The surge in oil prices amid Russia-Ukraine conflict and its impact on Budget, inflation

• Rising tensions between Russia and Ukraine are leading to a surge in oil prices, with Brent breaching the $90-a-barrel mark overnight on Thursday — the first time since 2014.
• Some analysts predict oil prices to hit the $100-110-mark per barrel in the near future as prospects of supply disruptions and rising demand support prices.
• Rates have surged sharply from a low of $65.88 on December 2, 2021, and if the prices continue to rise, it will put a lot of pressure on both the Central and state governments to review taxes.

Reason for rise in crude oil prices

• Geopolitical tension in the Middle East and 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 organisation has been slow to boost production since then.

How are crude oil prices determined?

• Prior to the formation of OPEC much control over the oil market was dominated by a number of multinational companies
• Twelve nations that produce oil around the world make up OPEC (Organization of the Petroleum Exporting Countries). OPEC covers about 40 percent of the global oil production.
• The mechanism by which they control prices of crude oil is the basic economic concept of supply and demand.
• Since OPEC as producers have no influence over the demand for petroleum they tend to change its supply in order to influence the price.
• They simply increase or decrease the supply of crude oil to change the prices.
• The prices in the market are also influenced by speculation demand and speculation supply.
• These simply are the supply and demand based on speculations of suppliers and consumers.

What is the impact on rising oil prices on Budget and inflation?

• 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.
• The country’s retail inflation, which is measured by the Consumer Price Index, has already risen to a five-month high of 5.59 per cent in December.
• Wholesale price index-based inflation rose to 13.56 per cent during the same month.
• Oil marketing companies haven’t increased retail prices for the last 80 days due to the upcoming polls and given the under recovery that is already built in, the Union Finance Minister may not have the headroom to increase excise duty.