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What’s the deal with crude oil?

  With global crude prices touching record highs in the last two years, India is bracing for an impact on its sectors and therefore the economy’s growth. In this article, we explore the reasons for this increase.  

Dr Suresh Srinivasan

Global crude oil prices have recorded its highest levels in the last 48 months; it breached the sensitive US$80 a barrel mark recently. Although the price has been inching upwards over the last year or so, the bulk of the increase came in the last few months. This is a major concern for the global economy, more so for a country like India, which imports close to 75% of its crude oil requirements.
Over the last 4 years, the current NDA government has been lucky, since oil price has remained quite stable; this has greatly helped the government in keeping the budgetary deficits low. But as we approach the 2019 election year and with the oil price inching up, this may be a major concern for the government, as the increase in petrol and diesel price can be an extremely sensitive issue for the voting public.

The situation
Generally, crude price increases occur on the back of geopolitical uncertainties or supply side constraints, or a combination of the two; the current increase is a combination. Developments with respect to Iran, OPEC and Russia not increasing production, and political unrest and uncertainties in Venezuela leading to supply shortage are a few reasons.
The perception — and anticipation — that the global economy will grow at a much higher pace over earlier estimates is also a reason, as countries attempt to increase their stock pile of crude; this boosts demand on the back of supply side constraints. In fact, global oil consumption has expanded much faster than anticipated. A catch up game is also in force. With low crude price prevailing over the last few years, oil majors have not been investing in capital equipment that increases production, but will now have to cumulatively invest to meet additional demand, and it will take a while for such capital investment cycle to stabilise. All these forces jointly operate to push up global crude price.

On the geopolitical side, developments with respect to Iran have intensified global uncertainty. Last month, the US pulled out of the Joint Comprehensive Plan of Action (JCPOA), commonly called the Iran Nuclear Deal, which was signed between Iran and the UN Security Council comprising China, France, Russia, UK, US and Germany in 2015. The deal provided certain checks and balances, whereby Iran agreed to cut down its destructive nuclear ambitions to the satisfaction of the international community, which the US believed was not working anymore. The US’s controversial pulling out of the agreement and warning to Iran that the strongest ever sanctions are likely to follow, has triggered a series of uncertainties, resulting in the eventual increase in crude oil price.

On the supply side, OPEC and Russia have been reducing outputs for over 15 months, but have not increased the same in light of such increase over the past 3 months. Venezuela has higher reserves than even Iraq, Iran, Saudi Arabia and Qatar, and its oil reserve life is estimated to be over 600 years. However, the country has been challenged by the ‘oil resource curse’, whereby the rulers are blamed for nepotism and corruption and for not making adequate investments to capitalise on such reserves and developing the economy. Its oil output, primarily heavy crude, has been steadily decreasing over the years. The re-election of President Nicolas Maduro has triggered off unrest in the country, and, followed by stringent US sanctions, has played a major role in the supply side shock; after all Venezuela is a major supplier to the US Gulf Coast, which houses a large number of heavy crude refineries. The Venezuelan crisis is serious, and has the potential to push up oil prices further. Analysts believe that crude breaching $100 a barrel may not be an unrealistic scenario!

With oil prices increasing, who would be worried? The US won’t face a major impact, as it can now up its shale production, which becomes viable once the oil price crosses $65 a barrel; hence they will meet the gap in short supply. Moreover, Canada is ready to supply heavy crude from its oil sands to the US gulf refineries. OPEC and other oil producing countries are happy with the high crude price, as they are getting a reprieve from the low price prevailing for years. So, in effect, only the emerging market countries that are consumers of crude will be worried with such high price.
Various sectors of the Indian economy are likely to be impacted; airlines, petrochemicals and tire sectors will particularly have a problem. All other sectors will be impacted through the inflation route — energy and transpiration costs will feel the impact with high crude price. Corporate results will be impacted in the coming quarters, and the slowly emerging economy’s growth will take a beating again!
The rupee depreciation is a major concern, as it already inches closer to `70 a US$. It has already depreciated by more than 5% in the last few months. Inflation is likely to increase, and it is expected that the Reserve Bank of India will increase interest rates in its coming review meeting.
The rise in the crude price and the resultant impact on the day to day life of the common man could come in handy for the Opposition, especially with the general elections in 2019 fast approaching. Retail prices of petrol and diesel are already at record highs; averaging `76 per litre for petrol and `67 for diesel.
With the election year approaching, the government may hold back a part of such increase through excise cuts and pass on a smaller portion of the increase to retail consumers of diesel, petrol, gas and kerosene, but such actions will impact the government’s fiscal deficit position, which is a firefight at the moment anyway!