Price Movements: Supply glut, political instability and production disruptions lead to price volatility

Supply glut, political instability and production disruptions lead to price volatility

The oil and gas industry across the globe has observed significant price volatility in recent times. Both crude oil and natural gas prices have exhibited an increase owing to factors such as administered crude oil production cut, decline in crude oil inventories, as well as political instability and production disruptions in some major oil producing countries. The increase in global crude oil prices has inflated India’s crude oil import bill to $88 billion in 2017-18. It is further expected to increase by 24 per cent to reach $109 billion in 2018-19.

Indian Infrastructure takes a look at the key pricing trends in the sector over the past few years…

Recent pricing trends

Crude oil

Brent crude oil spot prices averaged $72 per barrel in April 2018, an increase of $6 per barrel from the March 2018 level. On May 10, 2018, crude oil prices hit $80 per barrel for the first time since November 2014, due to supply- deficit concerns. This was primarily a result of the Organization of Petroleum Exporting Countries (OPEC) and non-OPEC producers’ decision to cap output at about 1.8 million barrels per day (bpd). The decision was implemented in January 2017 and it was agreed that the production cut would be applicable until the end of 2018. Consequently, OPEC oil output fell in March 2018 to an 11-month low due to declining Angolan exports, Libyan outages and a further slide in Venezuelan output.

Other major reasons responsible for the steep hike in oil prices include the decreasing crude oil inventories in the US and the OPEC, and supply disruptions in Libya and Canada. Global petroleum inventories declined through 2017 and the first quarter of 2018, marking the end of an extended period of oversupply. Between January 2017 and April 2018, crude oil inventories in the Organization for Economic Cooperation and Development (OECD) countries decreased by 234 million barrels. The US accounted for more than half of that decline, as US crude oil and other liquid inventories decreased by 162 million barrels over the period. By the end of April 2018, both OECD and US inventory levels were lower than the average for the April 2013-April 2017 period.

On June 22, 2018, OPEC decided to lift the over 15-month production cut approving modest hikes in oil production. This was expected to reverse some of the output cuts that OPEC and other major producers had implemented in early 2017 in a bid to end several years of supply glut. OPEC countries committed to increasing crude oil production by 1 million bpd. In fact, in June 2018, OPEC’s crude oil production increased by 320,000 bpd to 32,320,000 bpd, over the previous month. This was primarily due to the rise in production from Saudi Arabia and Iraq. Thus, the rise in OPEC’s crude oil production pressured oil prices – Brent and West Texas Intermediate oil prices fell 2.7 per cent and 0.3 per cent, respectively, on July 2, 2018.

The trend was, however, reversed in the second week of July 2018 with crude oil prices increasing further to $78.07 per barrel as a result of falling Libyan oil production, an outage at the Syncrude production facility in Canada, disrupted production at Shell’s Knarr field and the proposed US policy for curtailment of oil exports from Iran.

Natural gas

Domestic gas pricing is currently done as per the New Domestic Gas Pricing Policy, 2014. The new gas price is the volume weighted average of four annual gas prices – Henry Hub, Alberta Hub, National Balancing Point and Russian volumes. Under the new regime, gas prices are revised every six months. The gas pricing formula as per the New Domestic Natural Gas Pricing Guidelines will be applicable till March 31, 2019.

In October 2017, the domestic gas price witnessed two consecutive hikes after a long period of falling prices. The government had last raised gas prices when it introduced a new pricing formula in November 2014. Since then, it has reduced prices by more than half through five successive cuts. Lower prices have pressed the margins of explorers, but have helped the government increase demand for the fuel from fertiliser companies and power generators, and encouraged its use for transportation and cooking.

In the past two six-month periods, the gas price increased to $2.89 per million metric British thermal units (mmBtu) for the October 2017-March 2018 period and $3.06 per mmBtu for April-September 2018 (on the basis of gross calorific value). In percentage terms, three out of the past five revisions entailed a negative growth. The first revision, during April-September 2016, reflects a nearly 25 per cent contraction. Prices further slid by another 18.3 per cent during the next six-monthly revision, and finally picked up by about 17 per cent in the October 2017-March 2018 period.

LNG imports

India is increasingly relying on imported liquefied natural gas (LNG) to meet its natural gas demand. The share of spot LNG in total LNG imports has gradually gone up in the past few years to reach 55 per cent in 2017. The remaining LNG is sourced from long-term contracts with suppliers across the globe. Globally, natural gas spot prices have crashed from the high in 2008. Looking at a 10-year perspective, gas prices crashed in 2008 and stabilised thereafter reaching a peak again in 2013. Since then, prices have been on a gradual decline. In 2017, gas prices rose in Europe, Asia and North America, but remained below the 10-year average.

The spot gas prices have shown a downward trend over the past few years. In 2017, the Henry Hub spot gas prices witnessed a fluctuating trend, more or less remaining in the $2-$3 per mmBtu range. In January 2018, the price increased to $3.87 per mmBtu. The price fluctuated during the next four months (February-May 2018), however, it remained below the $3 per mmBtu level. The LNG spot price for Japan displayed a downward trend till August 2017. Thereafter, it started to witness an increasing trend. The spot LNG price (contract-based price) was $11 per mmBtu in January 2018, which was the highest in over three years. It declined to $10.6 per mmBtu in March 2018; however, compared to the corresponding month in 2017, the contract-based price increased by 24.7 per cent.

To take advantage of low global LNG prices, Indian oil and gas companies also renegotiated terms on three LNG contracts – RasGas (Qatar), ExxonMobil (Australia) and Gazprom (Russia). Earlier, these contracts were offering gas at nearly double the price.

Price outlook

Crude oil prices are likely to witness major fluctuations in the years to come. British multinational investment bank Barclays forecasts the price of Brent crude oil to average about $73 per barrel over the next six months, as Saudi Arabia, Russia, Kuwait and the United Arab Emirates add more supplies to the market. Morgan Stanley recently raised its six-month outlook for Brent to $85 per barrel after the US government decided to cut oil imports from Iran. In the short to medium term, crude oil prices will depend on supply-side factors, with concerns over declining output from major producers.

On the other hand, gas prices in the domestic market are linked to natural gas consumption in the US, Canada, Russia, the European Union and the former Soviet Union countries. The main variables in the formula for pricing are global prices in Henry Hub, Alberta Hub, National Balancing Point and Russian volumes. While a historical price trend analysis reveals a weak pricing scenario over a 10-year horizon, spot prices have increased as a result of supply-related concerns in the past few months. This is reflected in the domestic market where prices have inched up steadily since October 2017. Much of the existing domestic gas pricing scenario will be dictated by global prices.

On the domestic front, the price of new natural gas output is going to be subject to demand, which in turn is going to be affected by the price competitiveness of existing natural gas with alternative fuels (coal, crude, etc.) vying for market shares.

Overall, the demand for natural gas is expected to grow manyfold across the world led by China and India. This could put an upward pressure on natural gas prices, although currently, there is a supply glut in the market. Moreover, for domestic production to pick up adequately, the industry would need a floor price. This may incentivise domestic production and, in the long term, keep prices in check.