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Oil Prices Stumble, but for how long?

Shebonti Ray Dadwal is Senior Fellow at the Institute for Defence Studies and Analyses, New Delhi. Click here for detailed profile
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  • May 30, 2018

    After rising precipitously for weeks and breaching the US$80 a barrel mark, crude oil prices are retreating. While the rise was the result of a production cutback of around 1.8 million barrels a day (mbd) by the Organisation of Petroleum Exporting Countries (OPEC), in concert with Russia and other producers, in order to arrest the price fall from 2015 and clear the massive inventory that had built up, the fall too was due to the announcement by Saudi Arabia and Russia that they were ready to ease the curbs on the output. Nevertheless, the oil market is likely to remain volatile until there is greater clarity on the effect of the US decision to withdraw from the JCPOA (Joint Comprehensive Plan of Action), popularly known as the Iran nuclear deal, which was the immediate catalyst for oil prices breaching $80 a barrel on May 17, 2018. The new US sanctions, which are basically secondary sanctions and pertain to foreign companies doing business with Iran, provide for a 90 to 180 day grace period for the foreign companies to withdraw from their contracts in Iran, based on the nature of the commodities and projects. Once in place, these secondary sanctions have the potential to isolate Iran from the international banking system, with countries and companies dealing with Iran liable to be placed under US sanctions.

    So far, the European countries have resisted the US move and are making alternative arrangements, including the issuance of Euro-denominated loans to finance exports to Iran, which would allow them to continue trading with that country without coming under the ambit of US sanctions. The US action is also believed to be pushing the Europeans to be more creative in devising ways to circumvent the US dominance of the international financial system. These include mechanisms to update a 20-year old statute that would allow them to negotiate with Washington to safeguard their existing businesses with Iran. In fact, many institutions and companies around the world are growing frustrated with the increasing scrutiny and interference by the US in their business.1

    Other countries are also doing business with Iran in alternate currencies.2 China, Iran’s largest market for oil, is expanding its own oil futures market, which it launched on March 26, 2018. Beijing has, in fact, been proposing that the West Asian as well as other top oil producers make payments in yuan instead of dollars. Further, in order to make the yuan more attractive, China has made the yuan convertible to precious metals. Indeed, with China being a key market for exports in general, conducting transactions in the yuan would benefit the oil producers looking to gain a market share in China.

    However, while the rise in oil prices seems to have stalled for the time being, all eyes are on the next OPEC meeting scheduled to be held in June. Riyadh and Moscow have signalled that they would begin raising production to make up for the losses incurred by some members, particularly Venezuela, as well as to make up for a potential drop in Iranian oil production once the renewed US sanctions begin to take effect. But several other producers have voiced their opposition to easing the cuts.3 Although the Saudis and Russians can still go ahead and raise production even without a consensus, it is nonetheless expected that the Saudis at lease would prefer to take the consensual route.

    What does this mean for fuel prices in India which have risen relentlessly for the last 16 weeks? At the time of writing, crude was trading at $75.61 a barrel (Brent), while US West Texas Intermediate (WTI) was down by 10 per cent at $66.83 a barrel – its lowest since April 17, 2018. Despite this significant fall, petrol and diesel prices started descending only marginally from May 29, 2018. In Delhi, petrol, which was being retailed at Rs.78.43 a litre, has come down by 60 paise, while diesel, which was being sold at Rs.69.31 a litre, is down by 56 paise (the prices of these two fuels are much higher in other cities).* Since India takes a 15-day average of fuel prices to set its retail prices, the drop in international crude prices are reflected in the domestic market after a delay. 

    Since fuel prices began rising, the government had come under increasing pressure to cut excise duties on fuels, which has witnessed a steady rise since November 2015 even when international prices were ruling low. That was done to make up for the shortfall in revenue, since taxes on oil are levied as a percentage of its price. As a result, when oil prices fall, the government's import bill also shrinks concurrently although its revenue also declines at the same time. And given that revenue collected from fuel sales is a major source of government revenue -- Rs.16.57 lakh crore was raised as tax revenue from fuel sales, mainly from petrol and diesel during fiscal 2017-184 -- it is reluctant to pass on the price fall to the consumers, despite the fact that the administered pricing regime has been abolished. Hence, while the Central government levies a fixed excise duty of Rs.19.48 a litre on petrol and Rs.15.33 a litre on diesel, state governments impose a value added tax, making retail fuel prices in India one of the highest in the world.

    With the easing of international crude prices, the government, which was under public pressure to cut taxes, is unlikely to do so as a cut of Re 1 in central excise duty will mean a loss of revenue of Rs.10,725 crore.5 The government has been justifying the price increases by explaining that this was due to high international oil prices as well as the difference in the dollar-rupee exchange rate. Some Central ministers had suggested that petrol and diesel be brought under the Goods and Services Tax (GST) regime, which would see a significant drop in domestic retail fuel prices. Others have said that the onus was on state governments to reduce taxes as the Centre had already cut excise duty.

    Now, with the fall in global crude prices, and a concurrent rise in the value of the Indian Rupee vis-à-vis the US Dollar, consumers will have to wait and see how much of this will be reflected in domestic fuel prices. If international crude prices rise again, following an OPEC-NOPEC decision to maintain the production cuts, then Indian fuel consumers can expect further financial grief.

    Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India.

    *After announcing the drop in petrol and diesel prices by 60 paise and 56 paise, respectively, Indian Oil Corp (IOC) said that it had made a mistake and the price drop was only by one paise.

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