Govt has the leeway to cut oil prices
IT was just about a year ago that global investment bank Goldman Sachs predicted that world crude oil prices would touch $100 per barrel by the end of 2024. The forecast rattled emerging economies like India that are large importers. Luckily for them, the prediction has gone way off the mark. Oil prices have fallen by about 20 per cent over the past year with the benchmark Brent crude currently ruling around $70-72 per barrel. The turnaround has taken place despite a grim geopolitical environment, with the Russia-Ukraine war and the Israel-Hamas conflict showing little signs of ending.
Prices of oil products are usually raised when global prices go up but are rarely reduced commensurately when rates fall.
Oil markets have clearly factored in the fact that neither are likely to disrupt supplies even though Russia remains the third largest crude oil producer in the world. Its production is still flowing into major consumption areas despite sanctions imposed by Western countries. Many European countries, including Poland, Finland, Hungary and even Germany, continue to buy oil and petroleum products from Russia, though the amount has reduced considerably. In addition, the European Union makes sizeable purchases of products like gasoline and diesel from Indian refineries using Russian crude.
As for the West Asian conflict, it has disrupted international trade flowing through the Red Sea and Suez Canal owing to the depredations of Yemen-based Houthi rebels. Traversing these inlets has been made dangerous for merchant vessels, many of which are now taking the long and expensive route via the Cape of Good Hope. But it has not affected availability of crude and natural gas supplies from the region, and they are continuing to reach consumers through both sea and land routes.
It is thus a variety of other factors that have led to the bearish trend in oil prices over the past year. One of the most significant is weakening global demand, especially from the world’s biggest importer, China. Economic woes are continuing in that country as the manufacturing sector contracted for the fourth month in a row. Over the past year, there has been an expectation that the economy would revive and the real estate sector would come out of the doldrums. Such a scenario seems distant now and multinationals are slowly withdrawing from the second largest global economy which is now producing more than the rest of the world can absorb. China recorded a 5.2 per cent growth rate in 2023, but the World Bank has projected that it will touch only 4.8 per cent in 2024.The slowing economy has, in turn, led to a cut in oil imports.
Another factor contributing to softening prices has been rising output in the US, which has emerged as the world’s largest crude producer. In fact, countries outside the Organisation of Oil Exporting Countries (OPEC) cartel are expected to lead output growth this year. This has largely offset the voluntary production cuts of 2.2 million barrels per day imposed by OPEC Plus since last year. These were expected to be lifted last week but with markets remaining relentlessly bearish, the cartel decided to extend the cuts for some more time. Even this news failed to perk up prices which rose slightly and then fell again to reflect the surplus availability in the market.
The ebb in oil markets has come as a bonanza for India, which buys over 85 per cent of its fuel from abroad. Ever since the Ukraine-Russia war began in February 2022, prices have remained volatile. But India was able to get Russian crude at discounted rates which helped tide over the crisis of high prices during that year. The recent declining trend has meant that the Indian basket of crudes has fallen from $89 per barrel in April to $72 currently. The significance of this decline can be gauged from the rough estimate that every $10 rise in oil prices leads to a 0.5 per cent increase in the current account deficit.
In this upbeat scenario, the government has the leeway to cut prices of petroleum products like petrol, diesel and LPG to bring some relief to the common man. With several states going to the polls later this year, it would also be a pragmatic political move. A similar measure was taken in March prior to the General Election. But the fact is that prices of oil products are usually raised by governments when global prices go up but are rarely reduced commensurately when prices fall.
The resistance to raising prices also comes from oil marketing companies (OMCs), which have to bear the brunt when international prices go up and retail rates are kept static. The situation is different now as the OMCs are flush with funds, having ended the 2023-24 financial year with roughly Rs 81,000 crore of combined profits. These include the flagship Indian Oil Corporation, Hindustan Petroleum Corporation Limited and the Bharat Petroleum Corporation Limited.
The oil companies would undoubtedly be worried that world markets may firm up yet again and they could end up struggling yet again with under-recoveries on product sales. For the time being, however, this does not look likely. The malaise in the Chinese economy, for instance, is not expected to show any significant improvement in the near future, indicating weakness in demand will continue for some time. The output, on the other hand, especially from non-OPEC producers, is rising consistently.
As a result, global investment banks are quickly revising their price forecasts. Morgan Stanley has brought its projection for the last quarter of 2024 to $75 a barrel, while Goldman Sachs has kept to a safe range of $70-85. Citigroup has gone further and predicted it to fall to $60 in 2025. In other words, the moderation in oil markets is expected to continue in the medium term as well. The only scenario in which prices could conceivably shoot up would be a full-blown war in West Asia. In this backdrop, it seems conditions are as ideal as possible for domestic oil companies to go ahead with cuts in pump prices. The geopolitical scenario remains challenging, but it is a risk worth taking.
