Fuel Prices May Favour Modi In 2019. Here's Why

Have you noticed how no one is talking about petrol prices any more? Your friends aren't cribbing, there are no Prime Time talk shows about it. That's because prices have dipped in the past one month. In early October, petrol cost about Rs 84 per litre, in Delhi; now, at the end of November, it has dropped to less than Rs 74. And if you take your car to a pump in neighbouring Gurugram or Noida, where taxes are lower, you will save another Rs 1 on each litre.

So petrol prices have dropped by 12-13% in just six weeks, but that's nothing compared to the massive drop in the price of crude oil. Depending on which type of crude you track - Brent, WTI or any other - prices have dropped by 30-35% since the beginning of October. In other words, technically, there is a full-fledged bear market in crude right now. And this has come as a political breather to the BJP right ahead of the crucial assembly polls in Madhya Pradesh, Rajasthan, Chhattisgarh, Telangana and Mizoram.

Prime Minister Narendra Modi at a rally in Rajasthan ahead of polls on December 7

This sharp drop has taken pundits by surprise. Just a few months ago, every indicator, economic and political, was pointing to oil prices rising in the near future. Even in late August, the International Energy Agency was predicting that the last few months of 2018 would see a sharp rise in crude prices. Oil watchers believed that growing demand from China, India and the US would outpace global crude supply. 

Further, President Trump had quarrelled with Tehran, asking oil buyers including India to stop importing crude from Iran. In April, Iran was exporting about 2.5 million barrels of crude per day, but after Trump's sanctions, exports dropped to less than 1 million barrels per day by the first week of October. That's exactly when global crude prices peaked, and experts started talking of oil hitting the $100 mark, unless OPEC were to increase production. 

That's exactly what OPEC did. Rising prices made it more profitable to increase output and Saudi Arabia, OPEC's de-facto leader, decided to increase crude supply. The Saudis, who were already pumping 10.5 million barrels of crude per day by mid-September, increased supply by another 200,000 barrels in October. Other OPEC nations also followed suit, hoping to take advantage of the sudden rise in prices. 

US President Donald Trump has imposed severe economic sanctions against Iran, which limit the ability of other countries to buy Iran's oil

But neither the Saudis nor OPEC are the sole determinants of the way crude prices will move. For the past decade or so, Russia has emerged as the largest producer of oil, producing more than 11 million barrels per day, and it hasn't always moved in tandem with OPEC. The bigger joker-in-the-pack is the US. In August this year, the US overtook Russia to become the largest oil producer in the world. The three top oil producers - the US, Russia & Saudi Arabia - now control nearly 40% of global oil output, and two of them are not part of OPEC.

The US is also unique because much of the oil it produces is Shale Oil which is extracted using a very different method - by heating underground rock formations to extremely high temperatures to release the oil and gas trapped inside. This is a difficult method, technologically more challenging than pumping out oil from underground deposits. It is also more expensive. 

Globally, oil prices slumped more than 6 per cent to the lowest in more than a year last Friday

It costs just about $10 for the Saudis to pump out a barrel of crude. That means crude prices could keep sliding much further before it starts to hurt them. US shale oil, on the other hand, becomes profitable only around $45-50 per barrel. Most shale wells produce 80% of their oil within the first two-three years. So while US oil companies can pump out oil very quickly after each shale find, they have to keep drilling new wells to maintain supply. This also makes shale oil supply extremely price-sensitive. If prices rise, US oil producers increase output very quickly, and when they fall below break-even level, they cut output equally fast. That is why when crude prices rose this summer, US output increased by 4% in just three months, taking it to a record 11.7 million barrels per day in August. The Bakken region of North Dakota alone produced 1.3 million barrels per day in October, which was more than the output of some of the smaller OPEC nations. 

This massive increase in US output, combined with the increased supply from OPEC, meant a sudden glut in the crude market. Trump, who had managed to persuade his Saudi friends to increase oil output to keep prices down, surprised everyone by softening his stand on Iran. In early November, Washington agreed to let several countries including India keep buying oil from Iran. This sent a signal to the bears in the crude market that the bulls were about to go on the back-foot.

Journalist Jamal Khashoggi was killed at the Saudi consulate in Istanbul on October 2

The combination of a massive increase in global output and the easing of geopolitical tensions has resulted in a sudden slide in the oil market. Remember that crude prices are forward-looking: they are based on what traders anticipate future prices are going to look like. In October, OPEC declared that it doesn't think demand will hold in 2019. The bleak demand outlook has emboldened bears: right now, there are more people in the crude futures trade betting on oil prices dropping further than those who believe they will recover. 

OPEC, which had raised output throughout most of this year, is going to meet in early December to decide whether to cut oil production and stabilize prices. The problem for them is that Saudi Arabia is in the global doghouse right now over the murder of dissident journalist Jamal Khashoggi. The Saudi royal family needs to be in Trump's good books. One way to do that is to not push for higher crude prices. That is why the market is betting that oil prices aren't going up any time soon. And that is likely to be music to PM Modi's ears.

(Aunindyo Chakravarty was Senior Managing Editor of NDTV's Hindi and Business news channels. He now anchors Simple Samachar on NDTV India.)

Disclaimer: The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of NDTV and NDTV does not assume any responsibility or liability for the same.