In the past month, crude oil prices have collapsed. Spot contracts have hit 12-year lows at around $28 a barrel for Brent crude oil. Crude oil has dropped over 20 per cent in 2016 alone. Futures contracts have also fallen drastically with 2020 crude oil futures now priced below $50 a barrel. Some commodity analysts are predicting a further slide. The investment bank Morgan Stanley says that a stronger US dollar could drive crude oil down to the $20 mark. However, other analysts believe that oil could recover and head back to around $60 by end-2016.
The rout has been caused by a combination of factors. The lifting of sanctions on Iran will bring more supply into a market that is already seeing over-supply. Even if the Organization of the Petroleum Exporting Countries finally cuts production, it will be more than compensated by the return of Iran. Global oil inventory is also hitting a ceiling as there is little storage capacity left to spare. Over-supply coincides with weak global demand. Slower growth, in China in particular, is expected to impact demand adversely. In addition, there is the currency effect. Every major currency has lost ground against the dollar; other things being equal, dollar-denominated oil prices could fall if this trend continues. Going forward, the geopolitical complexities that could influence the supply-demand equation are mind-boggling. There is a proxy war on between Iran and Saudi Arabia. Production has also been affected by war in Libya and Iraq. Meanwhile, persistently low prices could lead to widespread shutdowns in production of shale oil and gas, leading to a reduction in exploration efforts.
Persistently low crude oil prices will impact India in several positive ways. There will be less pressure on the trade account, and probably a lower fiscal deficit, due to the lower subsidy burden. Fertilisers and retail petroleum products will cost less. The government has mopped up higher excise collections on petro-products as prices have fallen. Non-food inflation has moderated. The government has taken advantage of the lower oil prices and stepped up the pace to build strategic oil reserves in the country. This scenario also offers an opportunity to move ahead with policy reforms without causing undue consumer distress. For example, kerosene and gas subsidies could be eliminated, or at least, reduced substantially, by easing closer to market-driven prices. The government has taken some steps in this direction and more, hopefully, should be taken in the coming months. The same holds true for fertiliser subsidies; the subsidy mechanism for fertilisers requires overhaul.
On the other hand, there is some danger that exploration and production activity will fall by the wayside. There will not be much commercial interest until the price cycle changes. There is a commitment to shift to open acreage licensing from the current New Exploration Licensing Policy system. The absence of urgency could lead to delays in policy review. Given the long-gestation nature of exploration activity, policy reviews must not be delayed. Paradoxically, another danger could arise from reduced inflation. A concomitant fall in nominal growth may exacerbate debt servicing problems for the government, as well as for companies. Countering this deflationary effect will require prudent fiscal management and careful budgeting. The overall effect of lower crude oil prices over a long period would certainly be positive - but only if the opportunity is taken to review and revamp policy while conditions remain benign.