Oil prices, measured using the Brent Oil benchmark, have fallen more than 50% since striking $115 per barrel in June 2014. Latest prices are hovering just under $50 a barrel, having hit a low of about $43 per barrel in late August. Few predicted such a sharp fall in oil and fewer still suggested that it could remain so for 17 months.
As an investor in emerging markets, I had long ago stopped trying to predict oil prices. Oil is influenced by a multitude of factors, unpredictable in their (changing) relative importance. Global oil supply, demand from developed markets and developing markets particularly China, geopolitics and the supply behaviour of the oligopolistic Opec producers all impact oil price. If that were not enough, it sometimes behaves as an alternative reserve currency, an anti-dollar surrogate, and therefore could be influenced directly by US monetary policy. In this latest episode, new and significant supply from US shale oil, Opec’s decision not to change output and China’s soft economy have been blamed for the prolonged slump. There are conspiracy theories as well: a US attempt (with Saudi help) to squeeze Russia, a US and Sunni Muslim attempt to hold a re-engaging Iran in check and a bid by traditional oil producers to quell the US shale oil threat are the lead narratives.
Whether excess supply, deficient demand, conspiracy or a combination, the path of oil price has been downward for longer than most expected. This has important implications for many countries—socioeconomic, political and economic. Oil producers are significantly affected—Saudi Arabia may have to debt finance its budgetary burden for the first time in its modern history, Russia’s ability to finance conflicts in Ukraine, Crimea and elsewhere may well be impacted, Brazil’s woes are getting a whole lot more complicated and Venezuela’s economic disaster may be entering its terminal stage. Consumers in large markets like the US, China and India are the economic beneficiaries of lower oil price. Such a reduction is equivalent to a massive tax cut and it makes a greater part of a consumer’s wage available for spending or saving. The economic rebalancing that is triggered by a sharp price correction has already begun. Oil majors have begun to sack workers, reschedule capital expenditure and rethink greenfield projects. A supply reduction by oil producers is quite likely. The tax cut will stimulate consumption in many economies.
India imports 80% of its crude and is the unequivocal beneficiary of lower oil prices: it impacts India’s current account and budget deficits directly and positively. With the oil price having dropped from a median of about $80 in the last fiscal year to about $55 this year, on a year-on-year basis it also has significant implications for the inflation rate. This much is well known and widely telegraphed. Less appreciated is the fact that this provides India with a strategic window to undertake significant structural reform. Here are some ideas directly related to the oil price fall.
Accelerate India’s strategic oil reserve: India has had plans to build and implement strategic petroleum reserves (SPR) in the rock caverns of Visakhapatnam, Mangaluru and Pudur. While the financing for SPR must come from the budget, the stored oil can be part of “international reserves” on the Reserve Bank of India’s balance sheet. In recent weeks, China has been stockpiling crude at a furious pace and is nearly half way through building 500 million barrels in storage, which is equivalent to 90 days’ oil demand. India’s ambition is to hold nine days of demand (36 million barrels) and the implementation has only just begun with the completion of the Visakhapatnam facility. SPRs are no panacea, but have both a strong strategic and insurance rationale.
Accelerate Euro VI standard for vehicles: The current plan is to require auto manufactures to implement the Euro VI standard by 2020. Even though it is not trivial to accelerate engine design and development, revised standards must push auto manufacturers to do so. India must become more effective at managing its oil demand if it is to reduce its external oil dependence.
Make bolder budget choices: Even though fertilizer prices have remained flat for some time, they have fallen over 50% from a 2011 peak. In the context of an oil price “tax cut”, the fertilizer subsidy should be phased out. Finance minister Arun Jaitley has already begun a subtle shift from spending to investment in infrastructure. Carefully chosen infrastructure projects—in roads, ports, electricity transmission and agricultural markets—have the potential to catalyse the economy. Long-term social infrastructure projects in public health and education should be prioritized over unproductive government wages. An imperative is to streamline government functions and close unviable government companies. The cushion from lower oil price allows for generous retirement and retraining benefits for employees in these companies. India’s structural actions can convert a one-time windfall into a lasting one.
P.S. “Governing a great nation is like cooking a small fish, too much handling will spoil it,” said Lao Tzu.
Narayan Ramachandran is chairman, InKlude Labs.
