During the past couple of weeks, prices of several commodities touched new highs as a slumping dollar boosted demand for raw materials including gold, oil, lead and copper as a hedge against inflation. The dollar depreciated sharply against the euro on concerns related to US subprime-mortgage defaults. This was further aggravated by the Federal Reserve's move to cut interest rates. However, what has been the most concerning besides the subprime mess is the fact that the Brent crude prices have shot up 51% YoY to US$ 96 in the last five months. The sharp increase has again highlighted India's macro sensitivity to oil prices into focus. In this article, we delve further into the same.
Source: QuantumDirect Commodities Insight dated 9th Nov, 2007
||Growth (% YoY)
|Gold (US$ / t.ounce)
|Silver (US$ / t.ounce)
|Copper (US$ / tonne)
|Lead (US$ / tonne)
|WTI crude (US$ /barrel)
|Brent crude (US$ /barrel)
How is India poised to deal with the crude oil price rally?
Relatively low share of oil in energy consumption: India's share of oil consumption in the overall basket of energy resources is lower than that for most emerging markets. Oil meets about 28% of India's commercial energy requirements. While coal is the predominant source of energy (55% of total) due to its easy availability, the balance is sufficed by natural gas (8%), nuclear and hydropower (7%) and wind power (2%). According to the Planning Commission of India, coal reserves are expected to last for over 50 years at current levels of production, and hence coal will continue to remain a key source of energy for the country.
High share in world oil consumption: Despite oil being a relatively low contributor to India's energy resources, India is one of the leading consumers of oil in the emerging world owing to the relatively larger size of the economy. India's oil consumption has increased to 2.6 m barrels per day (3.1% share in global oil consumption) in 2006 from 1.6 m barrels per day (2.3% share) in 1995. Over the past 10 years, India's oil consumption has grown at an average 4.3% per annum, versus 7.5% for China and 1.3% for other major emerging markets (Source: IMF reports). India's efficiency of oil usage, as measured by oil intensity (primary oil consumption per unit of GDP), is higher than the world average and marginally higher than that for top emerging countries.
Dependence on imported oil is high: India's proven reserves of oil and oil production have remained largely stable over the last decade. As a result, increasing oil consumption has meant greater reliance on crude oil imports for India. India imports about 72% of its crude oil and petroleum products requirement, up from 44% in 1995. Crude oil accounted for about 25% of India's total imports in FY07 (5.3% of GDP). Also, India's overall oil balance (crude oil and petroleum product imports less exports) is one of the worst in the Asia Pacific region.
OMCs bearing the brunt of subsidised prices of petroleum products: Domestic prices of oil products have been historically directly or indirectly controlled by the government. Currently, although public sector oil companies are supposed to collectively fix prices of crude oil and petroleum products based on the 'import parity pricing', in practice, the government decides all price changes. Controlled petroleum product sales account for around 64% of total sales on a volume basis and 80% on a value basis. As a result, the oil marketing companies (OMCs) have been bearing the brunt of the 'government sponsored' subsidy and losing a couple of millions from their balance sheets every day.
The government on its part has taken very measured steps in the last 2 years with respect to the oil price pass through, the same being a politically sensitive issue. The prices of petrol and diesel were initially raised by Rs 4 and Rs 2 per litre respectively in June 2006. This was followed by rises of similar magnitude in November 2006 and February 2007. However, the pass-through remains incomplete, especially in the case of kerosene oil and LPG whose prices have remained unchanged since April 2002 and November 2004 respectively. Apart from reduction in customs duty on petrol and diesel to 7.5% from 10.0% in June 2006, the government also issued oil bonds aggregating Rs 241 bn during FY07 (Rs 115 bn in FY06).
Impact on inflation, consumption and growth
The government's involvement in domestic oil pricing means that movements in oil prices can have a less-than or greater-than proportionate impact on key macro indicators such as inflation, consumption and growth. As a thumb rule, advanced economies witness a 0.25% decline in their GDP growth due to a rise in crude prices by US$ 10 per barrel. The same for emerging economies like India stands at nearly 1%. Having said that, the rising input costs are expected to weigh on inflation numbers and thus pressurise consumption and growth. This will in effect have an impact on the demand for crude oil.
The International Energy Agency (IEA) has recently sharply reduced its forecast for oil demand growth through the rest of 2007 and into 2008 on the premise that the crude oil's march towards US$ 100 per barrel was already slowing consumption. It has predicted that the OPEC will need to lower its production by 700,000 barrels per day (bpd) in 4QCY07 and by 300,000 bpd in 1QCY08.
While the impact of the high crude oil prices on the country's GDP growth in the near term will be subdued thanks to the strong rupee dollar rates, the same would, however, mean an expansionary fiscal policy. Notwithstanding this, we believe that the growth may be impacted meaningfully if crude oil prices stay close to current levels over the longer term.