Given that US shale production has barely fallen as most had predicted, despite oil prices falling to an 11-year low, and Iranian oil getting back on track following the lifting of sanctions, crude oil may just fall to the $20 levels that Goldman Sachs and CLSA are predicting, especially given the low global demand. The immediate impact on India will be positive since the current account imbalance will further reduce, and finance minister Arun Jaitley will get another oil bonanza of the sort he has got this year—with crude oil prices falling from an average of $85 for FY15 to $50 for FY16, Jaitley will get an additional R65,000 crore through additional imposts on oil; a fall to $20 in FY17 will afford him the chance to do this again, though the magnitude will be proportionately lower. Given the economy is likely to continue to be weak, Jaitley is likely to continue to spend the money on additional capex as opposed to routine expenditure though just the additional expenditure on the pay panel and the defence force’s OROP will cost around R1 lakh crore extra, or around 0.7 percentage points of GDP.
The larger implications of cheap oil are, however, less comforting. Since sub-40 oil means a weak global economy, exports will suffer even more and, with economies in the Gulf badly affected, there could be an impact on India’s $65-70 billion of annual remittances. More problematic is the likely impact on India’s crude oil production since the public sector ONGC’s break-even cost is around $40—that means a significant part of its expansion plans, such as the $6-8 billion for the 98/2 field could get pushed back a few years. Given this, it is amazing that the government is locked in a court battle with its largest private-sector producer Cairn India over not extending the latter’s production sharing contract—Cairn’s average oil production cost is $20-22 for existing fields and while it will rise for new exploration, break-even costs will be lower than for ONGC.
Not only has the oil ministry not taken a decision on extending Cairn’s contract in the Rajasthan basin, it continues to charge a cess on production that was fixed at a time when crude was trading at over $100 as compared to today’s $36—the cess was raised from R1,800 per tonne to R2,500 in 2006 when oil prices rose from $35 to $65, and then again to R4,500 in 2013 when prices crossed $100, but was not revised downwards as it should have been automatically; that means domestic oil producers pay a cess equal to around 26% of current crude oil costs. This makes production uneconomical and means it is cheaper to import. More shocking, while the government dithers over lowering this unjustifiable levy, other countries like the US, the UK, Russia and Argentina are improving their fiscal terms in order to ensure oil producers don’t slash their exploration budgets dramatically—most oil firms have reduced their exploration budgets in the face of collapsing oil prices. A useful lesson for oil minister Dharmendra Pradhan is that long periods of low-priced oil are followed by long periods of high-priced oil since it takes several years for oil to flow after the investment cycle resumes. If India doesn’t do its best to ensure exploration investment remains at a certain base level—the government is also locked in a legal battle with Reliance Industries on gas pricing—it will be caught short when crude prices start rising and local production stagnates. The same thing will happen to subsidies, if in the window available, the government doesn’t free-up pricing of LPG and kerosene.