Oil Prices Are Bound To Rise, But The Question Is How Quickly And What It Would Mean For India

by Karan Bhasin - May 20, 2020 09:53 AM
Oil Prices Are Bound To Rise, But The Question Is How Quickly And What It Would Mean For IndiaOil tanks.
Snapshot
  • Normalisation is bound to happen as economies open, and with this demand for oil will rise, increasing prices.

    The question, however, is how quickly will oil prices recover and if this has implications for India.

The global Covid-19 pandemic resulted in a severe clampdown in economic activity with several countries announcing lockdowns and social distancing measures.

A consequence of them was a severe reduction in the demand for oil. This reduction in demand coincided with a sudden increase in oil supply by Russia followed by Saudi Arabia increasing its supply in retaliation.

The worst hit, in the process were, of course, US producers and oil contracts for delivery went negative.

This occurred as people ran out of storage space for oil and consequently, nobody was willing to purchase oil, and those who were holding the oil contracts had no option but to pay people for taking delivery of oil.

Many have since then asked that why do not oil producers simply stop drilling?

The answer is that the costs of not drilling oil are far too high and therefore, most producers are only limiting their production rather than completely stopping it.

It is important to recognise that oil markets are not perfect, and Organization of the Petroleum Exporting Countries (OPEC) and other producers have the capacity to influence prices.

However, in the present case, they decided to increase supplies rather than cut supplies. An obvious objective was perhaps to take losses and get several American producers out of the market so that they can concentrate market power in the post-Covid-19 world.

Oil prices, however, have started to increase and a major reason behind this is that several governments have started to lift lockdowns and are trying to normalise economic activity.

This normalisation was bound to happen as it was not possible to keep economies virtually shut till the time a vaccine was made available. As traffic resumes, so does the demand for oil and consequently, oil prices increase.

The question, however, is how quickly will oil prices recover and if this has implications for India.

A sharp increase in international oil prices could result in an increase in consumer prices across states as both central and state governments increased their share of taxes to benefit from the low oil prices.

As international oil prices increase, governments may have to reconsider the existing taxes to prevent consumer petrol and diesel prices from increasing sharply. This also means that the revenue mobilisation from these taxes could be lower than what was anticipated.

There have been many who have expressed these concerns over the last few days, some in the form of articles, while others during discussions.

However, with the global economy under a recession, the prospects of a significant increase in oil prices are unlikely as global demand will continue to remain weak over the coming weeks.

This will be true especially as aviation, travel and tourism sectors experience one of the sharpest economic contractions.

It is foolish to expect oil prices to stay where they are and equally foolish for them to rise back to the rates in 2019.

However, the important question is about what will be the policy response of the government to any changes in international oil prices; whether it will pass them over to consumers and let the retail prices increase – or whether, it will adjust its taxes that it has increased due to the reduction in prices to ensure that consumers are cushioned.

Perhaps, adjusting the taxes is any day a better strategy than allowing the retail prices to be hiked.

There are economic and ethical arguments for this. Economic arguments are based on experiences of economies that have hiked taxes – whether direct or indirect during recessions.

To try to think about balancing budget is what led to the Great Depression worsening across the US, UK and other industrial economies.

Therefore, small tinkering is still fine as long as we don’t go overboard with the objectives of revenue mobilisation, but even then, we must not let retail prices to increase as oil is a critical input.

The ethical argument is more important; that is, since consumers didn’t benefit from the low oil prices, then should they be penalised for oil prices increasing slightly even as they are lower than the 2019 level?

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