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A Not To Be Messed Opportunity
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When elephants fight, it is the grass that suffers, goes the saying. But paradoxically, in the latest battle for market share between the proverbial pachyderm forms of OPEC and America’s emerging shale oil giant, the smaller countries beneath them are far from being trampled. Instead, the precipitous drop in oil prices — with a barrel of crude costing less than $50 in early January — has been a bonanza for the vast majority of oil-importing countries. Amid signs that the price may fall further before the end of 2015, emerging economies like India have a clear window of time to balance their budgets and enact economic reforms.
The US shale oil industry has accused OPEC of declaring war on shale oil by refusing to cut production despite a glut in the market. Saudis blame US industries for flooding the market. Although the geopolitical condition today is very different — Saudi Arabia is allied with the US against Islamic State — the US industry’s memory is seared by the experience of 1986. That year the Saudis deflated the oil ambition of US firms by driving price down to $10 a barrel. The collapse in price drove the US oil industry to decline and allowed Saudi Arabia to gain dominant position. Now with the resurgent US boosted by shale revolution and keen to end its dependence on West Asia oil the battle for market share has resumed.
In recent years, new technologies to extract shale oil has enabled the US to increase output to its highest levels in three decades — over nine million barrels a day — freeing America of its historical dependence on OPEC-sourced oil. In an effort to retain market share, the Saudi-led OPEC has rejected pressure to cut production even though the global demand for oil has slackened. The resultant glut in the market has steadily driven prices down, bringing relief to governments like India and Indonesia, whose budgets have been weighed down by the erstwhile high cost of fuel subsidies. The plunging prices have not been good news for all, however, as evidenced by the recent collapse of the Russian ruble and the heightened economic pressure on Iran. Midsize oil exporters like Nigeria have been forced to devalue their currency, with Venezuela turning in desperation to China to help save its fast-sinking economy.
The Saudi strategy may be born of a well-founded sense that there is long-term weakness in their rivals’ effort to secure market share. For many US shale oil producers looking at prices below $50 a barrel, drilling new wells is not commercially viable. Already, many have begun cutting back production and laying off workers, and overall investment in US oil and gas sector has fallen by over 30 per cent last year. Environmentalists fear that by continuing to apply downward pressure on the price of oil, OPEC might also be trying to strangle fledgling alternate energy sources such as solar and wind power, which have a higher sticker price than hydrocarbons pumped from the ground.
There is a delicate financial calculus at play in OPEC’s decision-making. For example, the Saudi cost to produce a barrel of oil is just $2, but according to the IMF, it needs to have oil prices of around $89 a barrel to balance its budget. The current price of below $50 means that the House of Saud is absorbing a significant fiscal hit. But the major producers of OPEC have deep pockets and appear to be prepared to suffer short-term losses in a bid to destroy the long-term competition. The success of that approach will depend on how quickly the innovative upstarts in the US shale oil industry retreat and regroup, with a view to bouncing back with better technology to mount a fresh challenge to Saudi domination in future.
In the meantime, nations like India should take advantage of this brief window of opportunity to save large sums of taxpayer money and put their economic houses in order before the battle of the oil-producing elephants resumes.
(This story was published in BW | Businessworld Issue Dated 09-02-2015)