How boiling oil prices impact government, personal Budgets

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How boiling oil prices impact government, personal Budgets

  • The tension between Russia and the Western world over the Kremlin's military build-up on the Ukrainian border pushed oil price to $90 a barrel.
  • A potential invasion of the oil and gas transit hub of Ukraine by Russia, which is one of the world’s largest oil exporters, could disrupt supplies of the key commodities.
  • The spike also impacts assumptions on the key metric that goes into the Budget formulation.

Reasons for rising fuel prices

  • High demand: Crude oil prices have risen sharply since the beginning of the year as a surge in Covid-19 cases around the world owing to the Omicron variant of the novel coronavirus has not lowered demand for crude oil in line with expectations.
  • Geopolitical tension: In the Middle East, fresh tensions between Russia and Ukraine are leading to speculations of supply disruptions.
  • Key oil-producing countries have also kept increasing crude oil supplies despite rising demand.
  • OPEC+ had agreed to sharp cuts in supply in 2020 owing to Covid-induced travel restrictions, but the organization has been slow to boost production since then.

Impact of rising oil prices on India

  • The Budget for this year has assumed that oil prices will hover around the $65-per-barrel mark.
  • Prices have steadily risen to touch a post-Covid all-time high of $90.5 on Wednesday.
  • Not only do rising prices feed into inflation, but also increase the amount of LPG and kerosene subsidy the government is required to pay.
  • However, on the positive side, government revenues on taxes of oil and related products have also been rising over the last two years.
  • Current Account Deficit: The increase in oil prices will increase the country’s import bill, and further disturb its current account deficit (excess of imports of goods and services over exports).
  • According to estimates, a one-dollar increase in crude oil price increases the oil bill by around USD 1.6 billion per year.
  • India imports 80% of its crude oil requirements and the average price of Indian basket of crude oil has already risen to USD 54.8 barrel for January 2021.
  • Inflation: The increase in crude prices could also further increase inflationary pressures that have been building up over the past few months.
  • This will decrease the space for the monetary policy committee to ease policy rates further.
  • Fiscal Health: If oil prices continue to increase, the government shall be forced to cut taxes on petroleum and diesel which may cause loss of revenue and deteriorate its fiscal balance.
  • The growth slowdown in the last two years has already resulted in a precarious fiscal situation because of tax revenue shortfalls.
  • The revenue lost will erode the government’s ability to spend or meet its fiscal commitments in the form of budgetary transfers to states, payment of dues and compensation for revenue shortfalls to state governments under the goods and services tax (GST) framework.
  • Positive Outcomes: However, there could be a positive side for India too from the oil price hike. The value of Indian oil and gas companies could be positively impacted. The government could get greater value from disinvestment in Bharat Petroleum Corporation Limited.
  • Remittances from the Persian Gulf could increase.

What should India do?

  • What India needs now is a carefully devised strategy that is not driven by short-termism, but aims to gradually insulate the country from global oil price volatility.
  • Such a strategy should be centered on three things: expediting the migration to electric mobility, expanding the biofuel blending in petrol, and stimulating exports.
  • Migration to Electric Mobility: Since the transport sector accounts for around 70% of the total diesel sales in the country, it is an appropriate sphere for a transition from traditional fuels to electric motors. A favorable incentive mechanism (subsidy up to 60% of the total cost of an electric bus) to help the adoption of electric buses gain traction is already in place. Within the transport sector, trucks alone account for around 28% of diesel consumption. Thus, creating dedicated electric corridors for trucks on the highways could go a long way in curbing oil imports.
  • Biofuel Blending: Increasing the blending proportion of domestically available biofuels in cooking gas and transportation fuel is another way to reduce India’s reliance on imported crude oil. As is known, ethanol is mainly used for blending in our country. That ethanol is mostly derived from sugarcane molasses means its production is contingent on weather patterns. Moreover, sugarcane, refining of which creates molasses, is a water-intensive crop, so fresh incentives to increase ethanol production may not be good economics in a country where water scarcity is a serious problem.
  • Hence, methanol, produced from coal, should be given more weightage when it comes to blending. Besides, biodiesel supply should be augmented by making jatropha farming more productive through genetic modification. If all these fuels together reduce oil imports by 20%, the country could save more than $20 billion a year in terms of foreign exchange (assuming oil prices stay around their current level).
  • Other Measures: In the near- to medium-term, it is imperative to explore how fuels can eventually be covered under the goods and services tax (GST), which is essential not only to reduce any undue burden on users but also to prevent leakages and achieve efficiency.
  • To begin with, natural gas and aviation turbine fuels (ATFs) may be considered for inclusion, which might not cause substantial revenue loss for states but will foster confidence that other petroleum products will be brought under GST sooner rather than later.
  • Beside this India also need to accelerate its adoption of the renewable energy program.
  • International Solar Alliance, Paris Commitments, Target of 175GW by 2022 are some of the steps in the right direction.
  • What needs to be done is to streamline and integrate these targets with developmental and economic planning.

Difference between Brent and WTI

  • Origin: Brent crude oil originates from oil fields in the North Sea between the Shetland Islands and Norway. West Texas Intermediate (WTI) is sourced from US oil fields, primarily in Texas, Louisiana, and North Dakota.
  • Light and Sweet: Both oils are relatively light, but Brent has a slightly higher API gravity, making WTI the lighter of the two. American Petroleum Institute (API) gravity is an indicator of the density of crude oil or refined products. WTI with a lower sulfur content (0.24%) than Brent (0.37%), is considered "sweeter".
  • Benchmark Prices: Brent crude price is the international benchmark price used by OPEC while WTI crude price is a benchmark for US oil prices. Since India imports primarily from OPEC countries, Brent is the benchmark for oil prices in India.
  • Cost of Shipping: The cost of shipping for Brent crude is typically lower since it is produced near the sea and can be put on ships immediately. Shipping of WTI is priced higher since it is produced in landlocked areas like Cushing, Oklahoma where the storage facilities are limited.

Way Forward

  • In brief, the right option now is to use the current situation as an opportunity to push for initiatives that are in the best interest of the country.
  • Reducing the country’s reliance on oil imports would bode well for energy security, and make our financial markets less volatile in the event of untoward developments in the oil market.
  • And savings from reduced oil imports could in turn be used to finance infrastructure projects, which are crucial for India’s long-term growth prospects.