The unavoidable consequences of an oil output cut

The unavoidable consequences of an oil output cut

The Organization of the Petroleum Exporting Countries and its allies have decided to reduce production by 2 million barrels per day (bpd) to support prices when the world is already reeling under supply constraints.

Why did OPEC+ go for a large output cut?

Oil prices, which surged to multi-year high levels earlier this year with the outbreak of the Russia-Ukraine war, started to ease in June amid concerns of a global recession and interest rate hikes. From the highs of more than $130 per barrel in March, oil prices fell below $90 in September. Major oil producers in West Asia have said that current oil prices do not reflect market fundamentals. Demand is expected to falter because of concerns of a recession, which would pull prices down. The output cut is expected to bring huge returns for West Asian countries with several European countries turning towards them. 

What would be the impact of the cut?

The immediate impact of the decision was seen on Wednesday when crude oil prices jumped 1.5% post the announcement of the cut. Prices eased on Thursday, but supply concerns are likely to persist as the production cut accounts for 2% of global crude oil supplies and also because several countries such as the US and those in Europe are shying away from Russian oil. According to data from US Energy Information Administration, OPEC members produce around 40% of the world’s crude oil. Analysts are of the view that the production cut would take Brent prices above $100 per barrel. 

How will the reduction in output impact India?

India is likely to be severely impacted by the move as around 85% of its energy requirement is imported. OPEC members, Iraq, Saudi Arabia, and the UAE are major suppliers of oil to India. India also increased supplies from Russia, a member of OPEC+. Thus, the production cut and consequent rise in crude oil prices will increase India’s import bills. 

Will it affect retail fuel prices in India?

Fuel prices in India are technically derived on dynamic pricing and takes into account global oil prices. But, prices have largely been unchanged since May 2022. Even when oil prices fell below $90 per barrel, oil marketing companies (OMCs) did not cut prices. However, even if oil prices rise, analysts feel retail fuel prices will not be raised immediately as the country is already reeling under high inflation, way above the Reserve Bank of India’s tolerance band, and petrol and diesel prices are politically sensitive issues. 

What can India do to meet requirements?

India aims to diversify oil import sources to reduce dependence on a few countries. Indian Oil Corp recently inked long-term supply deals with Brazil’s Petrobras and Colombia’s Ecopetrol. India also aims to source oil from Guyana, Canada, and Gabon. Earlier this year, when the US and the EU imposed sanctions on Russian oil, India defied diplomatic pressures and bought cheaper oil from Russia. However, diversification would take time and India would remain dependent on traditional sources in the near term.