Global crude oil prices have been steadily declining over the past several weeks. The benchmark Brent crude has fallen below $92 a barrel, the lowest in a couple of years. But the last time that mark was reached, it was short-lived, with the price reverting quite quickly to the $105-110 range, in which it has hovered for much of the past two years. This time around, the decline may well be a little more enduring. Several factors seem to be combining to create conditions for prices to remain at current levels, if not decline further. To the extent that these factors are likely to be persistent, the outlook for a sustained period of softer prices is not entirely unrealistic.
Three factors are of particular significance. First, the surge in oil prices that occurred in late 2010 was attributed by many observers to the United States Federal Reserve's second round of quantitative easing. Abundant liquidity drove up the prices of all assets, including commodities, even as global fundamentals were weak. As this liquidity is rolled back, first through the taper and then interest-rate increases, commodity prices, in particular, seem to be softening. In other words, the "liquidity premium" is disappearing. Second, the turmoil in various parts of West Asia notwithstanding, supplies from the region have increased significantly. Iraq, in particular, is pumping much larger volumes of crude oil despite the heightened state of conflict it is in. Third, and very importantly, the shale oil and gas boom in the United States is now within touching distance. Add to this the expansion of Canadian production from their tar sands and North America is well on its way to not only being self-sufficient in fossil fuels but also a potential exporter. A combination of financial and real factors appears to be taking the global economy towards a relatively benign conventional-energy price scenario.
For large energy importers like India, these developments significantly ease macroeconomic conditions. India, in particular, suffers a triple whammy from high oil prices - inflation, balance of payments and fiscal vulnerability on account of subsidies. The decline in prices over recent weeks has already begun to reflect positively on all three parameters. If forecasts of the durability of this situation are accurate, the government and the Reserve Bank of India will find their fiscal and monetary objectives a lot easier to achieve. Of course, this window of opportunity shouldn't lead to complacency. Many things need to be done to take advantage of the opportunity and buffer the economy against a possible reversal in oil prices. From the government's standpoint, now that the under-recovery on diesel has vanished, it is time to deregulate diesel prices and let consumers directly face price volatility. Innovations in energy conservation will inevitably follow. For the other two subsidised products, LPG and kerosene, the quantum of subsidy has clearly narrowed. A commitment to a subsidy cap can now be considered, even as efforts to weed out ineligible beneficiaries are strengthened. From the monetary-policy perspective, oil-price dynamics yield a double dividend. Supply-side pressures are eased by lower prices, while demand-side pressures are moderated through fiscal improvement. An improving balance-of-payments situation also presages a more stable rupee. For both, good luck must be reinforced by good policy.
