are richly valued.
