Oil Conundrum: Crashing Crude, Rising Fuel Prices
About two decades ago, renowned
cartoonist Abu Abraham used to draw thematic cartoons which were largely used
by business houses for their promotional activities. One such cartoon put on
hoardings in the capital city of God's Own Country depicted Mahabali asking the
then Union Finance Minister Mr Manmohan Singh to explain why despite falling
inflation, prices were rising. " Please explain you are the economist, I am only an
Onamist!," Mahabali says with all humility.
Something similar is now being talked and discussed about the crash in crude oil prices and surprisingly rising petrol and diesel prices. How can this happen? Recently I was asked by a leading online business channel to give my perspective on this conundrum. Crude oil prices had fallen negative at one point of time and struggled to rise to $40 as the lockdowns were eased in many countries signifying a major loss of demand due to the pandemic.
India is among the third largest country after USA and China in terms of crude oil consumption and unfortunately meets 83% of its demand for crude oil through imports. According to International Energy Agency, India’s oil demand in total primary energy is projected to increase from 233 Million tonne of oil equivalent (Mtoe) in 2018 to 305 Mtoe in 2025, whereas China’s oil demand is projected to increase from 593 Mtoe in 2018 to 672 Mtoe in 2025.
Domestic production caters to only 17% of our demand. The demand is rising four percent every year. Therefore, it is evident that there is a need to balance the foreign exchange outgo and rising demand for crude oil. India's petroleum products consumption rose 5.94% in 2017-18 to 206166 TMT (Thousand Metric Tonnes) from 194597 TMT the previous year. In 2018-19, it further rose 3.41% to 21326 TMT. Import of crude oil accounts for 23% of our total forex outgo.
Domestic production is sought to be enhanced through more exploration of oil and natural gas with an estimated investment of $100 bn . Mr Dharmendra Pradhan, Union Minister of Petroleum and Natural Gas resources said that the government is putting thrust on building oil and gas infrastructure to ensure access to affordable energy to citizens. There is move to reduce crude oil imports by 10% in 2022. A gas pipeline network will soon be covering the length and breadth of the country; from Kutch in Western India to Kohima in the East, and from Kashmir in the North to Kanyakumari in the South. India government has also approved viability Gap Funding/ Capital Grant at 60 percent of the estimated cost of Rs 9265 crore for the North East gas grid project to develop gas pipeline grid of 1656 Km in the eight States of the North-eastern region.
Oligopolistic Market and Inelastic Demand
The global oil industry is in an oligopolistic market where a small number of large companies control the supplies of the commodity. The Organisation of Petroleum Exporting Countries (OPEC) which has thirteen nations with major production from Saudi Arabia, one of the founding members along with Iran, Iraq, Kuwait and Venezeula in 1960. They decide on curtailing supplies if prices fall and on increasing production when prices rise. For consuming nations, crude oil poses geo political risks as they are dependent on the Middle East and not forgetting the Shia-Sunni relations in many countries in the Islamic World, according to Kevin Morisson, Living in a Material World, the Commodity Connection. The second major threat for oil consumers is the longevity of supplies. The estimation of oil reserves is an opaque art that few outside the oil world understand. There is no global agency to monitor its reserves and there is a peak oil theory stating that oil reserves in major nations are in an irreversible decline. OPEC production is depleting. Then US and Canada are the biggest producers of Shale Oil and gas which is costlier than conventional crude oil and also more energy consuming. In fact, it is said that US has a major role to play in keeping crude oil prices higher to make shale oil and gas production worthwhile.
Coming to India, the oil industry is also an oligopolistic market with upstream and downstream players. The upstream players such as Indian Oil Corporation (IOC) and Bharat Petroleum and Hindustan Petroleum have major stakes in the market with Reliance, Adani group and Essar also having good stakes. Demand for petroleum products is inelastic in India because of the average economic growth which as 6-7% annually. This gives room for the government and oil marketing companies to hike prices.
Sale of petroleum products nets huge amount of money to the national exchequer as well as the coffers of state governments. As per official data, Union Government earned Rs 1.72 lakh crore from excise duties and taxes on petroleum products in 2014-15 which rose ot 3.65 lakh crore in 2018-19. The state's share in the bountry rose from Rs 1.60 lakh crore to Rs2.30 lakh crore.
When crude oil prices rise, neither the Central or state governments are willing to reduce the excise duty or other taxes while crude oil prices decline they tend to increase the tax rates. On May 6, the excise duty on petrol was raised by Rs 10 and diesel by Rs 13.
There is also a misconception that domestic petroleum prices are based on global crude oil prices, which isn't true. According to the government, it is based on global prices of petrol and diesel. For eg, global prices of petrol per litre may range from Rs 26 to Rs 40 based on location and refining margins in each country. Our base price are also pegged at around Rs 35 or Rs 40 per litre and rest of the money realised from the consumer is in the form of taxes.
The sharp fall in crude oil prices after the Covid-19 outbreak caused a savings of Rs 25000 cr for the government which it intends to utilise for various welfare activities for the poor and marginalised. A city gas distribution network covering 400 districts to serve 72% of the population is being undertaken.
How can Petrol prices fall in India?
India's petrol prices can fall only with increased domestic production now facilitated through reforms in oil and gas exploration. Petroleum Minister Mr Dharmendra Pradhan has said that an estimated investment of $100 bn has been lined up. Major players such as Saudi Aramco, ADNOC, BP, Shell, Total, Roseneft and ExxonMobil have already invested in exploration and prospecting in our basins along with public sector and private players in India. Our oil companies are also undertaking exploration projects around the globe. Already three bid rounds under Open Acreage Licensing Policy and two rounds of bidding under the Discovered Small Fields (DSF) policy have been completed. Through these successful biddings, India is expected to garner an estimated investment of 58 billion US dollars in Exploration and Prospecting sector by 2023. There is effort to increase the blending of petrol and diesel with ethanol and methanol. Already 10% ethanol is being blended with petrol and 15% methanol blending is being tried out. Among the goals set by the government are 20% ethanol blending in pretrol and 5% biodiesel by 2030. The excess food grains are converted to ethanol for blending with petrol and making sanitizers in the wake of Covid-19. Apart from this biofuels have to be promoted in a big way through research and innovation to keep crude oil demand in check.
Indian Strategic Petroleum Reserve Limited (ISPRL), a Government of India Special Purpose Vehicle, has established Strategic Petroleum Reserves (SPR) facilities with total capacity of 5.33 Million Metric Tonnes (MMT) at 3 locations, namely (i) Vishakhapatnam, (ii) Mangaluru and (iii) Padur. Even as oil marketing companies have healthy balance sheets on good refining margins in domestic market and export realisations, they have combinedly invested Rs 32,000 cr in refinery upgradation processes to produce BS-VI grade fuel.
Due to outbreak of Covid019, even as our SPR and oil company storage is full due to lockdown, the people are forced to shell out more money for fuel as refining margins have come down for oil refiners.
The key takeaways from the foregoing analysis is that an oligopolistic market, inelastic demand, increasing demand due to population and economic growth, increased dependence on exports, geo-political risks and currency risks, government dependence on the commodity to raise budgetary resources all create a situation where petrol prices continue to increase irrespective of world changes in crude oil market. The fuel prices are also an important contributor to inflation and thereby the increase in prices of essential goods. Therefore, it augurs well for the common man if fuel prices are contained and inflation brought under control in the post-covid era.