Why oil prices won’t come down in the foreseeable future

It is India’s Rs2 lakh crore problem. And it’s called crude oil.

With the global economy in general and the Chinese economy in particular slowing down, it was widely expected that the price of crude oil will also come down.

China has been devouring commodities at a very fast rate in order to build infrastructure.

As Ruchir Sharma of Morgan Stanley writes in his recent book Breakout Nations, “China has been devouring raw materials at a rate way out of line with the size of its economy…In the case of oil, China accounts for only 10% of total demand but is responsible for nearly half of the growth in demand, so it is the critical factor in driving up prices.”

Even though the Chinese growth rate has slowed down considerably, the price of crude oil continues to remain high.

According to the Petroleum Planning and Analysis Cell, which comes under the ministry of petroleum and natural gas, the price of the Indian basket of crude oil was at $113.65 per barrel on September 11. The more popular Brent Crude is over $115 per barrel.

The high price of crude oil has led to huge losses for the oil marketing companies in India as they continue to sell petrol, diesel, kerosene and cooking gas at a loss. The oil minister recently said that if the situation continues the companies will end up with losses amounting to Rs200,000 crore during the course of the year.

So why do oil prices continue to remain high?
The immediate reason is the tension in the Middle East and the threat of war between Iran and Israel. Hillary Clinton, the US Secretary of State, recently said that the United States would not set any deadline for the ongoing negotiations with Iran. This hasn’t gone down terribly well with Israel. Reacting to this Benjamin Netanyahu, the prime minister of Israel said, “the world tells Israel, wait, there’s still time, and I say, ‘Wait for what, wait until when? Those in the international community who refuse to put a red line before Iran don’t have the moral right to place a red light before Israel.” (Source: www.oilprice.com)

Iran does not recognise Israel as a nation. This has led to countries buying up more oil than they need and building stocks to take care of this geopolitical risk.

“In the recent period, since the start of 2012, the increase in stocks has been substantial, i.e. 2 to 3 million barrels per day. These are probably precautionary stocks linked to geopolitical risks,” writes Patrick Artus of Flash Economics in a recent report titled Why is the oil price not falling?
At the same time, the United States is pushing nations across the world to not source their oil from Iran, which is the second-largest producer of oil within the Organisation of Petroleum Exporting Countries (Opec).

What is also happening is that Opec which is an oil cartel, has adjusted its production as per demand. Saudi Arabia, which is the biggest producer of oil within Opec, has an active role to play in this. “This adjustment in the supply of oil mainly takes place via changes in Saudi Arabian production: this country keeps its production just above 10 million barrels/day to avoid the excess supply that would appear if it produced at full capacity (13 million barrels/day,” writes Artus.

If all this wasn’t enough, gradually the realisation is setting in that some of the biggest oil producing regions in the world are beyond their peaks.

As Puru Saxena, a Hong Kong based hedge fund manager writes in a column “it is important to realise that several oil producing regions are already past their peak flow rates and have entered an irreversible decline. For instance, it is no secret that the North Sea, Mexico, Indonesia and a host of other areas are past their prime.”

All eyes are hence now on the Opec nations. The twelve nations in the cartel currently claim to have around 81.3% of the world’s oil reserves.

The trouble is that this has never been independently verified. As Kurt Cobb, the author of Prelude, a thriller based around oil, puts it in a recent column on www.oilprice.com, “Opec reserves are simply self-reported by each country. Essentially, Opec’s members are asking us to take their word for it. But should we?”
Saxena clearly doesn’t believe that Opec countries, including Saudi Arabia, have the kind of reserves they claim to.

Why the price of oil will not come down
“Given the fact that the vast majority of Saudi Arabia’s super-giant oil fields are extremely old, one has to wonder whether the nation is capable of boosting production…We are of the view that Saudi Arabia has grossly overstated its oil reserves and it is extremely unlikely that the nation has 270 billion barrels of petroleum. After all, the Saudi reserves have never been audited and a recent report by WikiLeaks suggests that the Saudis have inflated their oil bounty by 40%,” he writes.

This is something that Cobb backs up with more data. “Another piece of evidence that casts doubt on Opec members’ reserve claims came to light in 2005. That year Petroleum Intelligence Weekly, an industry newsletter with worldwide reach, obtained internal documents from the state-owned Kuwait Oil Co. The documents revealed that Kuwaiti reserves were only half the official number, 48 billion barrels versus 99 billion,” he writes.

“In 2004 Royal Dutch Shell had to lower its reserves number by 20 percent, a huge and costly blunder for such a sophisticated company. If Shell can bungle its reserves estimate, then how much more likely are OPEC countries which are subject to virtually no public scrutiny to bungle or perhaps manipulate theirs,” adds.

Given these reasons the world cannot produce more crude oil than it is currently producing. The production of oil has remained between 71-76 million barrels per day since 2005. “When you take into account the ongoing depletion in the world’s existing oil fields, it becomes clear that the world is heading into an epic energy crunch,” feels Saxena.
In these circumstances where the feeling is that the world does not have as much oil as is claimed, the price of oil is likely to continue to remain high. India’s `200,000 crore problem can only get bigger.

(Vivek Kaul is a writer. He can be reached at vivek.kaul@gmail.com)