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Recently I have seen much hue & cry in the Indian newspapers citing the sky fall of crude oil prices and its effect on the oil producing countries. There are many figures and graphs giving cost of crude oil in various countries and analysis how this situation will affect their economy in the long run. One report suggests that if crude oil price remains below $ 50.00 per barrel then many OPEC countries like Saudi Arabia, Oman and Bahrain will run out of cash in less than five years. What is the basis of such statement? The basis is IMF report allocating some price to the oil which is required by the respective country to generate balance budget for them (no deficit- no surplus). This is termed as break-even oil price for that country. Given below IMF estimated break even oil price of few oil exporting countries- 

 However it will not be correct to predict the future based on this single parameter. To make a systematic step by step analysis- few other important aspects have to be studied in depth.

Cost Vs. Price of crude oil: 

I have seen that many people had committed a mistake in defining the price of crude oil. Before we come to the price, we must know what are the cost elements that are involved in one barrel of crude-

a)   Marginal Cost of Extraction: It varies widely depending upon the factors like- type of oil reserve (conventional or unconventional), geological condition, age of oil field, extraction process/ technology applied, cost of labour etc. This marginal cost covers only daily operation and maintenance cost including consumable material and labour. Sometimes this cost is also referred as “Break even dollar value per barrel”. This is the most critical cost element in terms of economic viability. Data shows that break even dollar cost is the cheapest for Saudi Arabia $7 to 9 followed by Iraq $10- 11 and then other Middle East countries $13- 15 per barrel. Contrary to this, break even dollar cost for US, Canada & UK are $36, $41 and $52.50 per barrel respectively. For enhanced oil recovery method (to produce shell oil etc) this cost may go up to $70.00 per barrel.

 b)   Cost of Finance: There is requirement of huge capital investment in developing an oil field. Now the cost of finance (principal + interest) may be recovered from each barrel estimating the total production during the entire life span of this oil field. This component is very important in countries where APM (Administered Price Mechanism) prevails.  

c)   Government Duty: Oil producing companies have to pay some taxes/duties/levies to the Government of that country where the oil field is located. The duty can be fixed (fixed amount on every barrel sold irrespective of selling price) or variable (some % of duty on the selling price) depending upon the type of agreement the oil producing company had executed with the local/ central Government.

 d)  Profit Margin: Every oil company wants to keep some profit margin for their growth & sustainability. So profit margin added to those three cost elements makes the final price of crude oil. 

From the above it is clear that when oil exporting countries want to reduce with the selling price of crude oil they have only two areas –

• To cut Government duty or in other words revenue earning from oil. Or
•  To reduce the profit margin of the oil producing companies. In other words giving subsidies to the state owned companies to enable them selling at a lower price. 

$30.00/bl Vs. $105.00/bl (Now and Then):

 Almost nothing has changed as far as cost of crude oil production is concerned. If we consider only cost (a) and cost (b), the cost of one barrel of crude is below $20.00 for countries like Saudi Arabia, Iraq and UAE. Therefore they had earned $85.00 per barrel in the old days in the form of Government revenue and profit by state owned oil companies. If we bifurcate these two factors- only revenue earning per barrel by these countries was in the range of $55 to $65 which is an astronomical figure. So one can understand that these countries have deep pockets to sustain the present level of oil price for a long time. Saudi Arabia, which was in the limelight of discussion, has a reserve fund of $700 bn.  

 Now think of oil importing countries like India. At the present level of international oil price, our Government is saving $75.00/bl. Even oil downstream companies/ refineries are also taking the advantage of low crude oil price. The refining margin of most of the Indian companies has improved. RIL had posted a record refining margin of $11.50 per barrel in the last quarter. So it is basically reverse flow of wealth or more precisely equal distribution of wealth from oil or “Oil Communism”. 

What will happen to oil exporting countries?

 As mentioned earlier most of the countries have deep pockets to face this challenge. The economic situation of these countries will depend on so many socio-economic factors and mainly on their response to the present situation. For example take the case of Bahrain- 

As per the latest data, GDP of Bahrain is $33.63 billion registering an annual growth rate of around 3.8%. The per capita GDP is $29,200 with marginal inflation of 2.8%. Bahrain has a strong trade surplus with export figure of $21.4 billion against the import bill of $15.17 billion making its currency valuation second highest in the world. The country has almost zero deficit budget with revenue and expense figures of $8.378 and $8.675 billion. From the above it is evident that both Bahrain Government & its citizen have enough elbow room to implement and withstand tough economic measures to tide over the present crisis.

How long this situation will continue?

Different experts have different opinion on this. However few critical factors hint that this situation may prevail for quite some time from now-

 1.  The major oil exporting country in Europe, Russia has heavy dependency on petroleum revenue. More than 70% of their export income comes from oil. Further, constant devaluation of “Rouble” had made the internal situation worse for their economy. Russia is not in a position to cut down production/ supply to jack up the oil price.

 2.  Huge capital investments had been made by the US companies for producing shale oil. It’s most likely that US Government shall lend support to these investors at least to recover the cost and thus keeping shale oil price low for a reasonable period.

 3. After lifting of sanction- Iran will reappear in the international market with its crude and natural gas. This added supply may pull down the existing price further.

 4.  Saudi Arabia has fear that it may lose its market share permanently if it exits from certain areas by curtailing the production/supply.

 5. One of the largest consumers of energy- China is showing slow down in their economy which has affected all international stock markets and dampen the spirit of global investors.

 Therefore this price situation of crude oil is likely prevail for quite some time and the price finally may settle down in $50- $60 bracket giving some respite to the oil importing countries like India. Our Government should now take the advantage of this “Oil Communism” and pass on the benefits to the citizens by the way of reduction of tax burden and enhanced infrastructural facilities.

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Oil Communism cost of crude oil price vs cost of crude oil