Supply continues to dominate prices

Though US crude oil production was up 19.5 per cent year-on-year from January-June this year and Canadian oil output rose 10 per cent year-on-year in January-March, recent increases in refinery processing rates and flow of crude oil out of the Midwest via pipelines and rail have provided support for prices.

Outside the US, output is also subject to disruption. North Sea output has been down 10 per cent year-on-year so far this year and Russia is exporting far less oil to Europe, even though output in Russia has risen this year. Variations in oil output from the Organisation of Petroleum Exporting Countries (OPEC) including Nigeria, Angola, Libya and Iraq, have led to fluctuations in OPEC output in the region of 535,000 barrels a day. Further outages in supply over the coming months are likely, due to persistent uncertainty in African regions and as fields in the North Sea go offline for maintenance. So far, August BFOE loadings are two per cent below last year's level at 774,194 barrels a day, and supply will remain low on a year-on-year basis for the rest of the year. In the very near term, therefore, global oil supply is likely to remain constrained.

On the demand side, global oil consumption has been driven largely by China and the US. Demand for oil in US was up 0.4 per cent year-on-year in January-July. In China, demand growth has so far been running at around 460,000 barrels a day, close to the +500,000 barrels a day we had predicted in late-2012. Despite the recent weakness in Chinese economic data, we continue to believe the Chinese oil demand will grow at something close to the seven-year average growth rate, with the potential for current consumption to be supplemented by accumulation of the second phase of China's strategic petroleum reserve.

Indian demand for oil was three per cent year-on-year in January-May, down from five per cent in 2012. West Asian demand for crude is also expected to grow by 3.8 per cent year-on-year this year due to near-term summer demand and longer-term urbanisation in the main Gulf Cooperation Council countries.

Robust demand and tighter than expected non-OPEC supply have led to an upward revision to the call on OPEC by 100,000 barrels a day by both OPEC and IEA in their July reports. This has helped Saudi Arabia and its GCC allies to maintain control over prices and this situation is likely to persist for the rest of the year.

We see oil prices averaging the $107.50 a barrel for 2013 as a whole, with tighter than expected supply and robust demand combining with ongoing geopolitical risk in North Africa and West Asia to keep prices in the upper half of OPEC's target $100-110 a barrel range for the remainder of this year.

What does this mean for India?

Crude oil prices might not be going up significantly in dollar terms, but the weakness of the rupee is compounding the problems India faces due to its substantial energy imports. First, the oil import bill has remained at around six per cent of GDP, despite an economic slowdown that in previous cycles might have coincided with lower energy costs. Second, the high rupee price of oil is making it more difficult for the government to wean the economy off oil product price subsidies that contributed to a sharp deterioration in government finances between 2008 and 2012.

Although cuts to subsidies will gradually reduce the government deficit, higher fuel prices risk exacerbating the country's inflation problem and might have a negative impact on oil product demand in future.
The author is oil markets analyst, commodities research, Natixis