What does lower oil prices mean for India?

A decade ago, any political turmoil in the West Asian region would have an immediate impact on the oil market with a concurrent rise in prices. Now, despite growing tensions set-off by the execution of respected Shia cleric Nimr al-Nimr by Riyadh on charges of fomenting terrorism, the subsequent attack by Iranian protestors on the Saudi embassy in Tehran and growing tensions between Iran on one side and Saudi Arabia and its GCC allies on the other, there has been no impact on oil prices. In fact, oil prices continued their slide, with Brent falling below USD 30 per barrel for the first time since 2004 after scaling USD 115 in June 2014. Nor do projections by the IEA and other energy agencies indicate that a recovery in oil prices is likely in the near future.

On the demand side, there has been a continuing decline in developed countries both due to slowing economies as well as climate change concerns. While the slowdown in the Chinese economy has raised fears that Beijing may cut oil consumption, the fact remains that China’s oil demand rose seven per cent to about 11 million barrels a day (mb/d) in 2015, and is expected to grow by two per cent in 2016. India, on the other hand, is emerging as the bright spot in an otherwise dismal oil market. It has doubled its crude oil imports to almost four mb/d in the past decade, and has overtaken Japan, Germany and South Korea to become the world’s third biggest importer, after China and the United States, and the second largest after China in Asia. Nevertheless, even strong growth in Indian demand will not dent an oversupplied market.

It is the strategy employed by the producers, notably Saudi Arabia, that has led to the current state of oversupply. Unlike in the past, when a sustained fall in prices would see OPEC cut production to shore up prices, this time around at the OPEC’s December 4, 2015 meeting, the Saudis persuaded other members to sustain production at around 31.7 mb/d, indicating a strategy of prioritising market share over price. While the decision was perceived as a ploy to drive out competition from non-OPEC producers like American shale and other higher cost alternates, the move was also aimed at Iran, which is poised to re-enter the market with fresh volumes this year, thus reaping financial gains and positioning itself to challenge Saudi leadership in the region. With the writing writ large that oil may be close to the end of its reign, the Saudis are looking to grab as much of the market as they can from their competitors, be it other oil producers or alternate energy resources, for as long as they can. They can afford to gamble because they hold the largest reserves of the lowest production cost oil and a massive sovereign wealth fund. As Saudi oil minister, Ali al-Naimi, said in an interview to MEES in December 2014, “If the price falls, it falls, you cannot do anything about it. But if it goes down, others will be harmed greatly before we feel any pain.” He went on to say that the Saudi marginal cost (of production) will at most be USD 10 a barrel in 10 or 20 years’ time. Further, he also stated that while the core Gulf producers could withstand around two to three years of low prices, there were many things in the energy market apart from the oil market that would determine prices in the future.

In the meantime, King Salman and Crown Prince Mohammed bin Nayef are undertaking sweeping economic reforms hitherto unheard of in the kingdom. These include: replacement of a petro-cash system with taxes, including on petrol, electricity and water, imposition of spending cuts to reduce a growing budget deficit, and even contemplating the sale of shares in Saudi Aramco, the world’s most valuable company and the country’s biggest cash cow. More importantly, the government is investing USD 109 billion to install 54 GW of renewable energy by 2040 to help meet growing energy demand and diversify the energy sector.

What does this oil price fall mean for oil importing countries, including India? In the short term, low oil prices are beneficial, as oil import bills have decreased by Rs. 300,000 crore in the last fiscal. However, if oil prices continue to remain low for a sustained period, the picture becomes less rosy for a number of reasons.

First, long-term low oil prices could lead to deflation in many countries that are dependent on oil sales revenue. Although, so far, there has been no visible sign that the Gulf States are cutting employment, the World Bank has warned that given the uncertain outlook, remittance flows from the GCC could decline if low oil prices were sustained for a few years. Since around seven million Indians are resident in the Gulf countries, concerns regarding their job security as well as remittances earned by them could arise. Second, economic and financial constraints in these countries could impact on bilateral trade. Already, India’s exports to the GCC countries, including petroleum products, have decreased. According to government data, India’s exports to the six GCC countries have fallen 18.8 per cent to USD 27.9 billion during April-November 2015 from 34.35 billion in the corresponding period last year, with exports to Saudi Arabia registering the steepest fall at 46 per cent.

There is, however, an issue of even greater concern. The longer the price of oil remains depressed, India, like other major oil importers, will not only increase its dependence on crude imports, but it will also become more dependent on OPEC, given that high-cost oil producers outside the cartel may not find it economically viable to sustain production at current prices. Even US shale production is declining. According to the US Department of Energy’s EIA data, drilling activity has fallen by 60 per cent compared to a year ago and only the most prolific shale wells are profitable at prices of around USD 40/b. Output from other producers such as Brazil and the Caspian region are also facing production declines.

Given that it currently sources about a fifth of its oil imports from African nations, and supplies from Latin American countries are also increasing, India is revising its oil procurement strategy. Some changes have been set in motion by the oil marketing firms designed to facilitate access to more remunerative deals, including the setting up of an integrated trading desk to buy crude, with direct negotiations taking place with suppliers for lucrative prices. Although the price of oil may not return to its earlier highs, given the downtrend in investments in new exploration activities, it will not be long before prices climb again. Over the last two decades India has seen its net energy import bill grow close to 20 per cent a year. The current low prices should therefore provide only a short window of opportunity to tide over short term oil procurement at low prices. The long term agenda should be to wean the country from greater dependence on imports on one hand and from fossil fuels on the other. If the oil-rich Gulf economies realise that the long oil run is nearing its end, India should read the writing on the wall and expedite the shift away from a fossil fuel-based energy sector as well.

Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India.