Oil prices flare up

With tensions continuing as Russia closes in on Ukraine, a threat of sanctions from the West is rapidly causing crude oil prices to hurl towards the $100/barrel mark. The consequences for India could be catastrophic in this case.

By Murali Gopalan calendar 30 Jan 2022 Views icon6838 Views Share - Share to Facebook Share to Twitter Share to LinkedIn Share to Whatsapp
Oil prices flare up

Oil prices are threatening to spiral out of control with an imminent Russian invasion of Ukraine that has the West on the edge. For the first time in over seven years, crude oil breached $90/barrel (Rs 6,660) in the fourth week of January and could comfortably cross the $100 (Rs 7,401) mark if tensions continue to escalate.

One can well imagine what this could mean for India which imports over 80 percent of its oil requirements and has had a cushy time for some years now thanks to prices being largely benign. They were beginning to rise in recent times but this did not deter the Centre from milking the excise duty proceeds from petrol, diesel and cooking gas to the maximum extent possible.

The policymakers were not deterred by the fact that the man on the street was coughing up over Rs 100/litre on petrol and over Rs 90 for diesel thanks to a gargantuan excise duty component. Oddly enough, protests were muted compared to the not-so-distant past when political rallies were inevitable with fuel price hikes. This time around, the Opposition clearly seems to have run out of steam and the Centre continued to rake in the revenue from auto fuels without a fuss.

However, things could get very tricky this time around. For the last few months, prices have remained pretty much the same at the pump level since assembly elections are underway and the ruling BJP cannot afford to antagonise voters with high stakes involved. A fuel price hike is a recipe for disaster during the elections and every political party across India’s vast landscape is more than aware of this reality.

Once the votes are cast, little time is wasted in implementing the long awaited hike which is the only way to ensure that the public sector oil companies stay afloat. The common man is absolutely aware of this too and this merry-go-round of deceit and cynicism has been part of the Indian political ecosystem for decades now.

Ukraine crisis
Today, we have a situation where crude oil prices could even soar to over $125/barrel (Rs 9,251) by end-February if there is no resolution found to the crisis building up in Ukraine. Russian President, Vladimir Putin, is in no mood to listen to reason and wants to assert his country’s supremacy. 

The problem is that the United States is not going to interfere either especially in the backdrop of its withdrawal from Afghanistan and leaving the country at the mercy of the Taliban. The US of today is in no mood to get involved in conflicts happening elsewhere in the world more so when the pandemic is still on the rampage.

Russia will still need to be mollified by the international community simply because its support is needed to take on a belligerent China which is building its presence ruthlessly in the Asia-Pacific region. Unless something dramatic happens, Ukraine will pass over to Russia without a fuss so that the bigger task of keeping China in check continues. Any aggression against Russia could see it align with China which is not good news for the world especially at a time when the US is in no mood to interfere globally as it used to in the past.

It is in this troubled scenario that crude prices are on the rise — which is only natural since politics, more than just economics, plays a big role in their movement. Abrupt tensions in the Middle-East or threats of war, as is being played out right now, inevitably leads to a flareup in prices and if they reach the levels of $150/bbl (Rs 11,101) recorded in 2008-09, India will be up to its neck in deep trouble. The last thing it needs now is a whopping import bill at a time when it is crawling out of the woods following yet another Covid wave.

The impact on the auto sector can well be imagined too should fuel prices spin out of control. The two-wheeler segment is already seeing how customer sentiment is being impacted at the commuter end. It is here that entry-level motorcycles, which take up a lion’s share of overall sales, are feeling the heat. 

Buyers in this category have already seen their incomes fall with the pandemic because of the nature of the jobs they are in within the unorganised sector. Motorcycles have already seen price tags increase thanks to regulation levies and now another burden in the form of more expensive petrol will literally be the last straw on the camel’s back.

It is also a given that sales of top-end cars/SUVs or premium bikes may not suffer as much since their customers are way more affluent and will not be concerned about paying more for petrol or diesel. However, compact cars which are largely sold in smaller cities and towns could find the going tough if the fuel price spiral continues unchecked. 

If the Centre chooses not to rein in prices and believes that the spirt of a free market regime should prevail, it will be tough going for commuter motorcycles and compact cars which depend solely on petrol especially in those regions without a CNG option. Those which have it (CNG)  like Delhi, Maharashtra, Gujarat etc will get by even while there is no telling how natural gas prices will react to the current global crisis. Logically, they will begin climbing quickly too which will put added pressure on automakers and customers.

Sops for EVs
Quite predictably, clean air proponents will argue why electric mobility makes so much sense except that the percentage of EVs in the country is so negligible that it is not even worth a debate at this point in time. Sure, the Centre has doled out tremendous fiscal sops for electric but the transition will take time especially when it means accounting for a more sizable portion of the current vehicle population.  

Further, there is no way these incentives will continue forever and the industry will be hoping that battery prices reach affordable levels before being able to proclaim confidently that the EV revolution is here to stay. Observers believe that all this will still be work in progress for a large part of this decade and the early adopters will typically be in the pickup space where the e-commerce boom is happening.

Till then, fossil fuels are not going to disappear in a hurry which means that India will just have to be prepared to cope with massive volatility of crude oil prices as is being seen right now when geopolitical tensions are on the rise. Since 2014, when the BJP came to power, it has had the good fortune of dealing with lower crude prices but this time around it will need to do a fine balancing act between protecting the interests of the common man as well as the oil companies retailing auto fuels.

Rewind to 2008 when the world had turned upside down with the Lehman crisis, the crash of Detroit especially General Motors and Chrysler, and the crude oil hike which saw prices reach dizzy levels. India’s public sector companies were still retailing petrol and diesel within the administered pricing mechanism which meant factoring in subsidies for the customer.

Things became so bad at one point in time that these PSUs were carrying out daily operations with very little cash in their kitty. While crude prices were averaging over $135/bbl (Rs 9,991), auto fuels were heavily subsidised and the trio of IOC, BPCL and HPCL were losing out big time everyday. 

The Centre had a compensation mechanism in the form of oil bonds but these would not come on time and interests on borrowings just soared as a result. Typically, the richer exploration duo of ONGC and OIL India which benefited from high crude prices would then be roped in by the Centre to help their struggling refining and marketing counterparts.

These were very difficult times and what added fuel to the fire was that the heavy subsidy on diesel naturally caused the fuel to be cheaper than petrol. It was precisely this fact that prompted customers to make a massive beeline for diesel-driven cars and automakers, especially those in the SUV space, benefited as a result. 

Those who were stuck with a petrol range, like Honda Cars India for instance, suffered because the prevailing mood then was predominantly diesel which was a good Rs 30/litre cheap than petrol during those days following the global slowdown. The behavioural pattern was perverse because the subsidy on diesel was largely intended for sectors like farming, power and trucks but ended up being used by more affluent owners of cars and SUVs. The Centre would do its bit by slapping heavier levies on diesel vehicles but clearly this was not the longterm solution.

Out of administered pricing
Once crude prices were back to levels of $30/bbl (Rs 2,220), the new Narendra Modi-led regime at the Centre which took charge in 2014 wasted little time in ensuring that both petrol and diesel were out of administered pricing and would follow market trends. On paper, this was welcome but both the Central and state governments realised that auto fuels were critical cash cows to keep their finances afloat. Over the years, the excise duty levels kept increasing even while global crude prices remained at reasonable levels of $65-70/bbl (Rs 4,801 - 5,180).

Customers were unhappy about paying so much for petrol and diesel while occasional respites came about in assembly elections as seen in 2021 when key states like West Bengal and Tamil Nadu went to the polls. The Centre countered criticism of imposing high excise duties by insisting that the money was used for welfare programmes and infrastructure projects. It is also likely that protests did not gather momentum because of the pandemic and the fear of contracting infections in large crowds. 

Further, with a large chunk of the population working from home, there was really no need to take long drives which meant that money was saved on fuel payments. Even today, while offices have opened up, the rotational work cycle is helping from the viewpoint of more modest spends on petrol and diesel but this is not going to last forever. As more people start heading back to work more frequently, they will realise that their vehicle fuel bills are hurting their home budgets and this is when the Centre will have to do its bit in softening the blow.

Right now, it looks as if global crude oil prices will continue increasing while keeping pace with the tensions enveloping Russia and Ukraine. There are other tremors likely across the east if China decides to get aggressive about pulling off something similar with Taiwan. 

India is literally caught between a rock and a hard place — it has ongoing commercial partnerships with Russia and could face pressure from the US, its valuable ally, to call these off if the Ukraine crisis continues. If this were to happen and Russia aligns with China, India will be in an even more difficult position. 

Chinese troops are already causing friction along the border and there are no signs of these easing out in a hurry. If India is forced to sever ties temporarily with Russia, it is going to needlessly lose another ally. 

High input costs
The auto industry will be hoping that crude oil prices do not continue to climb since they have the potential to disrupt the growth story. Manufacturers are already grappling with the challenge of high input costs, shortage of semiconductors, making massive investments in electrification and coping with the reality of a diminishing buyer base in rural India. 

High diesel prices will stoke inflation which is already pinching consumers’ pockets as truck operators increase freight costs. Petrol is constantly referred to as the rich man’s fuel but there is an endurance limit even for its buyer base. The only way out is to go in for a slash in excise duties even if it means foregoing revenues.

The best piece of news for customers is that prices are not likely to increase for some months thanks to the assembly elections this year in critical states like Uttar Pradesh, Punjab and Goa. On the contrary, freebies are assured during this time which means that people can breathe easy and carry on with their lives. 

Yet, there is no denying the fact that the Centre has a problem on its hands with crude oil prices shooting through the roof at a time when the economy is still walking a tightrope. The slowdown was already happening before the pandemic and the lockdowns that followed from early 2020 only aggravated it. Omicron could hopefully be on its way out by March but geopolitical tensions will remain which does not augur well for crude oil prices and the Indian economy as a result.

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