Volatile Markets: Trends in domestic and imported oil and gas prices

Trends in domestic and imported oil and gas prices

The oil and gas industry worldwide has witnessed volatility over the past decade and has changed in four fundamental ways – domination of US oil production, uncertainty over the clout of the Organization of the Petroleum Exporting Countries (OPEC), fluctuating value of the dollar and a shift in oil demand.

There are a large number of factors influencing the prices of crude oil and gas such as administered crude oil production cut, market speculation, decline in crude oil inventories, political instability, fluctuations in gas consumption, risks with respect to gas discoveries, and production disruptions in some major oil producing countries.

The increase in global crude oil prices inflated India’s crude oil import bill to $115 billion in 2018-19, a growth of 30 per cent over the $88 billion in 2017-18.

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

Crude oil

The major benchmark oil prices in the world are the Brent and West Texas Intermediate (WTI) crude oil prices. Brent is the benchmark for African, European and Middle Eastern crude, while WTI is the benchmark crude for North America. The pricing mechanism for Brent dictates the value for roughly two-thirds of the world’s crude oil production.

Historically, global oil supply was determined by OPEC’s production and global demand was led by the US. These factors, paired with a rapid rise in Asian demand, led to a price surge from $25 per barrel in March 2001 to $140 per barrel by June 2008.

However, the past decade has seen technological advancements and deregulation that has increased US shale oil production, leading to a shift in the balance of global supply from OPEC to the US. Prices fell from $112 for Brent and $105 for WTI in June 2014 to under $36 for both by January 2016.

Fluctuations in global crude oil production: US crude oil production sets record high; OPEC extends output cuts

On December 7, 2018, OPEC and non-OPEC countries agreed to cut oil production by 1.2 million barrels per day (bpd)  for a six-month period beginning January 2019. The agreement, in spite of increasing US crude oil inventories, has buoyed oil prices during the start of 2019. By May this year, Brent crude price reached $71.12 per barrel, and settled at $61.67 per barrel on June 6, 2019. Crude oil price volatility increased in May after declining for four consecutive months and stayed at elevated levels into the first week of June.

So far, as a result of the agreement, oil prices have been kept between $65 and $70 per barrel. But the US sanctions on Venezuela and Iran disrupting supply, the US-China trade war and Saudi Arabia’s biggest production cut (it produced 10.2 million bpd in January 2019, down 350,000 bpd from December 2018) have injected volatility into the market.

Also, a weakening demand outlook at the same time as near-term oil supplies disruption has lowered spot prices of crude oil while increasing futures price backwardation (a state when spot prices are higher than prices for futures contracts). However, OPEC and other countries are taking production cuts in an effort to steady the oil market and reduce volatility. Since the start of 2019, crude oil has experienced an almost 30 per cent increase in price, but is yet to recover from the 40 per cent drop in the fourth quarter of 2018.

Natural gas

India is increasingly relying on imported liquefied natural gas (LNG) to meet its natural gas demand. The country imported a total of 27.01 billion cubic metres (bcm) of LNG in 2018-19, up 2.6 per cent from 26.32 bcm during 2017-18. The share of imported LNG was 45 per cent of the overall domestic LNG consumption in 2017-18 as compared to 25 per cent in 2007-08. LNG imports are forecasted to increase from 22 million tonnes (mt) in 2018 to 33 mt by 2021. While domestic gas production is predicted to grow, it is not expected to keep pace with demand.

Presently, most of the gas produced locally is priced at a figure derived from a four-year-old government-set formula that takes the average rates from global trading hubs to determine domestic prices twice a year – in April and October. Recently, NITI Aayog has suggested free-market pricing for natural gas produced from domestic fields to boost output. The removal of price regulation in the gas sector will be done gradually as suggested by the Kelkar Committee. This means that the system of regulated gas pricing for domestic production will continue for at least another three years, but during this period, producers will be given the freedom to sell a portion of the total output under pricing deals (market determined) negotiated with their customers.

Globally, natural gas spot prices have crashed from the high in 2008. Looking at a 10-year perspective, gas prices collapsed 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.

Spot gas prices have shown a downward trend over the past few years. In 2017, Henry Hub spot gas prices witnessed a fluctuating trend, more or less remaining in the $2-$3 per million metric British thermal units (mmBtu) range. In January 2018, the price increased to $3.87 per mmBtu. The Henry Hub natural gas spot price averaged $2.32 per mmBtu in June 2019. The US Energy Information Administration (EIA) expects strong growth in natural gas production in the US to put downward pressure on prices in 2019, and expects Henry Hub natural gas spot prices to average $2.77 per mmBtu in 2019, down 38 cents per mmBtu from 2018. The EIA estimates that US natural gas production reached another record high in May 2019. Combined net injections into storage during April and May 2019 are estimated to be the largest on record for this two-month period at 831 billion cubic feet. This has helped reduce futures prices even though inventories remain lower than the five-year average.

Future price outlook

According to the EIA’s Short-term Energy Outlook, the 2019 Brent crude oil price will average $73 per barrel and will decline to $67 per barrel in 2020. The OECD [Organisation for Economic Co-operation and Development] Economic Outlook as of November 2018 is more bullish, pegging the real price of Brent oil (price adjusted for inflation) at $80 per barrel in 2019.

According to the International Monetary Fund’s Primary Commodity Prices Projections, Brent crude oil price will reach $53 per barrel and WTI $50 per barrel by 2020.

According to the World Bank’s 2019 oil price forecast, crude oil prices are expected to be at an average of $66 per barrel this year and $65 per barrel in 2020. This slightly downward revision of the oil price prediction is due to the lower-than-expected global growth outlook and higher than expected US oil production. Moreover, output cuts in Canada and a steep decline in the North Sea production saw total non-OPEC production in the first quarter of 2019 fall by 740,000 bpd, compared to the fourth quarter of 2018. Apart from this, unplanned declines in output from countries such as Algeria, Angola, Nigeria, Libya, Iran and Venezuela, which together account for a 15 per cent share in global oil production (2017), have added pressure on global oil output. This is owing to factors such as civil unrest, natural declines or sanctions.

As a result, oil prices rebounded from the lows of December 2018 (around $57 per barrel, monthly average) to around $72 per barrel in May 2019. In its latest monthly Short-Term Energy Outlook, the EIA forecasts Brent spot prices will average $70 per barrel in 2019 and $67 per barrel in 2020.

The EIA expects that natural gas prices in 2020 will again average $2.77 per mmBtu. In the short to medium term, crude oil prices will depend on supply-side factors, given the concerns over declining output from major producers. On the other hand, gas prices in the domestic market are linked to natural gas production in the US, Canada, Russia, the European Union and the former Soviet Union countries. On the domestic front, in one of the latest reform initiatives in the oil and gas sector, the government is set to provide pricing and marketing freedom for domestic gas to boost output.

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.