Crude oil prices rose to a four-year high of $86 a barrel in early October. When prices dipped after November 2014, India reformed energy subsidies and increased taxes on oil products to raise revenues. With prices spiking again, concerns are mounting on many fronts: Rising current account deficit (CAD), depreciating rupee, inflationary pressure, and fiscal uncertainty. We must understand what is at play — and leverage the shock for long-term energy security.
We have endured such crises before. The 1979 Iranian revolution and the second oil shock led to the rupee’s devaluation. The first Gulf War increased oil import costs by 0.6 per cent of gross domestic product (GDP). The Kurdish civil war in 1996 halted Iraqi oil shipments; the CAD almost tripled. UN sanctions on Iran forced India to reduce imports from there by approximately 38 per cent during 2010-13.
This time is slightly different. Crude prices do not just impact the balance of payments. There is also the physical need of hydrocarbons to lubricate the world’s fastest-growing major economy. By 2030, India’s share in daily oil trade will reach 12.5 per cent (up from 7.4 per cent in 2014). This would make it an important swing player in oil markets. It is, perhaps, this knowledge that prompted the Prime Minister last week to tell heads of international oil and gas companies not to kill the hen that laid their golden eggs. India has to weather cyclical price shocks as it integrates more deeply into global energy markets.
The unfolding dynamics are also different from past episodes. When prices crossed $100 per barrel in early 2008 or in the heady days between 2011 and 2014 (notwithstanding Iranian sanctions), excess demand was responsible. Now, it is too little supply, which explains the growing gap between oil prices and underperforming petrocurrencies (Norwegian kroner, Canadian dollar, Mexican peso).
Impacts on other emerging economies feed back into concerns about the rupee. India is among five Asian countries with the highest sensitivity of oil prices on inflation, after Sri Lanka, the Philippines, Vietnam and Thailand. Taiwan, South Korea and India, among others, are bracing for negative impacts on exports. The CAD (0.7 per cent in FY17) has jumped to 2.4 per cent, and likely to rise before FY19 closes.
We must distinguish between local causes for short-term spikes and structural shifts in energy markets. Last month, gunmen attacked the headquarters of Libya’s national oil company; its oil exports have fluctuated since June. Domestic upheaval in Venezuela has halved oil production in three years; exports to India fell 21 per cent in the first half of 2018. In September, Basra (Iraq’s oil capital) witnessed riots. While Iraqi exports are at record levels, oil traders factor such events into their risk calculus (Iraq is among India’s top three oil suppliers).
Against such domestic developments contributing to rising prices, consider three trends. First, the continuing shale revolution means US production will likely cross 11.5 million barrels per day by end-2019. It could become the world’s largest oil producer by 2023 — and a net energy exporter.
Second, despite maintaining production limits for nearly two years, the Organization of Petroleum Exporting Countries knows that alternative energy supplies (from the US) would eat into their market share. Holding back production to shore up prices works to some extent, but cannot sustain if markets were lost.
Third, the global economy has slowed, China’s growth rate has dipped, and the West’s energy demand is flattening. Rising demand for petrochemicals or aviation fuel could cancel out fall in oil demand for road transport. Still, even without a precise date for peak oil demand, a long plateau is possible. All these factors contribute to lower, rather than higher, oil prices in future.
How should India manage the current crisis without losing sight of the trends? The government is, rightly, asking for a review of payment terms with major oil suppliers. Seeking ways to continue purchasing Iranian oil, despite impending US sanctions, is also correct, especially if the Chinese and the Europeans do not follow suit. India should carefully watch how the recently launched Shanghai International Energy Exchange cuts into the Western-dominated market for oil derivatives, and hedge its purchases accordingly.
Next, deal with taxes and subsidies in politically sensitive but economically sensible ways. LPG subsidies were Rs 151.32 billion in FY17 and Rs 234.52 billion in FY18. Rising prices have raised the subsidy burden from Rs 205 per cylinder in June to Rs 320 in September. If prices remained high, total subsidy outlay would be Rs 264 billion for FY19.
The government cannot easily reduce duties on oil products without impacting the fiscal deficit. Cutting duties by Rs 1.5 per litre translates into a loss of Rs 82.87 billion of petrol and diesel tax revenues from October until end-FY19. Only 37.8 per cent of diesel sales are for trucks and buses. From an equity perspective, taxes need not be reduced on diesel for private and commercial cars and utility vehicles (22.09 per cent of sales). Passing through higher fuel costs to rich consumers should encourage fuel efficiency.
Finally, India needs a national strategy on alternative transport fuels — CNG, ethanol, methanol and DME (dimethyl ether), and electric vehicles – to promote a switch to cleaner fuels. Otherwise, we will remain dependent on ever-rising imported crude and insecure about fluctuating prices.
The maturity of an economy — and its policymakers — is tested in times of strain. India’s decisions now will determine how resilient it becomes in facing future headwinds.
The writer is CEO, Council on Energy, Environment and Water (https://bsmedia.business-standard.comceew.in) and co-author of Energizing India (SAGE, 2017)
Twitter: @GhoshArunabha; @CEEWIndia