Better for Indian policymakers to understand what makes oil prices move

India imports more than 85% of its crude, half of its gas, and 60% of the cooking fuel, and any uptick in rates reduces the purchasing power of Indian households, something that is called inflation

By how much will oil prices move this winter, and in 2023? If one had the key to the chaotic world of oil prices, then she or he would be the most influential and richest astrologer in the world. Even seasoned oil wizards working for some of the world’s most storied banks like Goldman Sachs have stumbled. When Brent crude soared to a record $147.50 a barrel in the summer of 2008, Goldman Sachs predicted the world’s biggest addiction to touch $200 a barrel — crude plunged to $45 a barrel in the winter of 2008.

The perils of predictions were no less evident last month when the bank cut its price forecasts for Brent averaging $100 per barrel in October-December, down from its previous forecast of $130 per barrel. Goldman saw Brent averaging $108 per barrel in 2023, down from a previous $125 per barrel prediction, attributing the downgrade to a strong dollar and weakening demand. The bank, in September, saw the Organization of Petroleum Exporting Countries (OPEC) maintaining production near current levels for 2022. But OPEC+ did the opposite — it decided to cut output by 2 million barrels a day on October 5.

So it may be better for Indian policymakers to understand what makes oil prices move rather than predict movements in rates — which is what seems to be happening if one goes by the frequent pronouncements made by state oil refiners in the media. But why should India bother about oil prices? India imports more than 85 per cent of its crude, half of its gas, and 60 per cent of the cooking fuel that goes into your vehicles and kitchens, and any uptick in rates reduces the purchasing power of Indian households, something that is called inflation. Alternatively, the government must borrow more to pay state refiners to keep pump prices constant.

India paid $90 billion for crude oil in the April-September period of fiscal 2022-23, 76 per cent higher from a year earlier. The jump in oil expenditure would have been even higher if Russia had not offered oil at a discount while inveigling its way to become one of India’s top three oil suppliers. At constant fuel prices, India will spend around $223 billion this fiscal on imported fuels, or over 6 per cent of India’s GDP, according to calculations based on oil ministry data.

Goldman still maintains a bullish view on oil because of a structurally bullish supply scenario, which it said has only grown stronger, inevitably requiring much higher prices. What that means is the pandemic, a push towards renewables and the Russian invasion of Ukraine — all occurring at the same time — have led to lack of investment in global upstream, low spare capacity to extract more oil in case of any geopolitical crisis — like terrorist attacks on oil facilities — and, low stocks.

Stocks are by far the most important from a near-term horizon because oil prices respond to the volume of oil stored by developed nations. Commercial inventories held in the countries of the Organisation for Economic Co-operation and Development remained a steep 243 million barrels below the five-year average of 2.736 billion barrels, International Energy Agency (IEA) said in its monthly October oil report. They would have been significantly lower had it not been for the release of 185 million barrels of IEA member country government stocks from March through August, IEA said.

Low stocks have also coincided with a massive cut in OPEC+ oil supply, the biggest since the group cut output by 10 million barrels a day in 2020 during the pandemic, heightening the price risk for nations like India because even after taking into account lower demand expectations because of a looming recession, it will sharply reduce a much needed build in oil stocks through the rest of this year and into the first half of 2023, the IEA said.

While global recession and China’s quixotic zero Covid policies portend a potential steep fall in prices, this is still seen as unlikely, given not only very low stock levels, an exhausted US strategic reserve, and especially the constrained supply side of the equation, said Tilak Doshi, a Singapore-based international oil expert. Surplus oil production capacity is extremely low (as the CEO of Aramco said recently), and any bullish development of the demand side (such as China coming out of lockdowns for example) would lead to an oil price shock on the upside, Doshi, who has worked for Aramco, added.

History has often served as a poor precedent for how oil prices move. For example, in 2017, Goldman Sachs was forced to issue a note explaining why it got it wrong when it came to predicting oil price movements. OPEC had then cut output to boost prices. That prompted the bank and traders to take long positions on the commodity. But what Goldman failed to realise was that unlike in the past US drillers pumped more from shale reserves as oil prices rose, negating OPEC’s supply cut, and sending oil lower. Shale turned the US into the world’s biggest oil producer and weakened OPEC’s clout in influencing oil prices.

While previous large spikes in oil prices have spurred a strong investment response from non-OPEC producers, this time may be different, the IEA said. US shale producers, traditionally the most responsive to changing market conditions, are struggling with supply chain constraints and cost inflation — and, so far, they are maintaining capital discipline. This casts doubt on suggestions that higher prices will necessarily balance the market through additional supply.

OPEC’s current cut also coincided with the US releasing its last installment of stocks from its strategic reserves, and amid threats of a price cap on Russian oil. Saudi Arabia and Russia ensured that bulldozing price caps on China, India and Turkey, the biggest buyers of Russian oil, will be tougher if supplies are already low, and the US, in an election year, may not risk roiling oil markets further.

“The political predilections of NATO and its US-led policy makers that see ‘bleeding Russia’ as the ultimate objective is driving energy policies of the West to the detriment of the world economy and the livelihood of billions of people faced with surging fuel, food and fertiliser prices,” Doshi said.