The price of a barrel of crude oil is down to $72. After peaking at $110 at the height of the West Asia conflict, it is back to where it started. This is good news for the Indian economy. It is good news for all countries that depend on oil imports.
A few weeks ago, crude oil inventories were dropping at an alarming rate. Had it continued, oil prices would have ended up at $150. Instead, with the signing of the US-Iran MOU, oil prices have dropped sharply.
The US and Iran are major oil producers and exporters. At first glance, it may appear that high oil prices benefit these countries. Especially the US, as its own oil flows were uninterrupted. In fact, the US exported record amounts of oil in April this year, owing to disrupted supplies from the Gulf.
Why then, did the US want oil prices to come down? It is not for the benevolence toward oil importing nations. In the short term, high oil prices are good for oil exporters. Their revenues go up. But in the long term, it is the opposite. In the long term, high oil prices encourage oil importers to find alternatives.
Substitution away from Crude Oil
In May, the International Energy Agency (IEA) predicted that sales of electric and hybrid vehicles would grow faster than expected. And this is because of high fuel prices. They claimed that the conflict would spur countries to reduce dependence on oil.
Anish Shah, CEO of Mahindra & Mahindra, recently said that the company may speed up production of electric vehicles in response to higher demand. Electric vehicle sales in India are up 65% in the first quarter of this year, relative to the previous year. This is due in part to rising oil and fuel prices.
It is trends like these that worry oil exporters. If prices stay high for too long, the substitution away from oil becomes entrenched. Oil exporting countries have a strong incentive to ensure that their product is available cheaply and reliably. The West Asia conflict made crude oil expensive and less reliably available.
This means both the US and Iran have a strong incentive to end the war and resume oil supplies. As oil exporters, they stand to lose the most if oil prices are elevated for long periods of time. The US wants low oil prices so that demand for its product is strong.
This mentality is a change from the past. Historically, there was little alternative to crude oil. When oil prices reached record highs in 2008, there was no talk of substitution. Instead, a global economic crisis followed. Today, energy comes from a wider range of sources. It is easier to substitute. For crude oil to remain competitive, its price needs to be low.
Oil Demand in the Future
What does the future hold for crude oil? It depends on who you ask. In recent years, there has been greater divergence in forecasts for oil demand. The IEA has the lowest forecasts, while OPEC has the highest. The US energy information agency (EIA) is in the middle.
The IEA is operating under implicit assumptions that countries will restrict or discourage oil use in the years ahead, for environmental reasons. Since the MOU was signed, they are now predicting a supply glut for the remainder of this year. The IEA predicts the oil demand will peak before 2030.
OPEC forecasts assume that demand for energy will grow, and crude oil will be a part of that growth even as other energy sources grow. For example, the boom in AI has increased demand for energy to power data centers. OPEC predicts significant growth in oil demand from India and African nations as their economies expand at high rates.
The EIA’s predictions are in between. They expect oil demand to keep growing over the next decade, but at lower rates.
It’s a good idea to take both the IEA and OPEC’s forecasts with a grain of salt. There are hidden incentives in both cases, and the true numbers will probably end up in the middle, closer to the EIA’s predictions.
Ultimately, the availability of substitutes for oil is good news for India and other oil importers. For one, it reduces reliance on a single primary source of energy. But more importantly, it keeps oil prices low. India doesn’t need to transition to an economy that uses less oil. It just needs the ability to do so. And this makes oil exporters compete and ensure that their product is easily available.
Disclaimer:
Note: The purpose of this article is to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly encouraged to consult your advisor. This article is for strictly educative purposes only.
Asad Dossani is an assistant professor of finance at Colorado State University. His research covers derivatives, forecasting, monetary policy, currencies, and commodities. He has a PhD in Economics. He has previously worked as a research analyst at Equitymaster, and as a financial analyst at Deutsche Bank.
