How rising Oil Prices affect the Indian Economy?


4 min read
How rising Oil Prices affect the Indian Economy?


What is Brent Crude?

Brent crude — also referred to as Brent blend is the leading global price benchmark for Atlantic basin crude oils. It is used to price two-thirds of the world’s internationally traded crude oil supplies. The Organization of the Petroleum Exporting Countries (OPEC) controls most of the brent production and distribution, often dictating costs for not only oil suppliers but countries as well. Most nations factor oil prices into their budgets, so OPEC has been considered a leading geopolitical force.

OPEC, a group of 14 of the most powerful oil exporting countries, use Brent as their pricing benchmark. They are considered an extremely powerful group, as oil prices dictate the budgets and policies of many countries.

Effect of ‘change in Brent Crude Price’ on Indian Economy

Price rise in Brent Crude
  1. Corporate profit margins

If the Brent Crude price surges, it mainly affects 5 major industries in India — Aviation, Tyres, Cement, Paint and Oil Refineries.

If Crude prices increase then:

Aviation Industry: Fuel cost will increase, Net Profit goes down.
 — Tyre Industry: Rubber price increases, Net profit goes down (synthetic rubber in the global market is produced from Brent Crude only).
 — Cement Industry: Most of the cement companies are using 80% of petcoke as fuel. So fuel price will crease and net profit goes down.
 — Paint Industry: Titanium dioxide (TiO2) and crude derivative products form 50% of the raw material cost of paints. Same.
 — Oil Refineries: HPCL, BPCL, RIL

2. Fiscal math: An increase of $10 per barrel in crude prices will lead to an increase of about Rs17,000 crore (or $2.5 billion at an exchange rate of 67/$) in fuel subsidies, equivalent to 0.09% of GDP. The CAD (Current Account Deficit) by about $9–10 billion dollars.

3. Inflation: Every $10 rise in crude prices raises India’s inflation by 10 bps. the economy is affected as a rise in inflation due to higher prices could lower real disposable incomes of households and therefore hurt consumer discretionary demand.

Why the US is not happy with Iran?

The primary point of contention has been the Iranian nuclear deal. Iran has been working on Nuclear program and when others saw it’s happening, they weren’t happy and Iranians were asked to hold the operations but they refused. Until in 2015, Under Obama administration, all parties finally reached a mutually acceptable agreement. They called it-The Joint Comprehensive Plan of Action (JCPOA).

When Trump came to power stopped the deal and started putting economic sanctions on Iran. Effective November 2018, US put sanctions on Iran’s energy sector, including petroleum. However, waivers were granted to eight nations to import oil from Iran which included China, India, Japan, South Korea, Italy, Greece, Turkey and Taiwan for a period of six months, to allow them time to gradually shift to alternative sources for importing oil.

US Strike on Iranian General is also a part of it.

According to the recent World Economic Outlook (WEO) by the International Monetary Fund (IMF), roughly 80% of the recent oil price increase was caused by deterioration in supply conditions (particularly faster-than-expected deterioration in Venezuelan output).

The waivers got expired in May 2019 and Four countries including Italy, Greece, Turkey and India have stopped importing from Iran. As countries reduce importing from Iran, global oil demand was supposed to increase as Iran is the fifth-largest producer of crude oil, contributing to 5% of world crude oil production; and sixth largest oil exporter, accounting for slightly less than 5 % to global exports as on 2017.

Why India is worried about US-Iran tensions?

India, which imports 84% of the crude oil it consumes, depends on Iran for 10 % of its oil imports (FY19).

Iran is India’s third-largest oil supplier after Iraq and Saudi Arabia. There are several advantages that Iran offers, which comprises:

  • 60-day trade credit, discount on freight
  • Insurance and payment in rupee terms of 45% of total supply from Iran

These reasons make Iran an important strategic trading partner for India. The rupee payment mechanism with Iran also helped India save its foreign exchange. There has been a decline in India’s crude oil production in recent years. Along with rising demand, this has contributed to increasing India’s import dependency to 83.7% in FY19 (P) from 80.6% in FY16.

Not only due to US sanctions on Iran (10.6%) but also on Venezuela (7.6%), India will have to consider alternatives to source crude oil for more than 18% of import requirements, which would impact its import bill. Further, it will be expensive to change the configuration of state-run refineries, currently equipped to process oil from Iran to other grades.

In short, it can be concluded that higher crude prices will adversely affect the twin deficits — fiscal and current account deficit — of the economy, which will have spillover impact on the monetary policy, and consumption and investment behavior in the economy.

Akshay Seth
Linkedin | Twitter
akshay.equity@gmail.com

Source: Blog | equityboxx

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