Do low oil prices really paint a picture of gloom?

The price of crude oil has been steadily falling. From being above $100 a barrel around July-2014, it has come down from this peak to around $28 a barrel today (18-Jan-2016) [1]… Many analysts have construed this as a bearish sign, proof of a general slowdown in the global economy. Stock markets around the world have also taken this as one of their cues to head south. Our own Sensex has crashed almost 15% in the last 6 months [2]…

Now, is this bearish outlook justified?

Adam Smith, the father of Capitalist theory, gave us that well known law of Supply and Demand [3]. When demand falls, prices decrease. True of course, though it would be a stretch to justify such a major drop in the price of crude when the fall in demand has been nominal (demand has slowed from a high of 95.43 mb/d in 3Q2015 to about 94.81 mb/d in 1Q2016) (mb/d º millions of barrels per day) [4]. This minor drop in demand cannot alone justify such a precipitous drop in oil. What then could be the reason? It has to do with the other side of the supply–demand curve, specifically a substantial increase in the supply of oil. It is this over-supply that is causing crude to crash. At almost their every meet in recent times, OPEC, the Middle East based cartel controlling almost 73% of the known reserves of oil [5], has steadily increased production [6]. Sounds counter intuitive doesn’t it? Why would OPEC increase production especially when demand is sluggish thus almost guaranteeing a crash in the price of oil and thus their profits?

The answer is the entry of the United States in the business of Shale fracking. A fancy term to mean extraction of oil from unconventional deposits of a mineral rock called kerogen shale by a technology called fracking. In simple terms, it’s the use of some fancy know-how not earlier feasible due to technological limitations to extract oil in otherwise hard to extract deposits of some rock present within the US itself. Shale fracking has taken off in recent years and production has gone up to such an extent that oil extracted from US shale deposits from initially being almost nonexistent is now touching almost 9 mb/d. To put it in perspective, Saudi Arabia extracts oil at the rate just shy of 10 mb/d. Thus the US in just a few years of shale fracking is almost matching up with Saudi production levels; to me a miracle of sorts… [7]

Now, Saudi Arabia and the rest of OPEC would obviously see shale as a threat to their monopoly on oil and that’s where the crude logic of increasing production to decrease crude prices is to be understood. Shale is harder to extract than regular crude and the process remains profitable if oil prices remain above $60 a barrel [8]. Below that the cost of extracting oil from shale is higher than the revenue generated from selling it. Thus by increasing supply even when demand is low, OPEC is taking a minor heart burn in reduced profits temporarily in the hopes of bankrupting US shale manufacturers for good. Some would say that it’s a smart strategy though many would claim that using cash reserves to reduce the price of your product below profitable levels to drive your competitors out of business and then raising prices back up is predatory pricing, is unethical business practice and if matter be made subject to Indian jurisdiction, violates the Competition Act of 2002 [9]…

Now, whether OPEC succeeds or not, and I’m hoping they don’t, is not the main thrust of this article. Though, as an aside, I will mention that shale manufactures have proven themselves to be a resilient lot. Although a few have shut shop with about 40 declaring bankruptcies in the US [10], many are braving on… With investments in newer and more efficient technologies and streamlining their manufacturing processes, many are surviving even in these harsh times [11].

Either way, the main point to take home is that the gloom and doom predicted by our analysts citing the drop in crude prices as evidence is unjustified. In fact, this is a once in a life time opportunity for us... Low oil prices means we can reduce our budget deficit, pay off our debt and reduce our gargantuan import bill. We will be saving around $24 billion in reduced import costs alone [12]. Further we can slash the price of petrol and diesel at home resulting in a corresponding drop in prices across the board of fruits, vegetables, other essential commodities and almost everything else under the sun. Imagine the fillip this would give to our economy and also simultaneously tame inflation, the commonest complaint of the poor man. So, let’s not fret about low crude prices and in fact seize this opportunity and make it work to our advantage.

In addition, let’s learn from the example set by the US in achieving self reliance in the most important commodity of today, thus ensuring a secure and prosperous future for their citizens… Let us not remain enslaved to OPEC with them controlling our pulmonary artery. If the US can extract oil from shale, why can’t we? Why is our government not exploring this option? Why are our private and public companies not rising up to the challenge? By some estimates we have around 527 tcf (trillion cubic feet) of shale oil [13] which is a substantial amount and if properly exploited could meet our needs for many years to come.

Thus, far from painting a picture of gloom, low oil prices represent that winning lottery ticket to jump start our economy…

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References

1. B. Team, "Oil price steadies after falling below $28 a barrel," 18 January 2016. [Online]. Available: http://www.bbc.com/news/business-35340893. [Accessed 19 January 2016].
2. M. team, "Sensex," 19 January 2016. [Online]. Available: http://www.moneycontrol.com/indian-indices/sensex-4.html. [Accessed 19 January 2016].
3. Wikipedia, "Supply and demand --- Wikipedia, The Free Encyclopedia," 2015. [Online]. Available: https://en.wikipedia.org/w/index.php?title=Supply_and_demand&oldid=696412379. [Accessed 19 January 2016].
4. I. Team, "Oil Market Report," 2015 December 2015. [Online]. Available: https://www.iea.org/oilmarketreport/omrpublic. [Accessed 19 Jamuary 2016].
5. Wikipedia, "OPEC --- Wikipedia, The Free Encyclopedia," 2016. [Online]. Available: https://en.wikipedia.org/w/index.php?title=OPEC&oldid=700492351. [Accessed 19 January 2016].
6. y. Team, "OPEC Crude Oil Production," September 2015. [Online]. Available: https://ycharts.com/indicators/opec_crude_oil_production. [Accessed 19 January 2016].
7. J. Lane, "Shale vs OPEC: What’s going on with oil prices? Will the bleeding stop, and when?," 13 January 2015. [Online]. Available: http://www.biofuelsdigest.com/bdigest/2015/01/13/shale-vs-opec-whats-going-on-with-oil-prices-will-the-bleeding-stop-and-when. [Accessed 19 January 2016].
8. T. Randall, "Break-Even Points for U.S. Shale Oil," 17 October 2014. [Online]. Available: http://www.bloomberg.com/news/2014-10-17/oil-is-cheap-but-not-so-cheap-that-americans-won-t-profit-from-it.html. [Accessed 19 January 2016].
9. Wikipedia, "The Competition Act, 2002 --- Wikipedia, The Free Encyclopedia," 2015. [Online]. Available: https://en.wikipedia.org/w/index.php?title=The_Competition_Act,_2002&oldid=691518692. [Accessed 19 January 2016].
10. C. Eaton, "Year after key OPEC meeting, oil bankruptcies rise to 37," 20 November 2015. [Online]. Available: http://fuelfix.com/blog/2015/11/20/year-after-key-opec-meeting-oil-bankruptcies-rise-to-37/#36696101=13. [Accessed 19 January 2016].
11. B. Olson, "Shale Wells Are Turning Into Cash Gushers," 16 April 2015. [Online]. Available: http://www.bloomberg.com/news/articles/2015-04-16/shale-wells-are-turning-into-cash-gushers. [Accessed 19 January 2016].
12. m. Team, "India's oil import bill to fall 21.7% to $88 bn in FY16," 25 June 2015. [Online]. Available: http://www.moneycontrol.com/news/economy/indias-oil-import-bill-to-fall-217-to-3688-bnfy16_1631401.html. [Accessed 21 Jaunary 2016].
13. J. R. Chowdhury, "Oil India shale drill in Northeast," 5 February 2015. [Online]. Available: http://www.telegraphindia.com/1150205/jsp/business/story_1508.jsp#.Vp3wh5pf3X5. [Accessed 19 January 2016].

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