Advertisement
Friday, Jul 01, 2022
Outlook.com
Outlook.com
Opinion

Oil's Not Well

Global oil markets are jittery with US president George Bush refusing to rule out a preemptive strike against Iran's nuclear facilities. Domestic political compulsions prevent the government from hiking prices. How long can this last?

Oil's Not Well
Oil's Not Well
outlookindia.com
-0001-11-30T00:00:00+05:53

Global oil markets are jittery with US president George Bush refusing to rule out a preemptive strike against Iran’s nuclear facilities. International crude prices have surged to record levels of $72.64 a barrel and are expected to remain high and volatile in the near future. There are no prizes for guessing what all of this implies for fast-growing emerging economies like India that import 70 per cent of its requirements of oil. So far, however, the inflationary consequences of costlier oil have not been felt due to the limited "pass-through" of global oil prices to domestic oil prices, thanks to administered prices.

Thus while the average basket price of crude that India imports zoomed to $65.5 a barrel by mid-April 2006, only 15 per cent of the world oil prices hike was passed on to domestic consumers. Domestic wholesale prices thus have been running at only a modest rate of 3.5 per cent from the start of April but are likely to rise upwards if global crude prices go through the roof. "We are confident about containing inflation.. (but) we are worried about global oil prices" stated RBI governor YV Reddy after recently unveiling the annual credit policy statement for 2006-07.

The world, too, is worried about President Bush’s intentions regarding Iran as this country continues to defy international pressure to halt its nuclear programme. The current price levels could even spike to $100 a barrel if the US indeed attacks Iran and causes supply disruption from the world’s fourth biggest exporter of oil. Few economies in the world can survive such severe oil shocks. There is thus a clear and present danger that costlier oil will tip the world economy into stagflation like the previous oil shocks did during the early and late 1970s.

Interestingly, the global oil price surge has little to do with demand-supply imbalances – the stock in trade of textbook economics. Global demand for oil this year is pegged at 85.2 million barrels per day while global supply is identical at 85.3 million barrels per day according to the US Energy Information Administration. But this hasn’t prevented prices from rising by 81 per cent to $60.9 per barrel in end-March 2006 from $33.7 per barrel in end-March 2004. The reasons include natural devastations like Hurricane Katrina, supply disruptions in Nigeria, threat of strikes in Norway among others.

None of these factors can, however, "explain" the zooming oil prices. According to oil experts, a more important factor is the limited spare crude oil production capacity worldwide. The US refineries have also to fully recover from the Katrina effect. Thus while demand and supply are in balance, any threat of supply disruption from a major oil producer or rumours to that effect, can result in prices spiking upwards dangerously. This is indeed what has been happening since The New Yorker magazine published a story this month that the US was contemplating a tactical nuclear weapon strike against Iran.

Such a prospect worries the RBI. Till now, however, the "pass-through" of costlier global oil into domestic prices has been contained due to political compulsions to insulate the urban middle class from inflation. There is simply no question of raising domestic oil prices while elections to five state assembly elections are underway. But in the process, India’s oil marketing companies have been taking a big hit and are awash in red. "Oil pass-through is yet to take place in our economy… it is increasingly clear that there has to be a fuller pass-through of increases in international crude prices", stated Dr Reddy.

The upshot is that the UPA government has to put in place a more rational oil pricing mechanism as per the recommendations of the Rangarajan Committee. Allowing a greater degree of pass-through of international prices to domestic prices clearly is warranted at the moment. As the current international oil prices have a "large permanent component" -- in other words, they are likely to stay high for a long time -- such a pass-through enables greater efficiency in the usage of oil in the economy. Higher prices will trigger the need for greater conservation in the utilization of oil.

Greater pass-through can also stanch the bleeding of India’s oil majors. Some of these are so-called navaratnas or PSU jewels whose continued existence as state-owned entities forms part of the UPA government’s commitment under the National Common Minimum Programme. Interestingly, while the Left exerts tremendous pressure on the government to safeguard these navaratnas at all costs, there is no concern that continuing with administered prices can bankrupt them. The government, for its part, wants to insulate the middle class from inflation for political reasons.

With oil not well, there is no getting away from enhancing greater self-sufficiency in oil production. Today, this is around 30 per cent and is likely to go down further to 15 per cent over the near term. With prices at $72 a barrel and testing higher levels, the country’s oil import bill will widen substantially. The need, therefore, is to curb import dependence through a more aggressive plan to step up domestic oil production through deepwater exploration. With a rational oil price mechanism, this is indeed the best way to insulate the middle class from global oil prices without bleeding the domestic oil majors.


N. Chandra Mohan is a Delhi-based analyst of economic and business affairs

Advertisement

Outlook Newsletters

Advertisement
Advertisement
Advertisement

Read More from Outlook

Lament Of Separation: Songs Of Habba Khatun, Last Queen Of Kashmir, Still Echo In Valley

Lament Of Separation: Songs Of Habba Khatun, Last Queen Of Kashmir, Still Echo In Valley

In happy times and sad, Habba Khatun’s sensuous songs make both young and old emotional. With the never-ending conflict bringing tragedies to every doorstep, Habba’s lyrics of separation amplify their mourning.

How Indian Laws Govern People’s Right To Love And Live

How Indian Laws Govern People’s Right To Love And Live

In India, only those relationships between a man and a woman are considered to be legitimate when there is a marriage between the two.

Kohli Quits Test Captaincy, Leaves Leadership Vacuum

Kohli Quits Test Captaincy, Leaves Leadership Vacuum

Virat Kohli, 33, had recently stepped down as India's T20I captain and was subsequently removed as the ODI captain.

UP Elections 2022: How Congress Is Harnessing Power Of 'Persecuted' Women To Counter BJP

UP Elections 2022: How Congress Is Harnessing Power Of 'Persecuted' Women To Counter BJP

A Mahila Congress leader, who is the face of the ‘Ladki Hoon, Lad Sakti Hoon’ campaign, however, has accused the party of anti-women bias after she was denied a ticket.

Advertisement