Oil price rise could impact transport sector

It will also hurt refiners, retail marketers and oil producers

There is never a comfortable moment for an oil hike but now might be particularly awkward. The economy is reeling from the ongoing demonetisation, and productivity has fallen sharply since November 8. Higher crude oil prices would put further pressure on the transport sector.

One can hope that the Opec (Organization of the Petroleum Exporting Countries) deal last week will not result in a major energy price hike. Opec members agreed to cut production by 1.2 million barrels per day. That is about 3.5 per cent of Opec production and about 1.9 per cent of global production, since Opec members produce 43 per cent of global crude oil. Russia, not an Opec member, will also cut production by 300,000 bpd and other non-Opec exporters will also slash by a matching 300,000 bpd. Assuming all those cuts hold, (there is often cheating by member-nations of the cartel) global production will drop by 2.3 per cent. If there is a big price rise, the government could pick up the subsidy or cut excise.

Global oversupply is reckoned at two million bpd. So, this cut in itself would still mean some oversupply. Moreover, excess supply for the past two years has been accumulated in speculative inventories as well as strategic oil reserves. Over three months of global supply is held by speculators. As prices rise, that inventory might be released. The US is a wild card, as a major producer outside Opec. Donald Trump would be happy to ramp up oil production regardless of environmental concerns. More, shale operations, which shut down across many US locales due to low prices, would become profitable over $55 a barrel. This puts a ceiling on price. But, shale operations take three to four months to restart. So, prices will have to rise for a while before shale gets into the act.

Through 2016, crude oil prices moved between $40 and $50 a barrel. The cut led to a $9 jump per barrel. Brent is now trending above $52. That’s because of fears of supply disruption. Libya, Iraq and Nigeria are in civil wars, including against IS and Boko Haram. The new US regime might again put sanctions on Iran, if Trump yields to persuasion from Israel and pressure from Republicans. Plus, there’s the chance of fuel oil demand rising, if it is a severe winter. It is hard to make fundamental assumptions about supply-demand in the face of such complex possibilities.

India will remain a massive net importer, whatever happens. It is possible India will see a dip in crude oil demand due to the slowdown of the past three weeks and a continuing slowdown through the next month, or even longer. Nonetheless, there will be large imports; since India imports 80 per cent of its crude oil in normal times. The equation for the Indian oil industry is clear. Price rise hurts refiners, including exporters, since the refining margins fall. The rise also hurts refiners-cum-retail marketers, which are all government-controlled. In theory, most refined products are free-priced (except for kerosene and gas) but the public sector undertakings (PSUs) are in reality forced to sell at prices set by the government.

The government is more focused on political considerations than economic. Price increase even hurts government-owned producers Oil and Natural Gas Corporation and Oil India, since the upstream PSUs are often forced to share subsidy burdens downstream where refiners-marketer sell at a loss. Low crude oil prices have meant a benign cycle for the past 27 months. The trade deficit has narrowed, though exports have fallen because crude imports have fallen even faster in value. The government has mopped revenues by keeping excise rates high at the retail level. Companies along the entire energy chain have also made profits.

If prices rise now by, say 30-50 per cent, and stay up for an appreciable period, it could get awkward. Hiking retail prices would further impede demand, weakened by demonetisation. Truck services are cash-dependent and reeling. The railways have seen also a revenue dip, since both freight and passenger traffic have suffered. The government could choose to absorb losses by picking up the subsidy (or cutting excise and therefore losing revenue) if there's a big price rise. Or it may choose to let oil PSUs absorb the shock, as in the past. However, as of now, it doesn't seem prices will spike too much. India has coped with triple digit prices before. However, a price trend reversal could be significant, since it might signal a new up-cycle.