What is your opinion on the global geopolitical situation, given the developments in Iraq and Ukraine? How do you see crude oil (Brent and NYMEX) prices doing, as a result?
The recent developments in Iraq are a stark reminder that most of the vital oil and gas producing countries of West Asia remain vulnerable to mass violent uprisings of the kind we saw during the Arab Spring and/or sectarian strife and militancy, all with deep-rooted, long-running issues that have no apparent or quick solutions.
Iraqi crude supplies appear to be flowing normally from the Basrah Oil Terminal in the Persian Gulf. Buyers have been nominated to lift 2.523 million barrels/day (b/d) of Basrah Light in June, reports suggest. Of this, 49 per cent is earmarked for buyers in Asia, with China being the biggest lifter, with an average of 630,000 b/d and India a distant second with 290,000 b/d. The other Asian importers are South Korea, Indonesia and Japan. The divergence this week – in Brent continuing to inch up, while the NYMEX crude rally appears to have lost steam – is likely a reflection of the US’ relative insulation from a drop in supplies from the region, thanks to its own burgeoning tight oil production. Both benchmarks at their current levels have priced in the longer-term outage of 250,000-300,000 b/d of Kirkuk crude supplies from the north, a situation that could continue for months.
The absolute worst-case scenario, though a bit deeper in the background as of now, is Iraq’s neighbours getting dragged into the civil war and sectarian violence engulfing the region. That could send crude prices spiralling to historic highs.
Could you quantify the impact for us?
The impact of the current strife is likely to be felt more severely on Iraq’s ambitious plans to boost upstream capacity in the coming years. The Kirkuk-Ceyhan oil pipeline, which carries Kirkuk crude from Iraq’s northern fields to the Turkish Mediterranean port of Ceyhan, and has a capacity of up to 300,000 b/d, has been shut since early March after being bombed by rebel groups, and is now expected to take much longer to be repaired, as the area remains inaccessible.
This puts a question mark on the 250-300,000 b/d of crude production and export from the north of the country. As the current sectarian strife could easily fester for months or even years, Iraq is unlikely to achieve its goals of four million b/d production by the end of 2014, and 8.5-9 million b/d by 2020.
What is the total world production/supply of crude as of now and how much does Iraq contribute to this? Which other global regions could the world rely on in the days ahead in case the Iraq conflict worsens?
Iraq is now Opec’s second largest producer, behind Saudi Arabia, and reached a high of 3.35 million b/d output in February, according to a Platts survey, its highest in a little more than three decades, and accounting for about 3.6 per cent of global demand. But should the Basrah Light flows be cut, there is no easy replacement for Iraq’s crude. Saudi Arabia, the biggest swing producer, with an output of 9.75 million b/d in May, reports suggest, is already close to the maximum of 10 million b/d that one has seen the kingdom produce, though it does claim to have a capacity of up to 11.5 million b/d.
What about gas prices?
The effect of disruption in gas supplies is typically more contained, as opposed to the more global nature of oil, because of the way gas is sold, stored and distributed. The impact of Russia cutting off gas supplies to Ukraine on Monday has been relatively muted this time, as Russia has assured that its supplies to the European Union markets, which go through the Ukraine transportation system, will not be affected. Ukraine itself has said it has enough gas in storage to be able to manage its needs until December, which is when it enters the peak winter gas demand season.
Would the spike in oil prices be significant enough that it derails the economic recovery in the US and euro zone and impacts emerging markets as well?
At their current levels, I don’t see oil prices derailing economic recovery in the US. It is worth remembering that thanks to the growing tight oil at home and Canadian oil sands supplies, US refiners are actually enjoying lower crude prices than counterparts elsewhere, and the strongest refining margins on the globe.
The world has been used to Brent broadly in the range of $110-120/barrel and NYMEX crude prices hovering at $90-110/barrel over the past two years. Growth in the emerging economies has already been slowing this year for a host of reasons. The major ones are the end of easy money, slow shift from export dependency to domestic consumption and inflation. Oil prices are in the mix but would become a major factor only if they break out of the mentioned bands.
Will Opec open more supply lines, then, to keep prices spiralling out of control?
Opec’s 12 members collectively pumped 29.97 million b/d of crude in May, very close to the 30 million b/d target agreed by the group. In the event of a shutdown of Basrah crude supplies from Iraq, Opec could ask members to pump full tilt but only a few have the capacity to raise production. Some of the other stop-gap measures would be the release of strategic stocks from the US strategic reserve and other OECD countries but these emergency measures are not yet being contemplated. Ultimately, we would need to see a diplomatic solution to the ISIS insurgency and underlying sectarian strife for oil prices to completely shed the Iraqi fear premium. A military solution to containing or eliminating the insurgency for now, by definition, is not sustainable.
Given all this, what’s the likely impact on India? Are the concerns overdone?
Indian refiners will need to find alternative supplies if their Basrah crude imports are affected. It’s not a huge volume but a far bigger impact is from the spike in global crude prices, which worsens the oil marketing companies’ (OMCs’) under-recoveries on subsidised oil products.
At the domestic level, a revision in gas prices is being discussed. Do you think this could now probably be put on the back-burner, given what the crude oil prices could do to the key macros?
Oil prices haven’t spiked to the extent that would justify India setting aside its fuel price reform or backpedal on the domestic gas price revision plan. It boils down to whether the new government wants to take the easy way out or take the bull by the horns and do what is right for the country in the longer term.
Oil and gas subsidies are not sustainable and erode the health of the OMCs, as well as the upstream players. If the Modi government intends to stick to its pledge of encouraging foreign investment in the country, freeing gas prices would be critical to attracting investment into developing the eastern offshore gas reserves.
No doubt, inflation above eight per cent is a major concern, as fuel price hikes would exacerbate the situation. Yet, history has shown us that there is never an ideal set of circumstances to do away with fuel subsidies. India has already embarked on a gradual, phased removal and that, to my mind, is the right course.