From under $30 per barrel in January, crude oil prices crossed the $50 mark in in May. This price spike is a reminder that current low energy prices will not be sustained, and that India must act fast to secure its energy supplies at reasonable prices while the window of low prices is still open.
Production outages in Nigeria—from attacks on oil infrastructure—are being blamed for the latest price spike. Nigeria’s oil production has fallen to its lowest level in 20 years after a new group, the Niger Delta Avengers, attacked oil-producing infrastructure and threatened further attacks. It is yet another complication in an already long list of potential complications that could cause sudden disruption in the world oil supply chain, such as possible confrontation between Saudi Arabia and Iran, civil unrest in Venezuela, labour unrest in Kuwait. All these factors and many others not yet on the radar can materially impact oil prices and yet cannot be forecast with any accuracy.
Apart from such unpredictable but significant events, some predictable trends are lining up. As oil prices have fallen, oil companies are cutting back investments in exploration and production, which means less oil in the future. Low investment in oil exploration during the 1980s and 1990s was one reason why oil prices eventually crossed $100 per barrel in the past decade. Cutbacks in investments will eventually land the oil market in the same spot.
Investment in upstream oil has already fallen for two years in a row—2015 and 2016—and some industry officials expect it to fall for a third year. Any operational oil field has a natural rate of decline of production, which oil companies offset by either finding new reservoirs of oil in the same field or producing from new oil finds, but production from new oil fields in 2016 will not offset the natural decline of production in existing oil fields the first time in several years. And the gap is only expected to widen in 2017 and probably lead to shortages by 2020.
India imports 1.25 billion barrels of petroleum annually, with imports set to grow. Any sharp changes in the oil market will be to its detriment. As the drop in oil prices over the past two years represents an annual saving of over $70 billion for India, it is in India’s interest to ensure low prices continue, but it is not in a position to act on the factors that move oil prices. India neither has the heft to affect geopolitical events nor can it influence the investment decisions of oil and gas companies globally.
At best, India can try to protect itself from untoward developments that lead to higher prices. Two approaches hold promise: firstly, India needs to buy existing oil and gas fields, a strategy which public sector firms have been trying for over a decade now. In the current scenario of low oil prices and low asset values, Indian companies need to become more aggressive in buying such assets. In the past 12 months, Indian firms have signed just one big deal, with Rosneft, for stakes in two of its major oil fields. This needs to change. One way is to acquire stakes in listed oil and gas companies with known reserves where stock prices have tanked but which are otherwise viable. The United States and Canada, which have thousands of listed hydrocarbon companies, are good places to look for such bargains, as Gateway House had earlier recommended.
The second approach, which is of a shorter term, is to use financial instruments like options and futures to hedge India’s exposure to high oil prices. It is also an approach suggested by Gateway House earlier.
The recent spike in oil prices to $50/barrel is an indication that the window of moderate energy prices will not be open permanently, and that India must act fast to secure its energy supplies at low prices.
Amit Bhandari is Fellow, Energy & Environment Studies, Gateway House.
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