The Big Oil Crash and What India Should Do Now ?: Sanju Verma

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Ms Sanju Verma
An Economist, Chief Spokesperson for BJP Mumbai and Author of the Bestseller–“Truth & Dare-The Modi Dynamic

WTI crude had a mind numbing and unprecedented crash, on 20th April 2020, from $18 per barrel to a low of  minus -$40.32, before settling at minus -$37.63, per barrel. One of the prominent reasons behind this was the lack of demand due to the Coronavirus outbreak which has forced many big economies of the world to enforce complete lockdown, to curb the spread of the dangerous Chinese Wuhan virus.

This in turn wrecked the demand for crude oil to historic low levels. In addition to the demand factors, an expiry of May futures on Tuesday, the 21st of April 2020, played a major role in this price crash. Futures contract refers to a contract for assets bought at agreed prices, but delivered and paid for at a later date. It allows sellers and buyers to hedge against the inherent risks, involved therein, futures contract usually trade by the month.

The June WTI (West Texas International) contract, which expires on May 19, fell about 18% on this unforgettable Monday, to eventually settle at $20.43 per barrel. However, while the US WTI crude prices crashed, ICE’s (Intercontinental Exchange) Brent crude oil was still trading over $25 a barrel on Monday,the 20th of April. The sharp divergence between WTI and Brent crude was seen as, WTI is produced in landlocked areas with limited storage facilities, which increases the cost of transportation. On the other hand Brent crude originates from oil fields in the North Sea, so the transportation costs are significantly lower and deliveries can be done offshore at multiple locations.

The storage constraint of WTI crude oil, led to the dumping and unwinding of May contracts,pushing WTI crude oil price to negative levels.Both WTI and Brent Crude are “sweet” crudes,though the viscosity and American Petroleum Institute (API) gravity of WTI is lesser than Brent,making WTI lighter,of the two.

Now the question rises whether the oil prices in India would fall,as the US crude oil turned negative. India imports more than 82% of its crude oil requirements every year. In fact, oil alone accounts for over 20% of the country’s entire merchandise imports. But the prices hitting negative in the US, won’t necessarily mean a huge fall for India because, India’s entire crude oil purchase cart is a mix of sour crude oil that is sourced from Oman, Dubai and of course, sweet Brent crude.

India does not consume WTI crude,which is mostly relevant for the local US, Canada and Mexican markets. True,Brent crude, which is what India imports, has also seen a steep fall,with prices on Wednesday 22nd April 2020, falling to $16 per barrel, which translates into an over 35% fall in barely 48 hours!! Brent may not be as cheap as the WTI, which is the benchmark US oil,but Brent has certainly fallen,too.

So yes, India does benefit from the sharp drop in Brent crude prices as ever dollar fall in the price of Brent crude,saves India $1.5 billion,by way of lower import bill, lower trade deficit and therefore, a lower current account deficit (CAD). But one must note that over and above the refining and processing costs, for crude which India imports from OPEC countries, there is a levy charge that is imposed for Asian countries,known as the  “Asian Premium”, which increases the import burden for countries like India.Hence, embarrassingly juvenile statements from the likes of an ignorant Shashi Tharoor who fancies himself as a “know all”, even on matters he knows nothing of, should be dismissed with the contempt they deserve. Do note, Tharoor, took to Twitter, asking the Modi government to pass on the benefit of the crash in WTI crude prices to Indian consumers,without so much as knowing the basic difference between WTI and Brent crude.

The government had on March 14th 2020, raised excise duty on petrol and diesel by Rs 3 per litre each, to raise an additional Rs 39000 crore in revenues,annually. The government moved an amendment to the Finance Bill, 2020, to raise the limit up to which the government can raise special excise duty on petrol and diesel, by Rs 8 per litre each in future, to Rs 18 per litre and Rs 12 per litre, respectively.

This amendment empowers the government to control the petrol and diesel prices more flexibly, by increasing or decreasing the excise duty on petrol and diesel.This is a welcome move,as it allows the government the leeway that it needs and rightfully deserves,to raise resources from fuel taxes which can then be used for more productive expenditure on building roads, highways, sports and other infrastructire. In any case,with electric vehicles (EVs) being the future and, with diesel being a polluting fuel, there is certainly merit in having a relatively higher tax on polluting fuels.

In a recent development, to stabilize the crude prices OPEC plus countries which control around 50% of the crude oil production worldwide and around 90% of world’s proven oil reserves, announced a record production cut of 9.7 million barrels of oil per day, starting May 2020. Some experts however, are of the view that, even this sizeable cut in supply from the oil producing countries won’t help much, as the global economy is in a complete standstill mode and a sharper output cut is needed, to prevent both WTI and Brent crude from going into a gravity defying freefall. Equally,the transportation cost of shipping oil, has gone up by 3 times since March 2020.

All the above developments might not help in reducing the import bill of India in the same proportion as the fall in crude prices,though ofcourse, other things remaining constant, a fall in Brent crude,is certainly beneficial for India. If rupee does not depreciate,then the overall gain from falling crude prices,on India’s overall balance of payments position and other economic parameters, is much faster. Depreciation of the rupee versus the USD,can negate the positives emerging from lower oil prices.

Hence, Indian policy makers have to ensure that the rupee is kept fairly stable. Needless to add, the Modi government, under Prime Minister Narendra Modi,has done a fabulous job of not allowing the rupee  to depreciate too much,even under extraordinarily challenging circumstances. The most important thing for India, is to build enough storage capacity to store oil. India currently has strategic petroleum reserves (SPR) of 37 million barrels, enough to last only for 13-16 days,at the current going rate of consumption.

The remaining capacity is not ready yet. Ongoing corona virus lockdown in India means there is partial economic activity and no significant demand for oil from industries,as of now. India refiners already have reasonable existing stock.Hence,now is as good a time as any,to not only replenish existing buffer stock but,to also invest in creating fresh storage capacities.Storing cheap oil will be the biggest challenge for countries, globally,going forward.

Do note,the bizzare crash in WTI crude on Monday,20th April 2020,was,besides the ongoing demand destruction,largely driven by the fact that storage capacity at Cushing in Oklahoma,had been completely used up.Brent crude oil prices for the next 7-9 months,will move in a range of $30-40, per barrel,unless there is a major geopolitical related supply disruption.With IMF predicting a negative GDP growth of 3% for the world and a negative 6% GDP growth for the USA,oil demand will not rise much in the near future.

Even China,one of the biggest oil consumers globally,is slated to have GDP growth of only 1.2%,in 2020. Russia,which has agreed to the OPEC cut starting 1st May 2020,may back out of this “output cut” deal,after some months,as it has often done that in the past.If Russia goes back to pumping record crude,any perceptible rise in crude oil prices is capped for good,in the near to medium term.With 160 million barrels of crude oil sitting in tankers and floating around the world,with very few takers,the world has a new challenge–where and how to store this excess crude.

The twitter thread below,written on 20th April and 21st April 2020 by Sanju Verma, summarizes, a lot of what has been written in this piece.

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