Crude Uprising

October 19, 2018 I Industry Research

Overview
Contact:
Uncertainty appears to have returned to oil markets as a cluster of
Madan Sabnavis factors is influencing the oil prices since the beginning of the calendar
Chief Economist
madan.sabnavis@careratings.com year.
91-022- 6754 3489
Given the current turmoil in the global economy; the looming tariff
Urvisha H Jagasheth
wars between the US and China, the unilateral sanctions imposed by
Research Analyst the US government on Iran and supply outages from Libya and
urvisha.jagasheth@careratings.com Venezuela oil prices have risen sharply by 40.3% y-o-y (January-
91-22-6754 3492
October period). Currently the oil prices are being driven by
“sentiment” of around losing a major oil supplier which is driving the
price higher.

As per the latest oil monthly review release by IEA, currently both global
oil demand and supply are now close to 100 mbpd levels. Production
has surged, led by the US shale revolution, and supported by big
Mradul Mishra (Media Contact) increases in Brazil. It is expected in future that a lot of potential supply
mradul.mishra@careratings.com could come to the market from places like Iran, Iraq, Libya, Nigeria and
+91-22-6754 3515
Venezuela, if their various challenges can be overcome. There is no peak
in sight for demand either. The drivers of demand remain very powerful,
especially from the petrochemicals industry.

In this report we will be highlighting the key oil statistical numbers, the
factors influencing prices and the oil market scenario in the Indian
economy.

Global Crude Oil Market

US sanctions on Iran

The US had been imposing economic sanctions on Iran to restrain its

Disclaimer: This report is prepared by CARE Ratings Ltd.
CARE Ratings has taken utmost care to ensure accuracy and
objectivity while developing this report based on
information available in public domain. However, neither
the accuracy nor completeness of information contained in
this report is guaranteed. CARE Ratings is not responsible
for any errors or omissions in analysis/inferences/views or
for results obtained from the use of information contained
in this report and especially states that CARE Ratings has no
financial liability whatsoever to the user of this report
nuclear activities until 2015 when the former agreed to a nuclear deal
in collaboration with UK, France, China, Russia, Germany and EU. The
nuclear deal, also known as the Joint Comprehensive Plan of Action
(JCPOA), was an international agreement that exchanges Iran's nuclear
ambitions for international sanctions relief.
US exiting the deal
On May 8th 2018, the US announced that it would withdraw from the
Joint Comprehensive Plan of Action with Iran and re-impose American
sanctions, including that on petroleum related transactions involving
Iran. According to the US, the deal was ill-negotiated and lacked
adequate mechanisms to prevent and detect non-compliance.
 Industry Research I OIL & GAS INDUSTRY

The threat by the US

The US has now asked all countries to progressively reduce and eventually terminate any kind of currency flow to Iran and
completely halt all oil imports from Iran by 4th November 2018 and threatened secondary sanction on countries and
companies which continue to trade with Iran post the time frame.

Some sanctions took effect from August 6th 2018, while those affecting the oil and banking sectors will start from
November 4th 2018. The sanctions will block banking channels, making payment for oil bought from Iran difficult as well as
stop re-insurance cover to refineries processing such oil.

Iran exports crude oil to China, India, European Union, South Korea, Turkey and Japan.

Crude oil production, reserves and spare capacity

Table: Top 10 countries with the highest proven crude oil reserves by the end of 2017 (Proven Reserves in terms of
Billion Barrels)

Sr. No Country Proven Reserves (R/P) Ratio

1. Venezuela 303.2 393.6
2. Saudi Arabia 266.2 61
3. Canada 168.9 95.8
4. Iran 157 86.5
5. Iraq 148.8 90.2
6. Russia 106.2 25.8
7. Kuwait 101.5 91.9
8. UAE 97.8 68.1
9. USA 50 10.5
10. Libya 48.4 153.3

Total World 1696.6 50.2

OPEC 1218.8 84.7
Source: BP Statistical review of World Energy 2018

Note: Reserves-to-production (R/P) ratio - If the reserves remaining at the end of any year are divided by the production in that year, the result is the
length of time that those remaining reserves would last if production were to continue at that rate. Reserves include gas condensate and natural gas
liquids (NGLs) as well as crude oil.

Venezuela has the largest proven reserves in the world but due to lack of investments in the upstream segment, payment
delays to suppliers and the initial sanctions imposed by the US on the economy; Venezuela’s oil industry has been declining
leading to a fall in production. The production fall has hit oil exports – which is the only major source of foreign currency
leading the economy to a major debt ridden crisis.

Saudi Arabia has the world’s largest spare capacity in the world but in order to make up for the sudden drop in supplies due
to more than expected production cuts from Libya and Venezuela, the kingdom’s spare oil production capacity runs the risk
of being stretched to the limit as the US sanctions against Iran will be further tighten the market.

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Table: Top 10 Oil Production during 2017 (mbpd*)

Sr. No 2017 % share of total oil supply

1. USA 13.3 14%
2. Russia 11.4 12%
3. Saudi Arabia 10.0 10%
4. Canada 4.8 5%
5. Iraq 4.5 5%
6. China 3.9 4%
7. Iran 3.8 4%
8. UAE 2.9 3%
9. Brazil 2.7 3%
10. Kuwait 2.7 3%

OPEC # 39.52 41%

World 97.48
Source: IEA

Note: #OPEC countries include Saudi Arabia, Iran, Iraq, UAE, Kuwait, Qatar, Angola, Nigeria, Libya, Algeria, Congo, Gabon, Equatorial, Guinea, Ecuador
and Venezuela; *mbpd- million barrels per day

The US has emerged as the world leader in the crude oil production by pumping in almost 13.3 million barrels a day
overtaking Russia and Saudi Arabia during CY17. In the current calendar year US is still the leading producer of crude oil. As
per IEA data, US oil production during August was around 15.2 mbpd followed by Russia and Saudi Arabia at 11.6 mbpd and
10.4 mbpd respectively.

What has caused Oil prices to rally?

Chart: Price trend (Daily) of Brent Oil since the start of the year (USD/bbl) and Major landmark events which caused
movements in the prices.

Brent touched the US withdrew from the Supply outages in

$70 mark; Supply JCPOA deal and imposed Libya and Canada
cuts by OPEC and Increase in US sanctions on Iran
its allies, closure of production
the fortis pipeline. weighted down
the oil prices

Onset of Hurricane Florence;

Concerns of tightening Tensions betwen US and Saudi
of the oil markets with on the case of the missing
the US sanctions on Iran Saudi Jounalist
1/2/2018

5/8/2018

6/5/2018

7/3/2018
1/16/2018

1/30/2018

2/13/2018

2/27/2018

3/13/2018

3/27/2018

4/10/2018

4/24/2018

5/22/2018

6/19/2018

7/17/2018

7/31/2018

8/14/2018

8/28/2018

9/11/2018

9/25/2018

10/9/2018

Source: Bloomberg, CARE Ratings

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India Crude Oil Scenario

India is the third largest oil consuming nation followed by the US and China. Crude oil is mainly sourced by the refineries
for the manufacturing of LPG, naphtha, MS-III, MS- IV, MS others, ATF, SKO, HSD-III, HSD- IV, HSD others, LDO, Lubes, FO,
LSHS, Bitumen and RPC/Petcoke.

*MS: Motor Spirit, LPG: Liquefied Petroleum Gas, ATF: Air Turbine Fuel SKO: Superior Kerosene Oil HSD: High Speed Diesel, LDO: Light
Diesel Oil, FO: Furnace Oil, LSHS: Low Sulphur Heavy Stock, RPC: Raw Pet Coke.

Table: India crude oil consumption and imports (in Million Barrels)

Import Consumption Import Consumption

For the year Per Day
2015-16 1,487 1,707 4.1 4.7
2016-17 1,568 1,799 4.3 4.9
2017-18 1,616 1,847 4.4 5.1
2018-19 (April-Aug) 696 790 4.5 5.2
Source: PPAC, CARE Ratings

*PPAC provides data in terms of thousand tonnes. We convert the data into barrels for a better understanding as worldwide crude oil is
measured in terms of barrels.

Table: India’s main oil importers (in Million Barrels)

2015-16 2016-17 2017-18 2018-19 (April-Aug)

Saudi Arabia 290 288 265 115
Iran 100 199 166 98
Iraq 262 277 335 139
Venezuela 167 157 134 56
UAE 109 142 105 43
Nigeria 168 130 133 43
Kuwait 82 67 94 30
USA 0 0 11 19
Source: Ministry of Commerce, CARE Ratings

Note: Ministry of Commerce provides data in terms of thousand tonnes. We convert the data into barrels for a better understanding as
worldwide crude oil is measured in terms of barrels.

Crude import volumes have been steadily rising in India, in sync with India’s total crude oil consumption. India imports
almost 87% of its total crude requirements. Iran is the third largest supplier of crude oil to India, after Iraq and Saudi.
Currently, India imports around 10% of its total crude imports from Iran. For Iran, India is the second-biggest buyer of crude
after China.

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US Shale Oil

Traditionally all the countries were dependant on the middle-east to fulfil their growing energy needs, including the US, but
all this changed with the emergence of the “shale revolution”. The shale revolution is referred to as the production of oil
and gas using the combination of hydraulic fracturing and horizontal drilling that has enabled the US to significantly
increase its production of oil and natural gas, particularly from tight oil formations. The existence of these resources has
been known for a long time, but the production was uneconomical until recently. Drillers have also gotten more efficient,
extracting more oil from wells for less money and this new production capacity has reduced the US dependence on oil
imports from overseas and in turned US resumed oil exports which had been halted in the 1970’s.

Note: US had banned crude oil exports 1975 onwards as a retaliatory measure to the OPEC oil embargo that banned oil sales to the US
and also because the oil production was diminishing which not was in line with the growing energy needs. As the crude oil production
surged the dynamics began to change and from 2016 onwards the export ban was lifted and the US resumed oil exports.

According to EIA it was estimated that in the US during CY17, about 4.7 million barrels per day of crude oil was produced
directly from tight oil resources which is equal to about 35% of total crude oil production in the country and in the future
shale gas and associated gas from tight oil will contribute to 2/3rd of total US natural gas production by 2040.

As per industry estimates US tight oil production can have a breakeven price ranging between USD 30-USD 60 per barrel as
producers have a different breakeven price depending on the basin they are operate in.

Chart: Production Cost Breakdown

Production
Cost

Capital Operating
Expenses Expenses
(66%) (34%)

Lease Gathering,
Completion
Drilling (31%) Facilities (6%) Operating Processing and
(63%)
Costs (6%) Transport (6%)

Source: UNCTAD

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Concluding Remarks

India’s stance

India usually follows only the sanctions levied by the UN, and as of now two state-owned oil refiners have booked import of
1.25 million tonne (9.2 million barrels) of crude oil from Iran in November. As per industry sources, India will go ahead with
its purchase commitment for December as well.

Given the current economic situation in the country the Indian government has also appealed West Asian oil ministers to
reconsider their oil sales in rupee terms, given the issues related to the widening of the fiscal deficit and current account
deficit. As of now OPEC and its allies have assured the Indian government to fill in the gap of the output which will be lost
once the Iran sanctions will draw near.

India imports 85% of its crude oil requirements and it is probable that US government might grant a time-bound concession
to India to import crude from Iran till we are able to source other buyers. Halting of sourcing Iranian crude could mean an
increase in the import bill for India, given the discounts offered by Iran and allowing of payments in rupee. The imposition of
sanctions on Iran will also increase the logistics costs.

What happens in November once the sanctions are implemented?

Reduction of Iranian barrels from international markets would bring in some supply void. It will be interesting to observe till
what level the US, OPEC and its allies will be able to bridge the gap. Iran was producing 3.8 mbpd in CY17 which is 4% of the
world crude oil supply.

Given the spare capacity with Saudi and Russia and eventual removal of bottlenecks for the US shale production, we see the
void to be filled up leading to an eventual stabilisation of crude prices in the long term.

In the short term once the sanctions have come into play, price of Brent could once again cross USD 85 given the sentiment
of losing a major oil producer, the rising tensions between US and Saudi on the impeding resolution of the missing Saudi
journalist, onset of the winter months and the supply outages in the Libya and Venezuela which are still continuing could
keep the prices of oil elevated for a while unless the US is able to raise its production from its Permian and Eagle Ford basin.
(Permian and Eagle Ford basin have the lowest break-even price). Therefore the current respite which has been witnessed
with the price falling below the $ 80 mark (mainly due to higher US stocks) will have to be watched carefully in the coming
days.

OPEC and its allies may not immediately increase supply in the short run on fears of facing another supply glut in the oil
economy.

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