OIL BOILS – POLITICS OR ECONOMICS?

about 8 months ago
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By Ruma Dubey

The newsmaker of the day, nay, of the week is oil. With fuel prices in India going up for the tenth straight day, things are getting very very sticky for the Indian Govt and its well-played out macroeconomics.

The Govt, which yesterday said that it would not cut excise duties, today has started saying that it will cut them after all and also urge states to cut their VAT.

But the question dogging the lay man and woman - why is the fuel price jumping up like this, crossing $80/barrel in the international market; there are even murmurs of $100 being whispered.

Quite a few reasons actually…

This time around, the BIG change is that demand has picked up while supply remains under restriction. Most of the global economies are doing much better and every country is doing its bit to push up demand and keep the growth engine chugging. The tax cuts in USA plus Japan and ECB refusing to tighten policy means that there is going to be no fall in global rising demand.

On the other hand, supply is short. One reason we all knew and were prepared for – the OPEC production cuts which they undertook to shore up prices. Well, that seems to be working very well for them right now.

Then Trump, braying for war with Iran, all of a sudden announced his decision to pull out of the Iran nuclear deal, torpedoing international diplomacy and launching oil prices into the sky. Of course, he has threatened sanctions too and if that happens, Iran which supply’s 4% of the global oil, will seriously impede supply only further. But the European nations are yet to agree and we will have to wait and watch whether they toe the line with Trump or set a new precedent in changing power politics, if they decide not to go along with US. For now, the uncertainty over the Iran sanctions is what is driving this oil surge.

Venezuela is also adding fuel to the fire and it could become a bigger issue than Iran. On Monday, Trump announced sanctions of the already broken country, following the re-election of President Nicolás Maduro. As such production has been on a decline in this South American country and it just got worse with the sanctions. ’s re-election on Sunday. A long period of production declines in the South American country is about to get much worse.

This in turn has bolstered OPEC. This fuel cartel would be beaming ear-to-ear with these developments. International Energy Agency (IEA) stated that Venezuela is producing 5,50,000 barrels a day, less than the cap it is subject to under the OPEC’s Vienna agreement. IEA said that Venezuela’s decline coupled with losses in Mexico account for about 40% of the oil that OPEC and its allies have been holding off the market.

It is unlikely that the OPEC will be moved by this rising crude oil price and ratchet up the supply – remember it is a cartel with the objective of making profits only. But given their past track record, on paper the production restrictions might remain but many would secretly start pumping more to make good of the supply shortfall.

That brings us to the US shale-oil producers. Most had shut down after oil slumped below $60, after which it becomes unviable to produce shale. Many have resumed production but for shale-oil units, apparently, it takes a while for shut down units to restart but most are expected to begin in the coming month or so. There is no doubt that US shale production which becomes very profitable with oil at $80/barrel will start pumping with more vigour soon.

Also remember, the USA is all set to hike interest rates and now all the more reason so with inflation ticking up due to rising fuel costs. In countries like India, where crude forms a very expensive item in the import basket, as fuel prices kick in, discretionary spending power of the consumer will get restricted. Plus, there is the impending interest rate hike from RBI too.

Thus what we have currently is a tight oil situation but logically thinking, this might not be a permanent condition contrary to what many analysts would like us to believe. Sadly, demand will go down and supply will once again remain higher in 2019. Yeah, but is unlilkely that we will see $40 price again. For now, geopolitical tensions and higher global demand are buoying up the prices and one tensions ebb, prices will come down too. Of course one does not know what more havoc Trump could cause…

So let’s not panic while the oil traders celebrate; what goes up does come down. That’s what the stock markets are teaching us too!

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