Oil Economics

 

 
Oil Economics

It was down to $83 odd a barrel before attaining $84 this week, down from $115 at the peak,  when talk was of it hitting $200 per barrel and crippling the economies of countries like India, abjectly dependent on imported oil.

Anything we can do in the easing of the current changed scenario, to diversify our energy sources, from solar to hydro to nuclear to wind and wave,  would, in any event, not come a moment too soon.

OPEC, the bane of the oil consuming countries from the Seventies when the first of the future shocks of hiked up oil prices first roiled the economies of the world, is now squealing in an ironically porcine manner, and scurrying to retain its customers.

The cartel is cracking, debating whether to cut production or reduce prices.  It is morphing into a Bedouin bazaar afresh. Saudi Arabia, Kuwait, Iraq, Iran, all have declared for lower prices. Venezuela, across the way in distant South America, may want cuts, but no one is listening.  America, in its neighbourhood, does not need its oil. It was, not long ago, OPEC’s 50% customer, but now is both self-sufficient and a net exporter. It has farmed new fields and discoveries,  exploiting them over the last decade, and turned shale oil into a viable, technical reality, based on adequate home based reserves. Russia, also not in OPEC, is selling its oil to whoever wants it, as are several others in its region. Demand in general is down from Europe and China, as their economic engines have slowed.

India, trying to grow, has an 80% dependency on imported oil.  With lowering procurement prices, down over 20% already, it is reportedly planning to cut diesel prices at the retail pump by an unprecended Rs. 3.50/litre, all at one go, in the first reduction of diesel prices in over 5 years. Transportation will be cheaper. Vegetable and food prices will come down.

The Modi Government may still fight shy of diesel deregulation because of the political implications should prices spike afresh. But will it, because deregulation means saying goodbye to over one lakh crores per annum in diesel subsidy, permanently, a lot of which is not going to the poor at all?

The prices, in any case are headed lower, even as some noted commodity investors think the prices are being manipulated lower. The implication is that the Saudis, with their huge oil reserves, want to drive prices down below viability for the expensive to produce shale oil. China too has an estimated 50% of the world’s untapped shale reserves.  

Saudi Arabia allegedly wants to prevent further exploitation of shale by driving down prices. But will this strategy, if indeed it is in place, be backed  by other, lesser producers in OPEC? Other commodity analysts say that the global demand supply dynamics have changed permanently. That petroleum prices are going to settle at around $ 70 a barrel.

If it comes about soon, such low petroleum prices, will significantly slow the ravages of inflation in India. The Rupee will strengthen. It will trim both current and fiscal account deficits, markedly improve  GDP rates and stimulate business, industry, agriculture and services. This, particularly if other subsidies beyond diesel are also cut, and expensive welfare programmes are accurately targeted to benefit only the poorest.

For India, sharply lower oil prices affords a wonderful opportunity for the Modi Government to fast track its development and reforms agenda. Interest rates can be boldly lowered, sooner rather than later. Gas prices can be slashed. Subsidies on petroleum based fertilizers can also be removed.

The Government can afford  to undertake a substantial external borrowing programme to finance its share of the most  urgent and important infrastructure developments.  Taxes can be cut. Our un der-funded PSU Banks can be better capitalised, and partially privatised for greater efficiency and less corruption .

The stock markets can be modernised and liberalised to accept much higher levels of FII, perhaps at least $100 billion dollars a year instead of the $30 billion odd coming in at present, between the equity and debt markets combined. This area is particularly ripe for reform, both in terms of policy, investment products, and technological improvements, to make it a world class affair. Because, as it stands today, India still has a surprisingly small market cap, and a highly restrictive debt market, given that it is the second fastest growing economy in the world.

This enhanced FII liquidity, quick to arrive if the right moves are made, could further serve, not only to bolster our currency, but contribute much more to finance the fiscal deficit. As it is, the Government does depend on these FII flows, as well as the remittances from NRIs, for long the largest inflow in the world, to manage its finances.

Prime Minister Narendra Modi seems absolutely ready and willing to move on the economy right now. This fortuitous oil price dividend can only help in multiple ways.

(825 words)

October 17, 2014
Gautam Mukherjee