Increasing crude oil prices huge blow to the economy

Written by Shobhana Subramanian | Updated: Feb 28 2012, 06:08am hrs
Surprisingly, not much of the text that finance chiefs and central bank governors of the G-20 nations put out in Mexico last weekend is devoted to rising crude oil prices. Theres no hint that the liquidity unleashed by central banks to bail out near-insolvent nations may have been partly the cause of the sharp spike in crude oil prices to $125 per barrel. Of course, rising geopolitical risks, namely the escalating tension between Iran and the West over the latters disputed nuclear programme, have exacerabated the situation. And if more liquiditylike the ECBs euro 489-billion LTROcomes in, it would only boost commodity prices further. The Thomson Reuters CRB Jefferies Index has risen around 6% so far this year with crude oil prices racing up 17%. Supply can be increased if the US and other economies draw down their strategic oil reserves. But should crude oil prices rise further, among the worst hit will be countries like India and Turkey, whose stock markets have outperformed their peers on hopes the inflation is easing.

India imports three-fourths of its oil requirements and has among the largest subsidies. It could spend more than 0.6% of GDP in subsidies this year. Assuming the cost of the Indian fuel of around $120 per barrel, the under-recovery for diesel is around R12.50 per litre, for LPG it is under R400 per cylinder while for kerosene, its close to R29 per litre. In June last year, diesel prices were raised by 9% and prices of LPG and kerosene, by 14.8% and 19.8% respectively. However, simultaneously, the customs duty on crude oil and petro products was brought down and the excise duty on diesel cut from R4.6/litre to R2/litre. This time around, the government cant afford to reduce customs or excise duties. As of now gross under-recoveries, for 2011-12 are expected to hit R1.38 lakh crore.

The fiscal deficit between April and December has already hit R3.8 lakh crore. So some hikes are necessary; a full pass through would impact the WPI by at least 3.5% and would most certainly reverse the falling inflation trajectory. The rise in prices of fuel should curtail consumption and hopefully bring down the oil bill. Against the Asia-ex Japan average of 6.7%, Indias oil consumption rose 15.2% in 2010, higher than Chinas 10.4%. Higher oil imports will pressure the current account deficit, estimated at close to 3% of GDP. While the sharp rise in portfolio flows ($8 bn) into the equity and debt markets this year has helped stem the depreciation of the rupee, any rise in risk aversion globally, could see these flows disappear as soon as they arrived.

Meanwhile, its track record exploration has been fairly good with some big successes, including Cairn, projects cannot be held up. The PMs office has called for a meeting this week to figure out why around 150 files are still gathering dust in the oil ministry and also take stock of the delays in exploration activity.

There are apparently inter-department disputes over two dozen blocks, relating to exploration rights. Reports say the London-based Hardy has been compelled to halt crude oil production at its Cauvery basin block since its waiting for clearances. The sooner these issues get sorted out, the better.