The Hindu Business Line : High oil prices would hit Indian economy

Crude prices are rising on the back of low stocks in the US, political tensions in Venezuela, the third largest producer of OPEC, and the Madrid bomb blasts. With overwhelming dependence on imported oil, the high international prices would add to inflationary pressures, particularly with the deregulation of domestic prices of transportation fuels, and does not bode well for India, says Paranjoy Guha Thakurta.

LOW STOCKS of fuel in the United States, political tensions in Venezuela, the third largest producer of crude oil in the Organization of Petroleum Exporting Countries (OPEC), and the Madrid bomb blasts have sent international oil prices skyrocketing to levels that are higher than those that prevailed before the outbreak of the US war against Iraq in March 2003.

Right through the first two weeks of March, the price of the benchmark Brent crude in London has been in the region of $33 a barrel and on March 18, this figure jumped to $38, the highest in more than 12 years. All this is pretty bad news as far as India is concerned.

Because of the coming general elections, the Ministry of Petroleum and Natural Gas has prevailed upon the oil companies not to raise the politically sensitive and highly subsidised prices of kerosene and cooking gas. At the same time, on account of the country's growing dependence on imported oil, high international prices of crude would add to inflationary pressures at home, particularly with the deregulation of prices of transportation fuels (diesel and petrol).

The other implication of high world oil prices is, of course, a rise in India's import bill. The Reserve Bank of India has reportedly estimated that every one dollar rise in the international price per barrel of crude oil adds $600 million (around Rs 2,800 crore) to the country's oil import bill.

Since the mid-1990s, the quantum of crude oil produced in India has either fallen or stagnated. The country's dependence on imported crude oil and petroleum products jumped from barely 30 per cent of the total demand in 1991 to nearly three-fourths at present, since domestic output has failed to keep pace with demand. Whereas diesel consumption stagnated recently, with the growth rate of the economy picking up, the demand for the transportation fuel has also risen.

The vulnerability of the Indian economy to fluctuations in the international prices of crude oil has gone up on account of the dismantling of the administered pricing mechanism (APM) for petroleum products. When the first Gulf war broke out in January 1991 after the Saddam Hussein regime invaded Kuwait, India was cushioned from the full impact of the surge in world oil prices simply because the country imported less than one-third of its requirements of crude oil and petroleum products.

Production from Bombay High had just about peaked at that juncture and the rise in the domestic demand for petroleum products was not outstripping the growth in indigenous output of crude oil.

Over the next 12 years or thereabouts, the situation slowly reversed and India started becoming increasingly dependent on imported crude. During the year that ended on March 31, 2003, an estimated 73 per cent of the total value of crude oil consumed in the country was imported and this proportion could rise to three-fourths this fiscal.

Since April 1, 2002, the Centre began dismantling the APM for all petroleum products and started reducing the subsidies on particular products such as kerosene and cooking gas. Though the Ministry of Petroleum and Natural Gas still wields considerable influence on the prices charged by "autonomous" petroleum refining and marketing companies, the fact of the matter is that domestic prices have become — and will continue to be — more and more closely linked with world prices.

Soon after 9/11 and before the American intervention in Afghanistan began, there was widespread speculation that oil prices would go through the ceiling. Memories of the Gulf War that followed Saddam Hussein's invasion of Kuwait in August 1990 were revived. Exactly the opposite happened.

From around $ 24 a barrel in early-September 2002, global prices of crude oil had plummeted to less than $17 a barrel by the third week of November that year. What is evident is that recent years have witnessed the acceleration of a process wherein the "seven sisters" — or the influential Western multinational corporations — have become progressively more powerful at the expense of OPEC.

Oil prices had crashed after the first Gulf war in January 1991. Prices of the benchmark Brent crude plummeted from $36 a barrel in mid-October 1990 to less than $20 a barrel in February 1991 while Dubai Light prices fell from $32 to $14 in this period. Why have international prices of crude oil not fallen this time round?

There are a variety of reasons why world oil prices have remained relatively firm even after the US successfully invaded Iraq. Disturbances in Nigeria and Venezuela resulted in the global demand for and supply of oil remaining rather tight. Add to that, oil stocks are said to be at their lowest in the last five years.

On top of all this, oil demand has been robust and is expected to have grown by over 1.4 per cent during 2003, the highest in the last four years. Supply and demand are currently balanced delicately resulting in prices remaining relatively high unlike in 1990-91.

It is evident that the improvement of the oil infrastructure in Iraq after the war has taken much longer than what had been anticipated. Mr M. S. Ramachandran, Chairman and Managing Director, Indian Oil Corporation — the country's largest oil refining and marketing company — had pointed out last year that Basra light crude oil may not start flowing in large quantities in a hurry. (Basra light happens to be the darling of Indian refiners.) He added that in Iraq there had been reports of poor reservoir management, corrosion, deterioration of water injection facilities and damage to storage and pumping equipment.

The global oil scenario remains uncertain and volatile. Iraq's future relationship with OPEC is still not clear. (OPEC was incidentally born in Baghdad in 1960.)

Whereas OPEC was committed to defending an oil price at $22-28 per barrel in the middle of last year, it has clearly been unable to do so. The OPEC President, Mr Purnomo Yusgiantoro, has repeatedly pointed out that the oil producers' group has been producing above official limits. On March 2, he said OPEC would need to pump extra oil to stem the price rally that added more than $4 per barrel to the price of crude oil since OPEC's February 10 decision in Algiers to eliminate oversupply and cut output by one million barrels a day from April 1.

In the run-up to the latest Iraq war, India had imported oil at relatively high prices to build stocks. The Iraq war and its aftermath have certainly not helped us. Though India has imported barely 5 per cent of the country's total oil imports from Iraq over the last three years or so, the Persian Gulf remains an important area from which India imports oil even if the purchases are contracted out of Russia or far-away Venezuela.

Industry experts estimate that around two-thirds of India's total oil imports come from the Middle East, simply because of the geographical proximity of this area to this country.

At the root of the problem of high international oil prices is a simple fact. The US currently guzzles as much as one-fourth of the world's total consumption of various petroleum products while possessing less than five per cent of the earth's proven reserves of fossil fuels and an equal proportion of the world population. America's high fuel consumption is met largely out of imports since that country's conserves its own oil reserves. The impact of this policy is felt on the rest of the world, including countries such as India.

(The author is Director, School of Convergence, International Management Institute, New Delhi and a journalist with over 25 years of experience in various media - print, Internet, radio and television. He can be contacted at paranjoy@yahoo.com.)