Why India’s oil price benefit may be short-lived and limited

Even with an agreement on production cut-backs by the now more diverse and fragile OPEC++ grouping of oil producers, prices may remain soft in the near term on demand destruction owing to COVID-19 lockdowns. That could cause many oil producers to stop pumping out oil. And with the economics of restarting oil production being skewed against such resumption, much of the high-cost supply could get permanently driven out of the market.

Goldman Sachs in a recent report argued: “Only a significant supply shortfall once demand recovers could slow this much-needed industry consolidation and rationalization”. It goes on to presage that: “This shock (Covid-19) is extremely negative for oil prices and is sending landlocked crude prices into negative territory. Paradoxically, this will ultimately create an inflationary oil supply shock of historic proportions because so much oil production will be forced to be shut-in”.

The supply shock is what could upset the applecart for India, even as it basks presently in the warmth of soft crude prices. And the longer the global lockdown continues, the earlier the supply equation will reset. This could inflate India’s oil import bill sooner that one might imagine. And here it is important to note the country’s high oil dependence—while oil consumption expressed in relation to GDP for the world has been on a secular decline, for India the growth in oil consumption is still very high. To give you a sense, while world GDP has grown at a compounded annual rate (CAGR) of 2.87 percent over the past 45 years, crude consumption has lagged at 1.22 percent over the same period. Recent statistics in India, however, reveal that oil consumption has grown, at times, faster than Gross Economic Value Added (GVA) in some years.

Source: Petroleum Planning & Analysis Cell (Govt of India); RBI

What’s more, even the low oil prices may offer limited succor for India’s fiscal health, as demand destruction will limit any gains from higher taxes on gasoline and diesel sales. Brokerage firm, Edelweiss, in a recent note argues that the net impact of the oil price drop on government finances will be minimal. The note suggests: “The fiscal tailwind from lower oil prices is likely to be in the 0.1-0.2 percent of GDP range—a sharp contrast with 1.1-1.2 percent of GDP during FY14-16”.

Given these factors, it may be optimistic to presume big benefits for India from the current crude prices. Rather, the reset in supply equation that might result from the impact of COVID-19 may well lead to a sharp rally in global crude prices once demand comes back. And this could correct the disruption in the crude-equities equation in the latter part of the past decade.