Saudi-Russia oil production cap – can it work?

Saudi Arabia, Russia and other oil producers are trying to cap oil production to support prices. Such distortions are unlikely to work. India should be more concerned about the long term rise in oil prices due to falling investment in exploration and production – and should protect itself by acquiring oil and gas assets to cover its energy needs.

Saudi Arabia and Russia – the two largest oil exporters globally – and Qatar and Venezuela recently reached an agreement agreement to freeze their oil production, in an attempt to prop up petroleum prices.

All the four economies rely on energy exports, and have been hit by the 70% fall in crude oil prices over the past 18 months. Venezuela, currently in a severe economic crisis, is also trying to expand this agreement to meeting include other major oil producers , with the objective of capping oil production.

Meanwhile, the price of oil touched a seven-week high on March 1. Could the OPEC moves be working. and could oil price go back to 2014 highs?

Unlikely. Three reasons why:

Increased production from Iran, now firmly back in the market after three decades. Iran has already increased its oil exports by 400,000 barrels a day, and will raise it further by 200,000 barrels a day in the next few months.
Slowing global oil demand, weakened: From 1.6 million barrels/day in 2015 to an estimated 1.2 million barrels/day for 2016.
Continued shale oil production in the US, despite the commentary to the contrary. Even if old wells are shut down, new wells can be drilled in weeks if prices recover. Till this capacity is exhausted, it will serve as a ceiling on oil price. The International Energy Agency expects expects the US to be the biggest source of new oil supply till 2021.

India needn’t worry about OPEC causing short term distortions in a well-supplied oil market. But there is a long-term worry, i.e. that exporting are facing severe financial distress which will result in lower investment in exploration and production of petroleum and therefore lower future supply. Global oil majors have scaled back exploration budgets for two years in a row now for the first time since 1989. The impact of such cutbacks are usually felt some years down the line, as seen during the Oil Shock of the 1970s and the last decade when prices shot up to $130 a barrel.

This is India’s time to make strategic investments in oil assets. Continuing on the path of the Rosneft sale of an oil-field to ONGC and acquisition of a stake in oil refiner Essar, Indian companies must seek other such targets–mid-size energy companies headquartered in the U.K. and the U.S. such as Tullow Oil and Chesapeake Energy. These companies own oil fields in North America and Africa and are currently available cheap–down 75%-80% from their 2014 values. These assets can help cover a part of India’s annual oil imports of 190 million tons, and will help insulate the economy against future oil shocks.

Amit Bhandari is Fellow, Energy & Environment Studies, Gateway House.

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