Crude pricing: Politically-motivated tinkering of oil could prove costlier

Oil prices on Thursday extended gains, pushed up by a weak dollar and by comments from Saudi Arabia that it would rather see an undersupplied market than end a deal with OPEC and Russia to withhold production. Prices rose on the back of ongoing weakness in the US-dollar against other leading currencies, further supported by rising stock markets. This author discusses the implications of rising oil prices and what it means for India

Benchmark sweet crude prices were dragged down by 6-7% this week compared with their four-year peak in January amid a global financial markets turmoil that began February 2. Brent futures traded on the Intercontinental Exchange had slumped to around $65/barrel February 8 versus the $70 psychological level first notched on January 16. 

There may be more downside and price volatility ahead for crude before the broader inflation and economic growth fears, which have been far harsher on the global stock markets, settle down. The second quarter, traditionally a slow demand season for oil, may also prompt a price slump. Nonetheless, crude is assumed to have sustainably vaulted into the $60-70/barrel band for 2018, compared with the $45-60/barrel range of 2017, as global supply and demand rebalance and the world’s bloated inventories continue to drain.

For India, the world’s third-largest consumer of oil after the US and China and one of the fastest-growing markets, rising crude prices is a worry. The country imports nearly 88% of the crude it refines, a purchase that has been rising in both volume and percentage terms to become a growing drain on foreign exchange.

There is another challenge governments typically face as prices at the pump begin climbing in tandem with international crude markets – consumer anger. Inflation is not unique to fuel prices but bigger digits at the pumps get more than their fair share of attention across the world. In developing countries, fuel prices are a politically sensitive subject and the transition to free-market pricing has been a powder keg for most governments throughout history.

Several Asian countries set about unwinding their costly fuel subsidies after the price crash of mid-2014, but few made as much progress as India. The government of Prime Minister Narendra Modi deserves kudos for neatly and fully deregulating petrol and diesel prices and instituting a pragmatic plan for the phased withdrawal of LPG subsidies. India also stands out among its peers in the region with the high level of transparency it affords the public on how the fuel prices are set.

Should some sort of price ceiling or government control be brought back into fuel prices because they are now higher? That would be a regressive step, which even if politically expedient for the time being, will extract a heavier price from the country in the long run. No government should have the fuel subsidies monkey on its back. India has the most to lose by back-pedaling now.

Political considerations aside, should the consumers be given some relief from spiking fuel costs? Petrol is far from a luxury product in India – the majority use is by two-wheelers in mid- and low-income families. If we are agreed that tiered pricing based on income levels is impractical to implement, there may be a case for the government to partially roll back the taxes on petrol, especially after having hiked them substantially since 2014. 

A tax reduction was effected last October, but more such moves need to be thought through carefully. A loss in fuel tax revenues will need to be compensated elsewhere if the government is to have enough funds to invest in critical areas such as rural development, agriculture, education, and healthcare. 

Finally, the Indian consumer is not bearing the full brunt of the rise in international crude prices -- the strengthening of the rupee against the US dollar has helped cushion some of the impact.  

The Indian “crude basket,” a combination of Brent and benchmark high-sulfur Dubai crude prices that serves as a proxy for the feedstock costs of the country’s refiners, averaged $67.06/barrel in January, according to government data, up 24% from the same month of 2017. However, in rupee terms, the rise was 16%. Branded IndianOil petrol prices in Delhi, to use a representative number, were up 0.78% on average in January versus a year ago, while diesel prices were 5.9% higher. 

While crude has settled into a higher band compared with the last three years, it is unlikely to go beyond $70, capped by the shale sector in the US, the world’s new swing producer. The Indian government should not be taking any hasty measures to tinker with fuel pricing.

Vandana Hari, Founder and CEO, Vanda Insights, a Singapore-based provider of macro-analysis on the global oil markets through regular reports and bespoke briefings.  You can reach her on Twitter: @VandanaHari_SG