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OIL CRISIS
Oil crisis is a sudden rise in the price of oil that is often
accompanied by decreased supply. Since oil provides the main
source of energy for advanced industrial economies, an oil
crisis can endanger economic and political stability throughout
the global economy.
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OPEC
Organization of the Petroleum Exporting Countries (OPEC) is
an intergovernmental organization of 14 nations as of February 2018,
founded in 1960 in Baghdad by the first five members
(Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela), and headquartered
since 1965 in Vienna, Austria.
As of 2016, the 14 countries accounted for an estimated 44 percent
of global oil production and 73 percent of the world's "proven" oil
reserves, giving OPEC a major influence on global oil prices that were
previously determined by American-dominated multinational oil
companies.
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Factors influencing oil prices
Sanctions on Venezuelan oil industry:
Rumors of US moving closer to putting sanctions on Venezuelan oil industry,
the world’s largest oil reserves, also aggravate the volatile sector.
As per the latest report from IEA (International Energy Agency), oil output from
Venezuela has slid to 1.5 million barrels a day in February, down 60,000 barrels
month-on-month and a decline of 540,000 barrels a day against the previous
year,the ongoing Venezuelan supply crisis would deepen that dips the oil
market into a deficit.
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Tensions between Saudi Arabia and Iran:
Increased instability in the Middle East alarming the global oil
market. Tensions between Saudi Arabia and Iran have emerged
again recently after the Saudi Crown Prince visiting US President
considers ending the Iranian Nuclear deal. Intensifying Libyan
conflicts also aided to the sentiment.
Global oil producers limiting supply:
With a view to rein global excess supply and lift prices, OPEC and
other top oil producers including Russia have been limiting daily
crude production by 1.8 million barrels since last year.
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Geopolitics
Iran and Venezuela are not the only sources of geopolitical instability
causing oil prices to rise.
“The ongoing escalation of tensions between Saudi Arabia and Iran,
continuing conflicts in Iraq, Libya, Syria and Yemen have significantly
taken their toll on the region,” Mitsubishi UFJ Financial Group said.
While a direct military confrontation between Iran and Saudi Arabia is seen
as unlikely, any intensification of proxy conflicts in the region would
undermine stability, the Japanese financial services group said.
The IEA warned that recent geopolitical events had increased uncertainty
over future global oil supplies.
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Impact on Indian Economy
India, the world’s seventh-largest economy, was a key beneficiary of falling
crude oil prices between 2013 and 2015.
An analysis by this newspaper, more than a year ago, had indicated that
almost the entire reduction of about 0.6% of the gross domestic product
(GDP) in India’s fiscal deficit between FY14 and FY16 could be attributed
to the sharp fall in crude prices.
Lower crude prices also contributed to the narrower current account
deficit. The biggest benefit of the fall in oil prices was evident in narrower
twin deficits..
Things, however, started reversing about two years ago and have
gathered pace in the past few months. As against an average price of
$46.2/barrel for the Indian basket of crude oil in FY16, it rose to
$56.4/barrel in FY18 and averaged $65/barrel in the fourth quarter of
FY18.
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In short, one could safely conclude that higher crude prices will adversely affect
the twin deficits—fiscal and current account deficit—of the economy, which will
have spillover impact on the monetary policy, and consumption and investment
behaviour in the economy.
If the rise can be attributed to demand-side factors, it is not necessarily
adverse for economic activity or financial markets.
The higher crude oil imports bill could be offset by higher oil and non-oil exports
(and of course, remittances).
Similarly, better domestic economic activity could help meet fiscal deficit
targets. However, if oil prices are pushed up by supply factors, it would be
concerning.
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The majority of the forecasts for oil price remain at $65-70/barrel.
Impact on fiscal math
As a rule of the thumb, an increase of $10 per barrel in crude prices will lead to an
increase of about Rs17,000 crore (or $2.5 billion at an exchange rate of 67/$) in fuel
subsidies, equivalent to 0.09% of GDP.
In the Union Budget 2018-19, the government had budgeted for petroleum subsidy
of Rs25,000 crore, similar to that in FY18.
Our calculations, however, suggest that fuel subsidy could be as high as Rs54,000
crore if crude price averages $65/barrel in FY19.
Additionally, a cut of Re1 in excise duty for both petrol and diesel will lead to an
annual revenue loss of Rs12,000-13,000 crore (or 0.065% of GDP).
It remains to be seen if the excise duty cut can be resisted by the government,
considering that the general election is less than a year away now.
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Impact on current account deficit
As a rule of thumb, an increase of $10 per barrel in crude oil prices will lead to
an adverse impact of $10-11 billion (or 0.4% of GDP) on current account deficit.
There are two opposite forces at work in current account deficit.
Higher oil prices will push the import bill higher; however, it will be partly offset
by higher oil exports and better remittances.
The latter will materialize, since more than half of India’s remittances are
reported to be channelled through the Gulf countries, which are likely to
witness better economic conditions with higher oil prices.
If we talk in numbers, an increase of $10 per barrel in crude prices will push
the merchandise imports bill up by about $20 billion, which will be partly offset
by an increase of about $6 billion in oil exports and $3-4 billion in workers’
remittances.
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Impact on inflation
With a weightage of only 2.4% in headline CPI, the adverse impact will entirely
depend on the extent to which higher crude oil prices are passed on to the
consumers.
Considering the general election next year, it is difficult to envisage a significant
hike in retail fuel prices, and thus, the direct impact on CPI inflation is likely to
remain muted.
