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Cooling oil prices: India breathing easy financial scene

The decline in world oil prices should bring some cheer to the government which has been battling inflation and an economic slowdown for some months now. From a peak of $147 a barrel in early July oil now trades at around $112. In July alone it fell by $20. However, these are early days to conclude whether the falling prices are part of a downtrend or are momentary.

The distinction between a relatively permanent decline — taking prices to, say, below $100 a barrel — or a temporary dip is important. If it is the former, it is good news for the global economy.

Living standards across the world can be improved. If, on the other hand, global oil starts moving up again, deep rooted concerns as to how much high it will go will keep central banks and governments on their toes.

One difficulty with the oil markets relates to forecasting the prices. Experts disagree fundamentally on the range within which they will move even in the short-term. For a slightly longer period, some see prices crossing the $200-mark a barrel and moving up further. Those who had predicted a fall, admittedly a smaller number, probably did not get their timing right.

Even the commodity exchanges and oil futures markets have disappointed. The spot markets did not give any clue about the recent flare up. Today while oil is at around $112 a barrel, the futures markets continue to indicate higher prices.

Speculation, widely believed but not proved to be a principal factor behind the phenomenal rise in oil prices, is present even when prices decline. It appears that plenty of speculative money is now betting on a downturn in prices. However, it is not speculators but fundamentals that should guide any assessment of price movements.

Demand from India and China are expected to remain strong.

Although the U.S. and other developed countries have curtailed their consumption, they are yet to build up their inventories to the required safe levels. This would indicate some large buying by the U.S. in the days to come. Disturbances in Nigeria and more recently in the Caspian Sea region in central Asia have cast a big shadow over supplies. It is noteworthy too that even with historically high prices, oil supplies have been very slow to respond. This is attributed to structural rigidities of the hydrocarbon sector. Long gestation periods and environmental concerns, for instance, have hampered quicker response by way of capacity additions to the price stimulus.

Saudi Arabia’s decision to hike its oil production to recent record levels is said to be one of the principal reasons for the softening prices. Reportedly, the world’s largest oil producer along with a few other OPEC countries has as much interest in preventing a further steep escalation in oil prices as the big consumers. That primarily arises from a belief that demand for hydrocarbons will come down if prices stay high.

To some extent this has already happened in the West. Besides, alternative energy sources and previously unviable projects within the hydrocarbon sector are beginning to look attractive at current price levels.

Softer oil prices are certainly good news for the Indian economy especially as many other commodities are also getting cheaper at the global level.

A principal cause for the current high inflation in India has been the surge in commodity prices. However, it is difficult to say how long and by how much commodity prices will continue to fall. Moreover, the decline in many commodities is attributed to lower demand in the developed world, whose economies are slowing down.

What is obviously of immediate interest to Indians is whether retail prices of petrol, diesel and other petroleum products will come down. Government sources have ruled out that possibility. In India, retail prices were never linked to global oil prices .Even after the last hike Indian consumers remain substantially subsidised. The oil marketing companies are still reeling under under-recoveries. The cost of the Indian import crude basket has started coming down but still trails global prices.

Any move to reduce retail prices will have to take into account the fact that serious distortions in the pricing have already occurred. Some of these, notably the huge subsidy burden, are complex and cannot in any case be rectified in the near future. Hence, even if global oil were to drop further sharply, there is no guarantee that retail prices can or will be brought down.

There is great irony in the fact that a high level committee on petroleum prices has suggested an increase and not a decrease in petrol and diesel prices. The committee headed by the former petroleum and cabinet secretary was however looking at the entire gamut of petroleum pricing. Its tasks go far beyond suggesting follow up action in the wake of lower global prices.

Yet the report which recommends a graded increase — Rs. 2.50 for petrol and 75 paise for diesel — each month until the retail prices fully reflect the global prices is ill-timed, not just because of the correction in global oil prices. In an election year, hardly any political party will countenance even a one-time increase leave alone successive hikes. But the report has value over the long term. Like its prescription for petrol and diesel prices, some of its other recommendations are for the long-term. These include using smart cards and the like to target subsidies on kerosene and LPG, reducing their entitlement and levying a kind of windfall tax on domestic producers above a certain point. All these require careful study.

At the present juncture, however, with very little possibility of any of its recommendations being accepted, the Chaturvedi committee report may end up as a theoretical exercise.

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