Sunday, September 26, 2021

How to perpetuate the benefit of oil price fall for Indian economy?

Crude is the single largest import that India makes. A $1 increase in price of crude is over $1.2 bi..

By admin , in Markets , at November 21, 2018

Crude is the single largest import that India makes. A $1 increase in price of crude is over $1.2 billion increase in our import bill. While renewables are expected to wean the world away from oil over time, oil would remain the most important fossil fuel consumed by mankind for a long time to come.

Oil is a commodity and prices should be expected to experience the commodity kind of swings. However, in the case of oil, the producers, particularly of the Opec, try to maintain the prices in a band given their low cost of production and large surpluses. It is also a commodity of strategic importance and one finds such influences on oil price too. This causes oil prices to be higher than what they should be if the market forces of supply and demand alone determined the levels.

However, in the end oil is a commodity, and its prices, in spite of all attempts on the contrary do fluctuate and demonstrate their commodity nature.

Also, while the focus on renewables is expected to gradually reduce the dependence on oil, the current oil consumption levels are expected to sustain for multiple years. Given the fact that the economies of oil producing countries are so dependent on the price of the commodity, one should expect to make attempts to prop up oil prices if they fall below a threshold for any sustainable period.

The annual average crude price trend is as under and provides further insights.

The question is: Is there anything that we can do to reduce the impact of high crude prices on the Indian economy?

If the Indian economy is seen to be getting stressed beyond $50 a barrel oil prices, can we try and insure the future in case the oil prices fall below $50 a bbl?

Oil offers several instruments to enable consumers to stock for the future. Some of these are:

  • A liquid futures market
  • Availability of oil tankers to store oil
  • The large caverns where a country can store oil and India has a few of these
  • Purchase of oil fields. The pricing of oil fields is related to the quantum of recoverable oil in the field and the price of the same. The same can be discounted to present value and bid.

The above instruments can be used to stock up the commodity in the financial or physical market and it is eminently possible to insulate the economy from oil shocks. The term and quantum of insulation can both be chosen.

Yes, there is a cost involved over and above the financial cost of holding the inventory in physical or financial form. The cost is the loss the country may have to bear if the oil prices fall below the level at which the country has bought its quantities for the future. This may have been the prime reason for the country not hedging last time the oil prices fell precipitously. The question becomes who would bear the losses?

However, is there an economic benefit to the country if it can assure itself of oil prices below a threshold, given that the oil prices are volatile and overtime should again be expected to rise over the threshold? If there is, then should not we evolve a mechanism to spread out the loss overtime just as we have evolved a mechanism to spread out the impact of higher oil prices overtime. Given that a large part of oil consumption is private transport related and power related, it should be relatively easy to absorb the cost.

Would motorist mind, in this case when the petrol pump prices are already low, that they are not getting lower and similarly for power costs? Our fertiliser industry still works primarily on cost plus mechanism and there the impact can be easily passed on. Yes, industrial competitiveness would get impacted in case oil prices fall further, but then they can also be made to share a part of the pain because lower oil prices would ultimately benefit them. In fact, the country can evolve a mechanism where a central agency can take demand at various price points and over different periods just like it happens in a book building process for financial transactions.

As a country, we need to be happy when oil prices fall as it is overall beneficial. However, it would be better if we think through a mechanism to perpetuate the benefit. Prices are still high and give us time to think through and put in a mechanism to benefit if prices drop in future. Else typically, the drops have not sustained and the opportunity gets lost.

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