The slump, the opportunity

A few things the Indian government could do while oil prices are falling.

Written by Vikram S Mehta | Published: September 7, 2015 12:00 am
oil price, crude oil price, ONGC, petroleum market,  world wide oil prices, international oil price, oil producing countries, indian government, bjp government, indian oil companies,  oil producing nations, indian express column, ie column, Vikram S. Mehta column The government has taken a positive step in announcing its intent to auction 60-odd blocks of marginal fields to the private sector. The international majors will not respond. They have slashed their exploration budgets and are not interested in small, marginal accumulations. The smaller (unlisted) companies may, however, be interested.

The petroleum market is caught in a bearish vice. Prices are down to levels not seen since 2010. There will be a bottom and prices will no doubt push up again, but the fundamentals of demand and supply suggest this may not be for some time. Meanwhile, oil producing countries like Russia, Venezuela, Nigeria, Iran and those in the Gulf are facing burgeoning risks of political and social upheaval. Their social contracts are fraying. The petroleum companies are also hurting and for the first time in decades, there is talk that the international majors might cut back their dividend payout. In such conditions, international interest in exploration in India will be minimal. This does not mean we should make no effort to attract such interest. What it does mean is that we will need to be innovative, flexible and focused on the ease of doing business index.

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The petroleum market is subject to the economic fundamentals of demand and supply and the non-fundamentals of geopolitics, speculation and currency fluctuations. The latter has often bucked the former. The turmoil in Libya and Syria, the sanctions against Iran, the Islamic State, civil sabotage in Nigeria and the reinforcing thrust of Wall Street traders are just a handful of the “non-fundamental” factors that pushed the price of oil into triple digits for 39 of the 40 months prior to June 2014. Combined with the growing demand from China and India, they more than offset the impact of the surge in US tight-oil production during this period.

Today, the economic fundamentals have come into their own. On the supply side, the market is flush. This is because Saudi Arabia is determined to protect its market share and is producing to near full capacity. It has passed on the baton of swing producer to the US. The US has not been able to accept this because it cannot control the production decisions of the 1,000-plus private oil companies that operate in the country. As a consequence, US tight-oil production has continued to rise. Further, Libya and Iraq have successfully re-entered the export market and now, with the P5 +1 nuclear agreement, there is a heightened prospect of flows out of Iran. On the demand side, the market is down. The reasons are the slowdown of the global economy and, in particular, the cutback in Chinese consumption. The combined impact of surging supplies and laggard demand has brought prices down from an average of $110 per barrel in June 2014 to less than $50 per barrel today.

This market situation will no doubt one day reverse. Cyclicality is a fundamental verity of the petroleum market. But this may not happen for some time. An increasing number of pundits are arguing that prices will fall further before they turn around. Saudi Arabia will not turn off the spigot, technology and cost efficiency will further reduce the break-even costs of US tight-oil production, even at prices below $40 per barrel, the marginal barrel will generate healthy returns, and the Chinese economy is headed towards a hard landing. In other words, supply will remain plentiful and demand will lag. These pundits may well be right but there is no doubt that, until such time as the global economy finds a sustainable and scalable substitute to liquid fuels, the price of oil will rise again.
India imports 80 per cent of its crude oil requirements and this import dependency is likely to deepen. The government should therefore ask these questions: Are there opportunities to be grasped in this low-price market? What steps should it take now to safeguard against the eventuality of higher prices later?

I cannot give a comprehensive answer to these questions because of lack of space, but let me offer four suggestions. I believe the government should move forward on these suggestions without delay. It can do so because none require legislative approval. They can be sanctioned by the executive.

First, the government must improve the operating environment. The supply and operating bottlenecks (that is, berthing delays, customs clearances, approval delays, etc ) could, in today’s straitened conditions, make the difference between investor interest and investor indifference. The government has taken a positive step in announcing its intent to auction 60-odd blocks of marginal fields to the private sector. The international majors will not respond. They have slashed their exploration budgets and are not interested in small, marginal accumulations. The smaller (unlisted) companies may, however, be interested. These companies will have tight budgets and for them, the avoidable costs of such bottlenecks will be material. Their response to the auction could well hinge on their perception of the government’s efforts to control such costs. I should add they will also want assurances of fiscal and contract stability. The draft revenue sharing contract put on the petroleum ministry’s site earlier this year did not have such a stabilisation clause. The government should include it in whatever contracts it signs with these companies.

Second, in keeping with the objective to improve the productivity of our currently producing fields, the government should seek technology partnerships to enhance the recovery rates of petroleum from our larger fields, including Mumbai High.

Third, the idea of “open acreage”, wherein companies can define the areas of exploration interest and offer a work programme at any time has been on the table for some years now. It has been resisted for a variety of reasons, none compelling. Now that it is clear that the conventional exploration licensing model (NELP) will find no takers, this idea should be dusted off and implemented.The government should compel ONGC/OIL to bite this bullet forthwith.

Finally, this may be the opportune occasion to build up our strategic reserves. Of course, the prices may fall further but it would be foolhardy to look for the “bottom fish”. This is the time to initiate conversations to lock in long-term supply contracts on “s” shaped pricing terms (floor and ceiling).

The writer is senior fellow, Brookings Institution, and executive chairman, Brookings India

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  1. S
    Sep 8, 2015 at 12:15 am
    As good an informational report and analysis as I have read in these pages. I learnt a lot. However, I wish to add that the US government is not above maniting and controlling the supply and production sources. Way back, while trying to ist US importers of Indian garments, I learnt that the American authorities could, and oft times did, disregard business decisions of not just 1,000 importers, but of tens of thousands of small and medium companies by a simple wink to the US Customs. With only verbal instructions from above, ladies's blouses came to be counted and clified as shirts, and men and women's pajamas as pants or trousers. But once I delved deep into the matter, I quickly learnt that there was plenty of self-serving creativity and subterfuge emplo by the exporters also. Maybe they are the ones that caused the American reaction. But then that's like attempting to solve the hen and chicken puzzle. One more thing, though. There are plenty of rigs and digging machinery sitting idle all over the world, plenty of it in India's neighborhood in the Middle East, Companies need purchase orders to retain their key workers, and keep money rotation going. I know from experience that many of the small US companies would be more than reasonable in their offers. But they would also tire fast at India's haggling or foot dragging. We already have a bad name in these matters.,, Arun Kumar Chhabra, Esq, Washington, DC, USA