Why oil prices have declined and what are the potential implications? | Explained-OxBig News Network

The story so far: Reversing course after being on an upward trajectory for about a week, oil prices slipped as much as 9% late Monday with emerging confidence about no disruption to oil supply globally and a de-escalation of tensions in the Middle East in sight. At about 7:20 p.m. GMT, the benchmark Brent crude futures were 5.6% lower than the previous day at $67.44 for a barrel.  

What exactly contributed to the downward revision in oil prices?  

At the centre of the latest shift is Iran opting to retaliate to the attacks and involvement of the United States in the Iran-Israel face-off by attacking U.S military bases in Qatar and not disrupting the Strait of Hormuz, an important oil chokepoint. Explaining the resulting decline in prices to news agency Reuters, John Kilduff, partner at the U.S.-based investment advisory firm Again Capital stated that oil flows for now were not the primary target and are not likely to be impacted. “I think it is going to be military retaliation on U.S. bases and/or trying to hit more of the Israeli civilian targets,” he stated. 

Tehran’s repeated assertions about closing the Strait of Hormuz amidst their conflict with Israel was the primary contributor to oil’s upward trajectory last week. For perspective, the Paris-based International Energy Association (IEA) notes that the strait serves as the exit route from the Gulf for approximately one-fourth of the global oil supply, including from major oil-producing nations Saudi Arabia and United Arab Emirates alongside Kuwait, Qatar, Iraq and Iran. In fact, intelligence and analytics provider Kpler further illustrated in a social media post Tuesday that in addition to risks of conflict escalation, subsequent navigation system interference and disruption have further reduced maritime traffic in the Gulf since the conflict began on June 13.

Other than Tehran choosing not to disrupt the important oil route, the situation further stabilised after U.S. President Donald Trump announced a “fully agreed” ceasefire between the two West Asian nations in a social media post Tuesday. This furthered the prospect of complete de-escalation of tensions in the region. 

As a result, the benchmark slipped more than 9% in post-trade hours. 

However, Tuesday also saw the two West Asian nations engage in actions which signify a violation of the ceasefire. Reuters reported that Israeli Defence Minister Israel Katz ordered their military to mount new strikes on targets in Tehran in response to the latter’s “blatant violation” of the ceasefire. President Trump, in a social media post, sought that Israel refrain from dropping bombs. “If you do so, it is a major violation,” his post read.

What do declining oil prices mean for oil manufacturing companies?  

Broadly, declining oil prices do not favour upstream companies, or companies that are into oil extraction and production. But they have the reverse effect on downstream companies, or companies that are into refining and purifying oil and related products before marketing it to the final user. This is primarily because the cost of extraction remains constant irrespective of the oil price. Thus, a lower price would imply lowering of profitability proportionate to their costs. Conversely, for downstream companies, a lowering of oil price would translate to them being able to procure oil at lower prices from the upstream companies. For perspective, Kotak Institutional Equities in a research note published June 20 when oil prices were on the upward trajectory, mentioned that, with the scrapping of windfall taxes and the low likelihood of their return, higher oil prices were positive for upstream companies. 

However, with the paradigm now reversed, upstream companies find themselves in shaky territory. Scrips of exploration and production companies such as Oil India Limited and ONGC declined 5.6% and 2.94% respectively on Tuesday compared to their previous close. Meanwhile, scrips of downstream companies such as Bharat Petroleum, Hindustan Petroleum and Indian Oil closed 1.92%, 3.24% and 2.04% higher respectively.  

What does the declining Brent crude mean for domestic oil prices?  

Gaurav Moda, Partner and Leader observing the energy sector for EY-Parthenon India points to crude prices being below $65/barrel before the geopolitical buildup. He observes that the landscape then held potential for lower market fuel prices in the near future, although this may have required “cost optimisation initiatives” among upstream majors. The EY partner adds, “While we are currently far from such prices, potential implications may be similar.”  

He argues that India has over the last few years consciously diversified its crude sources widely, plus built up sizeable inventories, and therefore is equipped for global volatilities in the near term. In fact, Union Petroleum Minister Hardeep Singh Puri on June 22, highlighted this source diversification over the past few years and noted that “a large volume” of Indian oil imports do not utilise the Strait of Hormuz. He added that Indian OMCs had supplies of several weeks as they continued to receive further supplies from several routes. “We will take all necessary steps to ensure stability of supplies of fuel to our citizens,” his post read.