From UPSC perspective, the following things are important :
Prelims level : Not much.
Mains level : Paper 3- Factors contributing to the drop in oil prices and implications for India.
The global economy, grappling with the COVID-19 pandemic, is now facing an energy war, with crude oil prices crashing in the international market.
Developments that contributed to the fall in oil prices
- First, Crude oil prices tanked, as the Organisation of the Petroleum Exporting Countries (OPEC) and its alliance partners failed to reach any consensus on cutting back production to levels that would enable prices to remain stable.
- Second, the U.S., as the largest oil producer today, has stayed away from the OPEC-plus arrangement, hoping that production cuts by OPEC-plus countries will help it increase its market share.
- Russia refused any production cuts, unleashing an energy war with Saudi Arabia. There has been a spectacular fall of around 30% in crude oil prices.
- The International Energy Agency (IEA) has scaled down global demand for oil, a move not taken by the energy watchdog since 2009.
- COVID-19 Factor: Demand for oil had already weakened owing to the global economic slowdown, and this weakening has become more pronounced due to the COVID-19 pandemic, which has hit China’s economy and reduced consumption by the world’s largest importer.
The US-Russia oil war
- Denying market share to the US oil producer: Russia’s decision to reject any production cuts is driven directly by its strategy of denying market share to American shale oil producers.
- Shale oil companies can sustain in high prices only: The American shale oil producers rely on higher prices in the range of $50-$60 to remain profitable because of higher production costs.
- At $31 per barrel, not more than five American shale oil producers can remain profitable.
- Sanctions on Rosneft: Russia also remains resentful of sanctions imposed on Rosneft, which is building the gas pipeline project Nord Stream 2 across the Baltic Sea, carrying Siberian gas to Germany, a major consumer.
- Delay in completion of the pipeline: This pipeline was delayed due to opposition from Denmark’s environmental activists and could not be completed before the U.S. sanctions kicked in.
- Moscow has accused Washington of using geopolitical tools for commercial reasons.
- The energy war over prices is Russia’s revenge, to cripple the American shale oil industry.
- Russia’s signal to Saudi Arabia: Russia is also signalling to Saudi Arabia that its American patrons can do little to protect its oil interests and it would be prudent for Saudi Arabia to reach some understanding with Russia.
- Both Saudi Arabia and Russia depend heavily on oil revenues — upwards of 80% of export revenues accrue from crude oil.
- Russia and Saudi Arabia fighting for market share: Both are also fighting to retain market share.
- Impact on India: It has been reported that Saudi Arabia has agreed to supply crude oil at lower rates to refiners in India and China, two primary customers, but refused to supply to other refiners in Asia. This will have an impact on India’s oil procurement from the U.S.
The benefits to importing countries
- Why the price drop matters to India? Lower crude oil prices are not necessarily bad news for oil importing countries like India, which is the world’s third-largest importer of crude oil and the fourth largest importer of LNG.
- Collateral adverse consequences: There are, however, collateral adverse consequences like the battering of the stock markets worldwide.
- Impact on the global economy: The global economy, already impacted by President Donald Trump’s trade war with China and other countries, including India, and the COVID-19 pandemic, may find lower energy costs helpful in overall growth.
Benefits for India
- From a high of $147 per barrel in 2008, crude oil prices have fallen to around $24 per barrel and may even go further southwards.
- How much the price drop matter for India? India, with 80% of its energy requirements met by imports from the international market, stands to save ₹10,700 crores for every $1 drop in prices.
- Non-oil related factors: While this may help manage the current account deficit, fiscal deficit and inflation, there are non-oil related collateral factors that can cause countervailing adverse economic impact.
How long Russian and Saudi Arabia can sustain the war?
- Can Russia and Saudi Arabia sustain the energy war for long?
- Saudi Arabia’s production cost is the cheapest in the world and it can ramp up production to around 12 million barrels a day.
- By offering discounts, it can undercut other producers, including Russia.
- Domestic considerations also matter.
There is no doubt that India will benefit from lower oil prices if the cost of fuel at the pump is passed on to consumers. It will reduce transportation costs and boost demand. The consumer, however, may not benefit much since the government may choose to use this financial windfall for other purposes, like bailing out banks which have been hollowed out by NPAs to leading Indian companies.