Oil prices unlikely to soften soon despite rise in US production; geopolitics associated with crude makes it an expensive product

The rise in oil prices has come as a surprise for most policy-makers and analysts, for the obituary of expensive oil was written a long time back. The supply glut and the global fall in oil demand had contributed to a period of low oil prices before 2017. The predictions of an era of cheap oil were however premised on the assumptions that any future rise in demand will be matched by higher crude and shale oil flows from the US, and that the countries will be able to wean themselves off the crude oil dependency by increasing the share of biofuels and renewable energy in their energy mix. While the two phenomenon have taken place simultaneously, the degree of their impact on crude oil dependency, has not been on expected lines. This is because, more than the supply-demand economics, the prices of international crude are mostly determined by their accompanying geopolitics.

 Oil prices unlikely to soften soon despite rise in US production; geopolitics associated with crude makes it an expensive product

Representational image. Reuters.

The current spate of rise in global crude oil prices can be attributed to two fundamental changes in the international energy architecture. The first concerns the supply side change, whereby the US has risen to be the third largest producer of oil. The Texas Light Sweet, a grade of crude oil produced in the US, is lighter than the Brent crude. The traditional refineries located in countries like India and China have been designed for refining the heavier grades of crude oil which made the US oil exports less profitable. However, with advance in technology and an upgrade in the global refineries, more countries have started importing the US WTI. It is also profitable, because the US WTI is priced cheaper than the Brent crude produced from the Gulf region. This, along with the discovery of shale oil, has pushed the US as the third largest global supplier of oil, and as per the IEA predictions, it may soon overtake Russia in terms of the net oil production.

While the increasing oil supplies from the US should have pushed the oil prices down, the geopolitics of the resource has been working to keep the prices up. The announcement of US sanctions on Iran has forced countries to cut their oil imports from the country. This has put additional pressure on oil production from the Gulf region. While production at the 2016 levels from the Gulf would have kept the rise in oil prices at bay, the announcement of production cuts beginning 2017, by OPEC member countries has further pushed up the oil prices. While earlier, the US would work to pressure the OPEC member countries in increasing production to stabilise prices, now with the change in its position, rising oil prices work to benefit the US economy. In fact, the impact of oil on US exchange and rate and its trade deficit has been much less significant, than before. Instead, the rise in prices have served to positively impact the domestic investment by the oil industry in the US, which has helped boost the overall economic expansion of the country. The shift in the US position from a heavy crude oil import dependent country, to now a net oil exporter will have significant repercussions for the oil prices in the future. If anything, the shift in the US position indicates that the era of cheap oil may be over.

The second significant change in the global energy architecture has been the rise of Asian countries, especially India and China as two of the largest crude oil importers in the world. More than 80 percent of domestic crude oil requirement are imported by India and China. Given their increasing rate of growth and heavy energy dependencies, the demand figures for oil will only increase from hereon, at least until the biofuels and renewable can achieve cost parity and provide a profitable alternative.

It then becomes imperative to acknowledge that global crude oil prices may hover over $70 per barrel, atleast in the near future, unless the world sees another technological breakthrough in the field. The need is then to re-calibrate the foreign energy policies of countries, in accordance with the shifts taking place in the global energy architecture. For countries like India, deepening our energy relations with the US, through an upgrade in our refining capacities for profitable use of the US WTI and shale oil, is imperative. Developing oil inventories and signing of long term gas contracts also becomes equally important. The era of expensive oil is here to stay. We cannot make policies based on aberrations. ​

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Updated Date: Sep 10, 2018 16:52:55 IST