Amid optimism of a sharp rebound in oil prices, along with almost all other commodity prices, during the last quarter of 2016, analysts seem to have drifted away from the fact that there is little or no change in the fundamentals of the commodity.
After the latest meeting in Vienna on November 30, 2016, OPEC members agreed to cut production by 1.2 million barrels per day (bpd) to 32.5-33 million barrels per day of production, down from 33.4 million barrels per day of production in September 2016. Non-OPEC producers will do so by 0.6 million barrels a day.
However, sustainability of oil prices above $55 per barrel is doubtful on account of several factors. First, as there is scepticism that producers would be able to keep their promises to slash output. Second, commodity traders believe the cut by OPEC will be largely offset by a rise in US shale oil production where the rig count has already gone up. They say a surplus will stay in the market and that if there is any up move, it will be for the short term. Third, oil producers cut investment worth $1 trillion in the aftermath of the oil price crash in November 2014 and that will begin to bite into supply in 2017.
More importantly, lower oil prices for an extended period of time could limit access to sources of funding for oil and gas companies. That, in turn, may create cash flow problems for them and hence the commodity sector will continue to remain under stress in the coming year. According to Moody's rating agency, the metals and mining sector in the U.S. is likely to have the highest default rate, followed by the oil and gas sector, in the year to come.
For India, oil and gold top the country's imports list. As oil prices rally, countries that are dependent on import of petroleum products for their energy needs may suffer as import bills could surge. India's oil import bill is expected to be $66 billion at an average price of $48 a barrel as the country is dependent on imports for 80 of its energy requirements. Every one dollar rise in oil prices from $48 per barrel level will cost the Indian exchequer approximately Rs 9,126 crore ($1.36 billion) more a year.
At the same time, if energy prices keep rallying larger than expected, they could inflate costs of agricultural output and thus food prices. This may not be a comfortable situation for the RBI and the government already battling the consequences of the demonetisation.
Hence, as several emerging markets face daunting policy challenges while adjusting to sluggish commodity prices, changing world demographics, high stock levels globally and the regime change in the US will act as a sufficient ingredient for volatile or direction-less oil prices.