Crude oil prices continued to decline on Monday. Since Wednesday, Brent Crude prices have dropped by about 5.7%.
That has brought a lot of cheer to the financial markets. Stocks have risen. The rupee has strengthened and bond yields have fallen over the past two days.
Why the sigh of relief? On Thursday, news reports said crude oil producers—Saudi Arabia and Russia—are considering increasing output. This comes at a time when Venezuela is suffering from a production breakdown and uncertainty looms large on supplies from Iran. Further, latest data shows rig counts in the US have increased, suggesting higher production in future. These factors are putting downward pressure on crude oil prices.
India being a large crude oil importer benefits from lower oil prices. But are the markets celebrating too soon?
The current decline in prices is merely a short-term breather, says Ritesh Jain, chief investment officer at BNP Paribas Asset Management India Pvt. Ltd. For the time being, the upward trend of oil prices is exhausted primarily owing to news flow, he adds.
Fundamentally, little has changed. Analysts from Goldman Sachs Group Inc. wrote in a report last week that Saudi Arabia and Russia’s announcement lifts some of the uncertainty on whether and when the Organization of the Petroleum Exporting Countries and Russia would increase production. The global investment banking firm does not view this as a material change to its bullish oil outlook.
According to Goldman Sachs, this response is occurring because of a tight oil market. Secondly, its magnitude is still uncertain but, even at one million barrels a day (mb/d), such an increase would simply offset the involuntary production declines with the group (of oil producers) still committed to restraining output. Thirdly, even at one one mb/d, its gradual implementation would leave the market in deficit through the September quarter, it added.
It must be noted here that production problems in Venezuela continue, which means incremental supply may not be very meaningful to balance oil markets.
According to Jain of BNP Paribas, overall lack of capex (capital expenditure) investments in the oil industry will weigh on output. “Sure, US shale oil production is increasing; however, lack of infrastructure will prevent more oil from hitting the market," he added. Add to that, demand for oil is robust.
In short, while lower crude oil prices are welcome, it may be premature to celebrate the current cooling off.