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Sentiment in the oil market has shifted from bearish to neutral as supply side issues overtook a pickup in demand. Crude oil prices are close to the $50 mark, a smart move of 85% from their lows in February. Oil prices, which touched a 13-year low in February, saw many supplier closing operations in the US. Oil production is the country is at 8.8 million barrel as day, the lowest level since September 2014.
While supply disruptions in the US caused a bottom formation, the present rise in oil prices is attributed to disruptions in supplies in Canada and Nigeria. Nearly 1.8 million barrels per day of oil supply has been hit in the near past. Supplies of around 1 million barrels were stopped from Canada on account of forest fires which resulted in closure of the wells. Though the fires have been arrested, re-starting the wells will take some more time. Analysts expect that it will take months before the production is fully restored.
But the bigger problem is from Nigeria, which is closing productions on account of increased militancy. Nearly 800,000 barrels per day of production has been capped on account of attacks and threats.
These two supply issues were the main reason behind Goldman Sachs, the most bearish of brokers in the oil market with a price target of $20 a barrel changed its medium-term recommendation. However, oil supplies have been disrupted faster than demand could pick up. Reports say that supply disruptions of roughly 3.75 million barrels per day shifted the supply demand mismatch since 2014.
News from the oil market has suddenly turned bullish, at least for the short to medium term. Shale oil production from the US, which was the main trigger for the sharp fall in oil prices, is on the decline. More companies in the country are filling for bankruptcy protection, the latest being SandRidge Energy and Breitburn Energy Partners seeking bankruptcy protection on Monday. US Energy Information Administration (EIA) said shale oil is expected to drop further in June for an eighth consecutive month.
Further, Nigeria and Venezuela supplies are not steady. Companies operating in Venezuela are shutting down on account of delay in payment from the government. Analysts feel Venezuelan supplies can come down further. Middle East oil producers continue to face the heat with rating agency Moody’s downgrading credit rating of Saudi Arabia, Bahrain and Oman.
Demand, on the other hand, is stagnant. This only indicates that till oil supplies resume, oil prices can continue to remain on higher sides, which is good for Indian and global markets but bad news for the Indian economy. Historically oil prices have coincided with market rallies.
Indian economy on the other hand will be at the receiving end. One of the few things that were in favour of Indian economy was lower oil prices, which emboldened the government to increase spending. In a tweet, Uday Kotak, managing director of Kotak Bank, said that India’s honeymoon on inflation, current account may be over. Micro needs to improve faster as macro tail winds slow down, he added. Government spending on infrastructure projects like roads and railways need to continue for the economy to grow faster.
However, there are some choices which the government has to deal with the rising prices. In an interview with Business Standard finance minister Arun Jaitley said that the government has wisely used the surplus created on account of lower oil prices. He said that the benefit was shared three ways. The consumers got a benefit by some reduction in prices of diesel and petrol, which also kept inflation under control and, in turn, enabled the Reserve Bank of India to systematically bring down the repo rate. Health of oil companies improved, while the third benefit was that the funds were used to expand on expenditure, particularly in infrastructure and rural areas.
Now that oil prices have risen, the government has a choice of either squeezing one of the three beneficiaries or the pain will be distributed to all three. In either case, the tailwinds that benefited Indian economy have changed.
Jaitley in the interview had said that among all the negatives that the government inherited there were only two positives. One was a majority in the lower house of the parliament and second was low oil prices. He is soon losing one of his advantages as oil prices rise and restricts government’s mobility in pushing the economy.
