Oil and gas prices are expected to jump after the world’s top oil-producing countries agreed to cut production last week. The grouping has announced a 2 million barrels a day cut in their combined crude output, stoking fears of higher energy prices when the threat of a recession is looming large over the world. The Saudi Arabia led-led cartel, OPEC+ which also includes Russia, has announced the cut, hoping to spur a recovery in oil prices that have dropped to pre-Ukraine war levels. The cut comes despite gentle persuasion by the US, the world’s largest energy consumer.
The actual output cut, however, would be far less than 2 million barrels per day as many OPEC+ countries have informal cuts already in place. But Brent Crude soared above its 50-day moving average, and looks poised to rise further. The biggest impact of the output cut will be on inflation. Before the cut, analysts were of the view that inflation has peaked and the FED will shift gears after the current series of jumbo hikes.
The move by OPEC+ doesn’t augur well for the Indian economy which had witnessed a fall in its oil import bill as prices remained subdued in recent weeks. New Delhi was also able to limit losses that state-owned fuel retailers were incurring on selling petrol and diesel below cost price. India is heavily dependent on imported crude that meets 85% of its energy needs. Changes in global crude prices reflect on domestic pricing. Prior to the hike, fuel retailers in India were not only able to curb losses on diesel by Rs 5 per litre from the peak of around Rs 30 a litre, but had also started making a small profit on petrol.
Oil prices have been on an upward trajectory ever since Russia’s February 24 invasion of Ukraine that sent shock waves through global energy markets. Brent was at $90.21 per barrel before the invasion and rose to a 14-year high of $130 per barrel before it started declining. The basket of crude oil that India imports averaged $116.01 in June, marking the highest rates since March 2013.
Impact of high crude prices
The push in crude oil translates into an increase in consumer prices which hit countries around the world earlier this year. This pushed inflation rates to levels not seen in decades and created political tension. India was no outlier and has been witnessing runway inflation as prices of food jumped. Higher petrol prices will also push domestic producers of other goods to increase prices.
Earlier, state-owned fuel retailers Indian Oil Corporation (IOC), Bharat Petroleum Corporation Ltd (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL) had a monopoly over fuel retailing. They used to incur losses to help the government manage inflation. Now, the prices are decontrolled. The government is criticised for not passing on the fall in global crude prices to consumers, while increasing fuel prices every time crude prices rise in the international market.
To make matters worse for India, the rupee has been depreciating against the dollar. The rupee hit a record low of 82.33 against the US currency last week mainly due to a surge in US bond yields and global crude oil prices. With a falling rupee and higher prices of crude oil, losses on diesel are likely to widen for fuel retailers while margins on petrol will erode.
Meanwhile, OPEC members defended their decision and said that the move comes due to significant uncertainty about future demand for oil, amid fears that the global economy is heading towards a recession.
Global impact of OPEC decision
There are conflicting views from analysts. Many analysts are not convinced that the OPEC move may cause a significant dent to global supplies. As discussed earlier, the actual impact of the cut on global supplies on the ground would be smaller as several OPEC members already have unannounced cuts in production. However, this is still not enough to rein in the sentiments of the oil markets in the coming days.
Analysts are also sceptical that any long-term effect of the OPEC cut is not theoretically possible since recession fears are real. The same will compel advanced economies to keep prices under check.
Oil industry analysts, however, believe that the crude prices are unlikely to fall due to lower demand triggered by high prices. There are several factors in play that will lead to further rises in prices. Apart from the cut by OPEC+, the US has started reducing release of crude from its strategic petroleum reserve. Also, oil supplies from Russia could see a fall, putting more pressure on global crude supply. The combined impact of these factors would more than offset the demand destruction caused by high fuel prices.