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Oil at USD 120 – What next?

Oil prices (Brent) have spiked to above USD 118 per barrel at the time of writing this. Expectations that there could be a sanction against Russian Oil are causing this spike. This is the highest price in more than 7 years, and causes a headache for India’s Macro environment.

Consider this – The last time petrol and diesel prices were changed, nearly 2.5 months ago, Oil prices were at $85 per barrel. We are looking at USD 115 + prices today.

India imports nearly 1.8 billion barrels of oil per year. A USD 1 move in oil prices cause an extra outflow of USD 1.8 billion (Rs 12K Crore). If oil prices sustain here for an entire year, we are looking at an additional Rs 3 lakh crore of outflow on account of this. Of course we also export petroleum products, and that would increase our inflow as well, but let’s look at the import scenario for now.

What are the options that we have?

1) Increase prices of fuels, and pass it on to consumers. In this case we will see petrol prices around 130-135/litre in the near future, & the consequent impact on inflation.
2) Reduce Excise duties on Fuels. Central government’s budgeted estimate for excise collection is Rs 3.3 lakh crore for FY23. If oil remains at $110 for the year, this entire collection will be used in countering the price rise from here.
3) Cap the price, and introduce subsidy for the oil marketing companies. We used to do this a decade ago. This would roll back us to those times, and would put the privatization / deregulation / disinvestment theme back by a decade as well. This would be a really retrograde step in our opinion.

There could be a combination of the above steps that may play out, but the impact of an average oil price at USD 110 per barrel for an entire year is about Rs 3 Lakh crore. This has to get adjusted in the fiscal plan somewhere, if the government has to take care of this, without increasing fuel prices.

So, if you increase prices, it flows through in inflation. If you keep prices constant, it would increase fiscal deficit, and that in turn would increase the government borrowing and interest rates.

What Next?

What happens if oil prices remain here? Is there a possibility of even higher prices? USD 130 / USD 140 per barrel anyone? What sectors does this impact negatively? Oil Marketing / Paint / Airlines / Logistics?

If oil prices remain high, are there any easy choices here? India had a great time between 2014 and 2021 with oil prices largely being benign. But the lack of investment in oil production globally, along with supply crunch, could result in higher than average oil prices for a while. As an economy with have to address this challenge. What options do you think exist here?

The Other Possibility

Oil futures are in substantial backwardation. What that means is that futures of upcoming months are trading at a big discount. It shows that the oil price spike is being considered as a short term issue for the time being. If sanity prevails and the geopolitical issues resolve, we could see a sharp cut in the oil prices as well in the near term. Though the medium to longer term picture still is unclear

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LinkedIn Posts

Some posts around the Insurance industry this week.
– Market share of insurance companies in India – You can view it here
– Distribution Channels used in the insurance sector – You can view it here
– Market share of top insurers globally – You can view it here

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