No need to hit panic button as oil prices may not impact govt's finances

In July 2008, when crude oil breached $147 a barrel, storied US bank Goldman Sachs warned of $200 oil, only to slash it to $45 in 2009. In Covid-19-struck 2020, when gold crossed $2,000 an ounce for the first time, or exceeded Rs 5,600 a gram in India, analysts expected it to reach Rs 8,000. Perhaps one can see something similar now when analysts jumped the gun after crude surged to nearly $140 a barrel earlier this month, and forecast dark days for India’s economy. They expected high current account deficits, and pump prices to jump by over Rs 10 a litre. There were also expectations of fuel tax cuts, hurting federal and state finances.

Oil and natural gas hurt India’s economy, a major petroleum importer, in two ways: they inflate the import bill, weakening India’s fiscal position, and they contribute to inflation. After Russia invaded Ukraine, oil jumped by 40 per cent before falling to below $100 a barrel. LNG also whipsawed in line with the European gas benchmark TTF, rising to over $50 per million British thermal units (Btu) before retreating to $34 per million Btu.

Analysts have spelt out bleak scenarios for India’s finances and growth, assuming strong crude prices. “India would be adversely impacted by rising oil prices, given its status as a net oil importer,” Nomura said. A report by ratings agency ICRA said, “We estimate every 10 per cent increase in oil prices would shave off (approximately) 0.20 pp from GDP growth, adding downside risks to our GDP growth projection of 7.8 per cent in FY23. If the oil price averages $130/barrel in FY2023, then the CAD [current account deficit] will widen to 3.2 per cent of GDP, crossing 3 per cent for the first time in a decade.”

Others were more optimistic, arguing that the current conflict and sanctions against Russia throw open new opportunities in oil trade that India can seize if it chooses to ignore US threats. “India’s attempt to diversify its import sources will tend to reduce the financial burden on the government, thereby reducing the risk of high import bill. Moreover, cheaper crude may bring down the current cost of production and help cool off inflationary pressures,” said Gargi Rao, economic research analyst at GlobalData, which forecasts India’s fiscal deficit as percentage of GDP to decline marginally to 5.3 per cent in 2022 against 5.7 per cent in 2021.

It can be argued that current scenarios are somewhat extreme because it’s simplistic to correlate a few days of crude price spikes towards a burgeoning current account deficit, or, forecast a massive cost benefit from discounted Russian Urals oil.

New Delhi does not give any subsidy on fuels, barring a meagre transport adjustment for domestic LPG users. It has asked oil companies to refrain from raising pump prices but consider absorbing some of the marketing losses from selling petrol and diesel below cost with higher gross refining margins made from crude processing. BPCL and IOC have deferred plant maintenance to capitalise on strong refining margins, which are at over $10 a barrel. IOC, BPCL and HPCL may make lower profits but the government’s finances are untouched as there is no need to cut fuel taxes.

Russian oil is not a panacea because sufficient volumes are not available in the long term, while the economics of transportation to India make it unviable in the absence of discounts. It is unclear how long discounts will last and to what extent they can compensate Indian refiners for higher logistic costs. Urals can give value to Indian refineries, said R Ramachandran, former refinery director, BPCL. Urals, a medium sulphur, medium residue oil, is similar to Arab light and Iranian light, typical staples for Indian refiners.

Recent commitments by state refiners to buy as much as 10 million barrels of Russian crude are insignificant, and at best a symbolic exercise by New Delhi to demonstrate its independence in light of US pressures. The volumes contracted amount to hardly two days of India’s crude processing needs. Compare that to the 2.5 million barrels a day sourced from Iraq, Saudi Arabia and UAE over an entire year. Moreover, it is unclear if Russia can offer huge volumes to India over a sustained period, said Ramachandran. China and East European plants will compete for Russian oil because they are better placed logistically than India to import crude over land and sea. Before the Ukraine conflict, the first call on Urals was from European and Chinese refiners, leaving only an odd parcel available for India.

Oil prices have eased after speculators initially drove up the prices by $40 a barrel. The uncertainty and supply disruptions may also subside with Russia actively courting China and India for supplies, while East European countries still continue to absorb Urals. Diversion of Russian oil to China, and to a small extent India, may prompt West Asia, traditional suppliers to China and India, to divert shipments to Europe — balancing the crude market and cooling prices. A US-Iran truce can add another 1.5 million barrels a day to the market, around 1.5 per cent of global demand, boosting supplies — despite stringent sanctions, Iran still exports one million barrels a day, mainly to China. Meanwhile, demand for oil appears to be flagging as China, parts of Asia and Europe are experiencing yet another surge in Covid-19 infections, leading to a shutdown at one of China’s biggest production centres. Demand attrition will put further pressure on oil prices.

India spent a net $101 billion in the purchase of oil and LNG in 2018-19, after deducting $38.2 billion it gained from petroleum product exports, when the Indian crude basket averaged $70 a barrel, according to the oil ministry. Oil product exports is a huge foreign exchange earner for India, and may increase next year because of shortages of diesel and petrol in Europe amid Russian disruptions, and surging prices. In 2019-20, India spent a net $93 billion when oil averaged $60 a barrel, before Covid-19 impacted the world, bringing crude down to $45 a barrel in FY20-21. In the April-January period of the current fiscal, net oil and gas purchases totalled $91 billion. Crude averaged $76 a barrel in April-February. If crude averages $85 a barrel next fiscal, India may need to spend a net $20 billion more, marginal compared to over $620 billion in foreign exchange reserves. Lower than expected oil demand and ethanol substitution in petrol may further reduce the need for imported oil next fiscal.