“Oil plunges below zero for the first time in an unprecedented wipe-out”

For the first time in history, oil futures witnessed a slump of this magnitude in prices. The oil crash was the most publicised headline for nearly a week. What had been forgotten with the sensationalism of ‘oil is negative!’ is that oil prices have been continuously falling. Perhaps such a huge drop in futures prices was rather unprecedented, but a blowout in the markets was becoming more and more likely. States across the globe had already found themselves in an uncomfortable position as they faced complete lack of demand and shortage of storage facilities. It is quite hard to gauge the adverse consequences of such tremendous, prolonged oil market shocks on the diverse economies across the globe. Hardly anyone comes out as a winner. Brent Crude hovers within the range of $20-$30 a barrel today, and had fallen below $15 a few days ago. The last time prices were below $20 was nearly 22 years ago – in 1998.

This is not the first time the world is witnessing fluctuations in prices. Oil prices are determined mainly by the demand and supply of oil and its petroleum-based products. With high demand, the prices may rise, but they can be offset with increased supply and vice versa. The general trend is that in the industries where oil is used as an input in production, the rise in prices causes the overall costs to increase, thereby affecting output and GDP. Whereas, with a fall in prices, many industries: airlines, transportation, manufacturing, even tourism – benefit from cheaper costs of production. Ultimately, the cost is transferred to the consumers, affecting the incomes at their disposal.

In the recent past, it has been observed that the scenario changes when a country is no longer just a consumer nation, but also a producer nation. Take the case of U. S. Oil companies – even though they will suffer an immense blow with falling prices, it also means cheap inputs for them. High prices will drive employment and investments in new prospects, such as high-cost shale deposits and new fracking facilities. But it also translates to lower real incomes for both the consumers and oil inputting producers. A similar situation is likely to arise in many advanced economies with higher per-capita incomes, that have substantial alternative sources of energy. One important reality that is not talked about enough is that regardless of whether it is oil futures in the US that slip into negatives, or whether Saudi Arabia halts production; it is always the developing world that is by far the most affected by any movement in oil markets.

The Indian Narrative

India is one of the largest importers of crude oil and petroleum products in the world. Nearly 80% of our oil demand is imported, forming 20% of our total merchandise imports. Whenever demand or supply move rapidly, the position of India becomes more vulnerable to crude oil shocks on the economic front.

Usually, India comes out as a winner in a time of falling crude prices, claiming a convenient position with narrower fiscal and current account deficits. This can be seen in the trend between FY 14 to FY 16, when low crude oil prices were one of the primary drivers of slimmer deficits. The trend reverses with a hike in prices. In the current scenario, the positive effect on the fiscal deficit is temporary, and likely to be negated by fewer subsidies given to oil companies combined with extraordinarily little demand for oil in production.

However, retail inflation in the country is offset by the low inflation in the oil market. Fuel and electricity account for 6.84 percent of the Consumer Price Index, while transport and communication’s weight in the CPI index is 8.59 percent. In February and March, the average food and beverages inflation was around 8.64%. In April, despite the lockdown, food inflation has been estimated at around 6.5%, while fuel prices rose by 1.5%. Higher food prices can hopefully be counterbalanced because of low fuel prices, resulting in reduced overall prices and a lower CPI in the coming months.

As of the stock markets, although it has been observed by analysts that there is little correlation between oil prices and the stock market as both have different prompts for their upward and downward movements, the companies depending on crude oil do observe significant variations in their stock prices in the event of an oil price shock. These include tyre, lubricants, aviation and refining companies. As oil price rises, it increases the input cost, thereby affecting the overall profitability position of these companies in the short run which has a direct impact on the stock price. On the flip side, a drop in oil prices becomes favourable for these companies. Considering that the last two months have witnessed near zero levels of production, and a complete shutdown of airlines in India, a sustained low oil price will help the case of such companies very much.

However, the fall in crude prices at a global level does not necessarily mean lower prices for Indian consumers at the petrol pumps. This is because the retail prices for petroleum are determined as per the global fuel prices and not the prices of crude oil. The pricing formula is such that it considers an average of 15 days of movement and thus no immediate impact is experienced on petrol pump prices. Additionally, VAT is also levied on petrol and diesel which shoots up their prices. Had they been calculated under GST, they would have been cheaper. Secondly, India does not procure oil from WTI but from Oman, Dubai, and Brent crude, prices of which are a bit higher. West Texas Intermediate (WTI) is more relevant for local US, Canada, and Mexican markets. More importantly, consumers have limited exposure to the gains of this event because the Government of India uses this opportunity to impose higher excise duty, especially in these times of very limited economic activity. The government enforced a Rs 3 increase in excise duty on both petrol and diesel this year to raise additional revenues of Rs 39,000 crore. An amendment to the Finance Bill 2020 has also been passed which allows the government to raise special excise duty to as much as Rs. 8 in the future.

India has not been following the general trend associated with falling prices. There is a simultaneous fall in the value of the Indian rupee with a 3.34 percent drop against the US dollar since March. This hurts the current account position. It is relevant to mention here that RBI held $475.6 billion in foreign exchange reserves as on 27 March 2020, an increase by $62.7 billion since March 2019. These funds can help provide some relief to a crippled economy that emerges out of the lockdown. However, the Indian government will not be a winner in this situation until the rupee continues to depreciate and import bills are on the rise. Another shortcoming of the current situation can be the losses Indian Oil marketing companies (OMC) are facing especially when looking to divest its 53.29% stake in Bharat Petroleum Corporation (BPCL). This disturbs the disinvestment target of the government and the planned gain of 60,000 crores from this sale. Indian oil and gas producers expect a price range of $50-$55 to make production and exploration viable along with some meaningful profits.

All in all, the oil market will show little signs of settlement until and unless the world economy draws back on track and the demand revives. Moreover, if the situation remains so, clean energy transition fuels such as natural gas are likely to be explored more practically. A ray of hope emerges as Goldman Sachs predicts a three-stage rally in the prices with the fundamentals of oil markets showing some improvement. Global supplies are being controlled. It is an ardent hope, that as the lockdown eases and the demand for oil steps up in India, producers can set off the huge losses (at least in part) sustained from inactivity against low oil prices.

By Somya Yadav