Opinion | Indian growth’s crude volatility challenge
Opec’s current woes may benefit India—but they are also a warning that it cannot be complacent
Just last month, Union petroleum minister Dharmendra Pradhan had pressed the Organization of the Petroleum Exporting Countries (Opec) for “responsible pricing”. He had cause to be worried. Crude prices had surged to their highest point since 2014. The relief offered by the Narendra Modi government’s excise duty cut on retail sales of petrol and diesel had been wiped out, turning a poor fiscal decision into a pointless one. Much has changed in the month since. Brent crude prices have come down by a fifth and short selling is surging. Retail prices are falling in India. This should have been good news for New Delhi. But the Opec+ meeting on Sunday showed why it isn’t that simple.
Back in May, Opec responded to pressure from US President Donald Trump by ramping up production. The fear at the time was that the loss of output from Venezuela and the coming reimposition of sanctions on Iran would push already high prices. The International Energy Agency (IEA) had warned that the market would enter a “red zone” if these losses were not offset by Opec+. It didn’t quite turn out that way. US crude production has touched a record high of 11.6 million barrels a day. Russia has followed suit, touching 11.4 million barrels a day. With waivers for eight importers of Iran’s oil, the Iran sanctions have turned out to be toothless. And there are concerns about global demand given the strain on emerging markets and the trade tension between the US and China. Unsurprisingly, a wrong-footed market has hastened to self-correct.
Equally unsurprisingly, the Opec+ meeting ended with a near consensus on the possibility of reversing the production boost going into next year, save Russia. Such volatility goes back at least a decade. In October 2006, Opec cut 1.2 million barrels of production a day based on IEA analysis of the market. That was a mistake. Global demand spiked in the last bout of exuberance before the party ended and non-Opec supply declined. Opec figured it out too late. Its production boost didn’t do anything to prevent crude from taking off into nosebleed territory, hitting $145 in 2008 as the financial crisis was kicking off. The boosted production and flatlining demand meant prices swerved to an average of $60 per barrel in 2009.
That didn’t last long. The United Progressive Alliance’s second term was blighted by soaring crude prices, while the first few years of the National Democratic Alliance government benefited from a dramatic drop. The uncertainty has continued after the Opec+ decision to cut production came into effect in January 2017; if there is indeed another production cut in the offing, it won’t be the first U-turn since then.
Structural factors mean that the volatility doesn’t seem likely to fade any time soon. First, the reconfiguration of the US’ trade treaties and relations under Trump has had a destabilizing effect on global trade and growth. Second, the role US shale will play remains somewhat uncertain. Currently, it is living up to the expectation that it will keep crude prices in check with its relatively low cost of production. This trend may continue if the pipeline infrastructure gaps are addressed over the next year or two. But there is also a chance, as the Goehring & Rozencwajg third quarter market commentary released last month points out, that two of the three major US shale fields are showing signs of having almost exhausted tier 1 reserves. This will mean higher costs of production going forward and an upper bound to supply. Third, there has been little upstream capital investment over the past few five years, leading to a collapse of non-Opec discoveries. This will affect supply for years to come.
The uncertainty is a problem for New Delhi. It would be an exaggeration to say that high oil prices sank UPA 2 and low oil prices underwrote the NDA’s first years in power—but not by much. The NDA has experienced the downside of the volatility since, with rising prices feeding into the current account deficit and hurting exports. With general elections next year, populist measures with fiscal downsides—such as the excise duty cut—are a possibility if crude prices rise again. And with the Reserve Bank of India’s switch to an inflation-targeting regime, the importance of oil prices in setting policy rates is greater than ever.
These are not short-term issues. Opec reckons India’s oil demand will rise by 5.8 million barrels per day by 2040, accounting for a massive 40% of the overall increase in global demand during the period. The importance of the import bill to India’s macroeconomic fundamentals and political landscape will rise commensurately. The government has made some attempts to hedge against future spikes by asking state refiners to look into futures contracts. But that is one strand of what will have to be a complex policy mixture—ranging from efforts to work with China for putting pressure on Opec and boosting India’s renewables sector to increasing the quantum of spot purchases when appropriate.
Opec’s current woes may benefit India—but they are also a warning that it cannot be complacent.
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