Price of oil had remained
in the USD 100-120 (United
States Dollar) range for the last few years. In this period a new source of oil has been discovered. Large amounts were known to exist in semi-liquid form trapped in the sands in the bowels of the earth. This is known as shale oil. The cost of extracting this oil was very high till recently. Recent advances in technology of "fracking" has made the cost low though this is still much higher than extracting crude oil that is found in viscous liquid form. Oil producing countries like Saudi Arabia, Iran and Russia are almost wholly extracting crude oil.
The cost of extracting shale oil is about USD 60 per barrel against only USD 20 or even less for crude oil. It had become economically viable to extract shale oil with oil prices remaining USD 100 and above most of the last decade. The increase in supply of oil from shale oil has led to a steep decline in the global price of oil. The availability of oil in the world market has increased due to the increased production of shale oil.
The demand for oil is declining at the same time. Growth in China, Japan and Europe is stagnant. The increase in supply along with decrease in demand has led to the present crash in the global oil price from USD 100 to USD 60 per barrel. The cost of extracting shale oil and the price of oil in the market are nearly equal. Extraction of shale oil is just economic at the present but it will become uneconomic if the price declines any further. Members of the Organization of the Petroleum Exporting Countries (OPEC) produce about 40 percent of global oil. Saudi Arabia is the leader of OPEC. Saudi Arabia does not want the US shale production to stabilize. The cost of extracting fossil oil is about USD 12 ber barrel for Saudi Arabia against USD 60 for shale oil. Previously OPEC has cut production whenever oil prices have declined so that the supply had been reduced and prices had stabilized. But this time OPEC has refused to cut production. OPEC is willing to live with falling prices so that US shale oil production comes to a halt and the dominance of OPEC on world oil markets is retained.
Another reason for Saudi Arabia to continue pumping oil is that it is locked in a bitter war of nerves with Iran for dominance in the Arab World. The Saudi strategy is to destabilize the economy of Iran by lowering the price of oil. Unlike Saudi Arabia, Iran does not have huge foreign exchange reserves to withstand a decline in oil price for a long time. Saudi Arabia is no friend of Russia either since the latter has supported Iran. Both these countries are heavily dependent on oil exports. Saudi Arabia wants to kill these economies through low price of oil. The Russian rouble, for example, has declined from 53 to 75 roubles-to-a-dollar in the last few months though it has recently stabilized at about (65 rouble-to-a-dollar. Saudis are targeting US shale oil, Iran and Russia—all with the single bullet of cheap oil.
But these are short term tactics. Ultimately the Saudis would like the price of oil to remain high because that is how they make most of their money. Consequently, the present decline is anything but temporary. The price will bounce back up as soon as the Saudi strategy against shale and Iran plays itself out.
India is helping Iran and Russia in facing the Saudi pressure majorly. Manmohan Singh had wilted against US pressure and reduced oil imports from Iran. Modi Government has reversed that policy and allowed imports of oil from Iran against rupee payment. A similar arrangement is on the anvil with Russia. The recent visit of Russian President Putin saw an agreement being signed on increasing bilateral trade between Russia and India in rupees. An agreement was also made to speed up the laying of a pipeline from Russia to India for the shipment of oil. These moves are enabling Iran and Russia to face the US-Saudi pressures. No wonder, the US has criticized these moves. India has to decide whether it wants to buy expensive oil from Saudi Arabia in dollars or cheap oil from Iran and Russia in rupees.
The Finance Minister has a choice to make. He can pass on the benefits of cheap oil to the consumers or he can impose higher taxes and collect more revenue from this source.
Vol. 47, No. 36, Mar 15 - 21, 2015