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The very crude oil war

THE NDA government has been lucky for much of its term as far as global oil prices are concerned.

The very crude oil war

Slippery road: A $10 price rise will affect GDP growth by nearly 0.3 percentage points.



Sushma Ramachandran      

THE NDA government has been lucky for much of its term as far as global oil prices are concerned. These crashed from a peak of $140 a barrel to around $40 per barrel within six months of it coming to power. The luck seems to have run out. International prices are currently hovering at nearly $70 per barrel and agencies like Goldman Sachs are projecting it will reach $80 dollars within six months. Finance Minister Arun Jaitley has said in post-Budget interviews that oil prices crossing the $70 mark will be a worry for the next fiscal.

The reason for rising world prices becoming a headache for policy makers is that India imports over 80 per cent of its crude oil requirements. The oil import bill for the current financial year, 2017-18, is expected to reach $81 billion, $10 billion higher than in 2016-17. This is despite the fact that the volume of crude oil imports will be roughly the same, at 213 million tonnes. The trade deficit is also widening as a result of higher oil imports. The net result is that the government is left helplessly monitoring the situation in the international oil markets.

In this arena, the short-term outlook depends a great deal on the global economic and political scenario. The two most important issues will be whether the oil cartel, the Organisation of Petroleum Exporting Countries (OPEC) is able to maintain production cuts laid down a year ago and also whether US shale oil companies will be able to raise their output levels. On the first issue,  there has been surprising unanimity in maintaining these production quotas by OPEC members till now. Saudi Arabia, as the largest exporter, has been the main motivator in this regard. However, there may be some glitches in future as output from Venezuela has crashed owing to political developments there. The role of Russia will also be crucial as it has been cooperating with OPEC for production cuts since January 2017. It is this combination of OPEC and Russia that became the big driver for the hardening of world oil prices in 2017.

As for US shale oil production, it is rising rapidly once again with the aid of improved technology. In addition, US crude inventories are being built up yet again. It must be recalled that it was primarily the entry of shale oil supplies produced through the technique of fracking that led to the softening of world oil prices in 2014. In case shale oil production is ramped up in coming months and inventory buildup continues, there is a distinct possibility that global prices can be contained around the $70 mark, despite pessismistic predictions by financial agencies.

Geopolitical developments will also cast their shadow on world oil markets. The tensions between the US and North Korea will have an impact in case these continue to remain at the high level that has been witnessed over the past year. Similarly, the fate of the conflict in Syria and Iraq will play a role in maintaining the stability of the markets.

As far as India is concerned, the issue of high fuel prices has several ramifications. Firstly, a large oil import bill will be a huge burden on the exchequer.  Raising resources just to meet the country’s essential and critical oil needs is unavoidable, but will make it difficult to meet the fiscal deficit target, even though it has been pegged at a more achievable 3.2 per cent for next year. Besides, it has been estimated that a $10 rise in oil prices will affect GDP growth by nearly 0.3 percentage points. 

Secondly, it will lead to a rise in the subsidy on petroleum products. The subsidy has been pegged at Rs 24,933 crore for 2018-19, marginally higher than the previous year. The bulk of the subsidy, as much as Rs 20,377 crores is on account of LPG and the balance for kerosene. This is mainly due to launch of the Ujjwala free LPG scheme for rural women. Higher world prices will lead to a substantial increase in subsidy.  

Finally, it will hurt consumers as prices of most petroleum products  will rise steeply unless the burden is mitigated in some way. The simplest method is to cut Central and state excise levies on petroleum products. The Budget has marginally cut excise duties but, strangely enough, brought in a road cess so prices will not fall for the general public. In fact, the heavy taxation on products like petrol and diesel and the resulting revenue bonanza is the main reason these have been kept out of the purview of the GST. What really needs to be done is to bring petroleum into the GST net, so that the tax can be capped at 28 per cent. Keeping such a major commodity out of the GST ambit makes it a rather unrealistic system. But states are strenuously resisting this move, given their reliance on the big revenues garnered from these products.

The issue of high oil prices is thus a complex one. On the plus side, imports may not be cheaper than expected owing to rupee appreciation that has been taking place for some time now. This may be bad news for exports, but it makes imports cheaper.

On the minus side, Mr Jaitley has little leeway to act on world prices. But he can and should give relief to consumers by cutting the new road cess and pushing the GST Council to include petroleum under its regime. In the long run, the government thus needs to try and find more oil in onland and offshore areas by making a more attractive oil exploration policy. Even more important is the need to finalise a long-term energy policy by examining all the options available, including natural gas, nuclear power and renewable energy. This should ensure that the country is not largely dependent for essential energy needs on petroleum. If it does not evolve such a policy rapidly, the country will have no option but to rely on the vagaries of world markets for its critical fuel requirements.

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