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Oil production freeze adds to price uncertainty

News of a deal between Saudi Arabia and Russia to freeze their output of crude oil at January 2016 levels has sent a ripple through the world markets, and could not have come at a worse time for India. Saudi Arabia is the force behind the oil-exporters' cartel, the Organisation of the Petroleum Exporting Countries, or OPEC, and Russia is the largest producer of crude oil in the world. This would mark the first deal between OPEC and non-OPEC countries on oil production in over 15 years. The finances of both have been hit by the precipitous fall in the global price of oil - a 70 per cent decline since July 2014 - and so it is not surprising that they are taking a re-look at their output numbers. The initial reaction to the deal was cautious - the biggest question mark was the reaction of Iran, once among the largest exporters in the world, but more recently hit by economic sanctions. With the sanctions now lifted, news that Iran was considering increasing output by 500,000 barrels of crude oil a day had sent prices to a 13-year low in mid-January.

But, when Iran's oil minister met with his counterparts from Venezuela, Iraq and Qatar on Wednesday, the meeting resulted in his stating that the "ceiling" proposed by Russia and Saudi Arabia on production would be a useful step towards stabilising the market. Iran is faced with a dilemma. On the one hand, it expects to increase output to at least recover the market share that it had before sanctions were imposed. On the other hand, more supply would reduce prices even further - and Iran desperately needs a higher return on its crude oil in order to invest in creaking, decades-old refining and extraction infrastructure. Thus it has welcomed the deal without promising to join it. But, certainly, the implication that all stakeholders at least were on board with the idea of a production ceiling deal sent oil prices up by five per cent on Wednesday. While geo-political tension in West Asia means that none of the participants likes each other very much at the moment and there are conflicting views on whether the development would result in higher oil prices, there is little doubt that the producers' incentives to agree on a deal are sharp. Also on Wednesday, the credit rating agency, Standard & Poor's, cut the rating of a number of oil-exporting countries - including Saudi Arabia's, which was slashed by two points from A+ to A-.

This movement in the oil market's structure has made the future path of oil even more difficult to pin down than usual. But this confusion comes at a difficult time. The Union Budget for 2016-17 is being written, and one of the crucial variables in it is the global oil price. The government's finances have gained considerably from the fall in global oil prices - the estimated price of a barrel of oil in the ongoing financial year's Budget was $70. The difference between that and the actual price will allow the government to do a lot better than it otherwise would. Many traders are expecting a barrel of Brent crude oil to be between $40 and $45 in the summer, but the oil major BP expects it to be closer to $60 by the end of the calendar year 2016. The finance ministry should play it safe and ensure that a higher rather than lower oil price is chosen in the Budget, so that there are no unpleasant surprises to the fiscal arithmetic somewhere in the middle of the coming year.