On Sunday 12th April 2020, a group of major oil-producing countries, including members of the Organization of Petroleum Exporting Countries (OPEC) as well as Russia, Mexico and other non-OPEC oil producers, known as ‘OPEC Plus’, agreed to cut oil production by 9.7 million barrels per day (bpd) which is about 10 per cent of global oil supply. The agreement is valid till April 2022 and output cuts would begin on 1st May 2020. Moreover, in response to the unprecedented situation created by COVID-19, oil producers who are not part of ‘OPEC Plus’ group like Brazil, Canada, Norway and the United States (US) are also expected to cut their oil production and therefore, the total cut in global oil production is likely to be about 20 million bpd or almost 20 per cent of the total global oil output. The move to cut production is supported by the US, Russia and Saudi Arabia, three largest oil producers, and is expected to stabilise the global oil market as well as contribute to ensuring the resilience of energy systems across the world.
Since February 2020, owing to the outbreak of COVID-19, global oil prices have been falling and the price war over global oil market share between Saudi Arabia and Russia in March further pushed prices spiralling downwards. As a result, in March, oil prices reached an18-year low, falling as low as $ 22 per barrel. The situation had become so grim that on 16th March, two key pillars of global energy governance, OPEC and International Energy Agency (IEA), an oil-consumer countries’ organisation based in Paris, took an unusual step and issued a joint statement. The statement described the current crisis as ‘a grave and unprecedented global health crisis with potentially far-reaching economic and social consequences’ and noted that ‘if current market conditions continue’; the income of developing countries who are dependent on energy exports ‘will fall by 50% to 85% in 2020’. The statement also warned that it will have ‘major social and economic consequences, notably for public sector spending in vital areas such as healthcare and education’.
Owing to the 12th April agreement, it is expected that output cuts would be enough to respond to the falling global oil demand. However, analysts at Goldman Sachs believe that agreed-upon production cuts would not be sufficient. As countries across the world are imposing lockdowns, and border restrictions, domestic as well as international travel has come to a halt. Therefore, fuel demand for land and air transportation has dramatically fallen. It is estimated that oil demand has plunged by as much as 30 million bpd which is about one-third of the global oil production. Moreover, the capacity to store oil in storage facilities, large oil tankers and in strategic petroleum reserves of major countries is limited. Therefore, it would be interesting to watch how the oil market responds as the production cuts come into effect.
Impact of Falling Oil Prices
Falling oil prices affect oil-producing countries negatively and oil consumers positively. Many oil producers depend on oil exports to a very large extent as their primary means of earning foreign exchange and much-needed government revenues. Oil forms a major chunk of such countries’ overall exports. For example, oil contributes to more than 95 per cent of Nigeria’s total exports and 58 per cent government revenues. For Angola, the share of oil in total exports stands at 95 per cent and in fiscal revenue at 52 per cent. Therefore, any plunge in oil prices adversely affects such countries’ prospects of economic development. Furthermore, such excessive dependence exposes these countries’ economies to the fluctuations in global oil prices.
However, the negative impact of falling oil prices on oil-producing countries is not uniformly felt. Oil producers could be divided into two broad groups: rich and poor. For rich countries like Saudi Arabia, United Arab Emirates (UAE) and the US, the impact of falling oil prices would not be as catastrophic as it would be for countries like Nigeria, Angola and Iran. Rich oil producers would be able to withstand the crisis, as they have in the past, and come out with relatively less harmed. However, for poorer oil producers, whose dependence on, and vulnerability to, global oil prices are much higher than rich countries; the effect of fall in oil prices and consequently plummeting exports and revenues would prove altogether disastrous.
In the current scenario, COVID-19 has already pushed major economies to a standstill and therefore, global economic growth would be adversely affected. In fact, International Monetary Fund (IMF) has estimated that the world economy is likely to shrink by almost 3 per cent in 2020. Moreover, due to the national lockdowns and severe restrictions on movement, oil demand from major consumers like India is falling continuously. China’s oil demand had also fallen significantly in February and March. It would severely affect the prospects of oil-exporting economies, especially those in the developing world. Plunge in oil exports, due to falling demand and OPEC Plus cuts, would further constrict government revenues for many oil producers. Therefore, it would be difficult for such countries to manage their finances, implement developmental programmes and tide over the crises smoothly. They are also likely to struggle in their fight against COVID-19.
Many of these countries were already hard-hit due to the fluctuation in oil prices since 2014. In fact, Africa’s largest oil producer, Nigeria, had not fully recovered from the drastic fall in oil prices during 2014-2016. This year, the Nigerian government had prepared its budget keeping $ 57 per barrel as a base price for oil and expected to produce 2.1 million bpd. However, on account of COVID-19, it has already been forced to revise these estimates. It will be required to adjust finances accordingly. The governments across the world will be faced with a similar challenge. They are likely to restrict expenditures on social sectors such as on education and health. Therefore, it is clear that due to COVID-19 induced global economic and oil crisis, oil-producing countries would be forced to devise innovative ways to tackle the looming crisis.
India and Falling Oil Prices
For an oil importing country like India, falling oil prices should ideally come as good news. In 2019, India imported almost 84 per cent of its total oil requirements and spent $ 112 billion for it. Therefore, falling global oil prices presents India with an opportunity to reduce its spending on oil imports and save valuable foreign exchange. A fall in oil price by a dollar helps India to save approximately $ 1.5 billion. Therefore, when oil prices plunged in March, it was expected that the Indian economy would be a major beneficiary of it. Sectors that depend on oil as a critical input such as petrochemicals, power generation and transport were expected to do well. However, owing to the severity of COVID-19 crisis and the consequent measures such as 40-day strict lockdown have made it difficult for India to make the best use of this opportunity.
Falling oil prices and its impact on the Persian Gulf region has serious implications for India. There are 9 million Indian expatriate workers based in the Gulf countries and these workers send about $ 40 billion back home as remittances. Indian states like Kerala are a major beneficiary of these remittances. However, falling oil prices are likely to perniciously affect these expatriates based in the Gulf region and as a result, economy of Kerala is also likely to suffer. The looming crisis in the region’s economies is likely to lead to greater efforts at localisation of labour force and consequently, lowered or delayed salaries, stopping of further recruitment and in many cases, job losses. Many of these workers are staying in high density population zones and therefore, are at the risk of catching COVID-19. Therefore, there is a distinct possibility that falling oil prices and expatriates’ vulnerability to the spread of pandemic may result in large-scale return of workers once the air spaces are reopened. Indian policymakers would then be confronted with the challenge of treating COVID-19 infected patients and rehabilitation of returning workers.
Meanwhile, if oil producers are agreeing to cut production and boost oil prices, India would also be required to take steps to support its oil requirements. It was reported that India is going to fill its strategic petroleum reserves. Lower oil prices would also make it possible for India to expand its strategic petroleum storage facilities and enhance its total oil stocks from 9.5 days to 22 days. Moreover, in the context of the US’ decision to support ‘OPEC Plus’ arrangement, India may explore opportunities to purchase oil from partners like Iran. Last year, India had stopped oil purchases from Iran in the context of US sanctions on Iran. However, changing energy market calls for a rethinking about such a decision.
As the world struggles to fight COVID-19, the oil market is headed for further instability. There are predictions that this crisis is likely to permanently change the oil industry. Whether it happens or not, lower oil prices have emerged as a reality and hence, developing countries like India would do well to make the best use of it.
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