Why an OPEC Deal to Cut Oil Production Matters for Sri Lanka

Yesterday, after weeks of speculation that it may not happen, members of the Organisation of Petroleum Exporting Countries (OPEC) – a producer cartel – agreed to cut supply by around 700,000 barrels per day (bpd). In overnight trading, oil prices rose sharply by 5-6% and hovered at close to US$ 47 a barrel. By this morning the gains had somewhat tempered.

Under the agreement, OPEC oil production is expected to be reduced to a range of 32.5 to 33 million barrels of oil per day from 33.4 million. This is first time in eight years that OPEC has struck a deal to limit crude output since the downturn in 2008. The deal, including details of actual cuts, will likely be formalised at the next OPEC meeting scheduled to be held in November.

Why does this matter for Sri Lanka? The low oil prices seen throughout 2015 and early 2016 (as low as US$ 26 a barrel in February) has substantially helped oil importers like Sri Lanka. Low oil prices have meant low oil import bills, and at a time of declining export revenues, this has been much needed relief on the external balances side. Sri Lanka’s oil import bill was 41% smaller in 2015 than 2014 (US$4.5 Bn in 2014 compared to $2.6Bn in 2015). Of total imports, oil imports fell from 24% in 2014, down to 14% in 2015. Looking at 2016 (only H1 figures are available),

Oil Imports

– H1 2016 – $1.12 Bn

– H1 2015 – $1.47 Bn

– H1 2014 – $2.5 Bn

% of Total Imports

– H1 2016: 13%

– H1 2015: 18%

– H1 2014: 27%

Y-o-Y Changes

– H1 2016 Vs. H1 2015 : -20%

– H1 2016 Vs. H1 2014 : -52%

– H1 2015 Vs. H1 2014 : -40%

Of course it remains to be seen at what price oil stabilises in Q4 2016 and early 2017. It’s unclear as to whether this OPEC cut in production will be enough to drive sustained higher prices, given that a big new producer Iran (after sanctions on it were lifted) has been granted an exemption from the cut, Nigeria and Libya are also exempt, and there is substantial US shale oil and gas inventory built up that may now be even more profitable than before to come on stream. The OPEC cut could be self-defeating if there is a big drilling response from around the world, particularly from the US.

For Sri Lanka, we squandered an opportunity to reform energy pricing in the country. We didn’t take advantage of the breathing space offered by low oil prices in 2015. Against a backdrop of declining export revenue, a steady increase in the oil import bill certainty doesn’t help. The way forward strategy is to a) reform energy pricing so that its more in line with global prices and consumers and firms price that in in their consumption decisions; and b) boost export competitiveness and market access so that export revenues rise in line to support a higher oil import bill. Of course in the medium to longer term, Sri Lanka needs to strive to move towards more non-conventional renewable energy sources.

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