Use the oil crash to boost India’s strategic reserves| Analysis
Over the last four months, the coronavirus pandemic has caused several epochal events and historical firsts. One such belief-defying event was the plunge of crude oil prices to negative territory — minus $37.63 per barrel — on Monday, April 20, in what can be seen as the surest sign so far that the global economy is headed towards a deep recession, if it is not already in one. When the futures contract for West Texas Intermediate, one of the world’s most popular benchmarks for crude oil prices, was due to expire on Tuesday, oil traders in the United States (US) began panic-selling the day before to avoid actual physical delivery of oil — a product that suddenly no one seemed to want.
The images that we have seen of wide empty streets around the world without traffic signify the drastic drop in demand for the commodity. With the movement of people severely curbed, and economic activity coming to a halt, as lockdowns are instituted in cities and countries worldwide, the demand for oil has nearly vanished. All oil storage facilities in the US are almost filled to capacity and oil traders had to pay to offload their stock.
This does not mean oil will be free from now on. Prices recovered and were trading at just about $3 a barrel the following day, and will rise modestly in the next few days. The price of the Indian basket of crude oil is trading at about $20 a barrel, less than half of what it was in February this year ($54).
What does this mean for India?
While a fall in oil prices could mean disaster for oil-producing countries, it is usually a bonanza for India — the consumer, the government, and the economy all win. Oil prices can contribute a lot directly and indirectly to the general price levels in India, and so, apart from being able to fill up their vehicles at lower prices, the Indian consumer benefits from general lowered prices. The government wins as lower prices lead to higher demand and, therefore, higher tax collections. More important though, the amount it has to spend on fuel subsidy decreases, leaving it larger fiscal space for other government programmes. Finally, since India imports nearly 80% of its oil requirements, lower global oil prices imply a fall in the country’s overall import bill and stability for the rupee.
The coronavirus pandemic, however, has thrown these calculations off-kilter. With forced lockdowns, broken supply chains and a halt in industrial activity, there is no demand for the product. Inflation mechanics will be determined more by the delicate dance between unnaturally low demand (which will push prices lower) and broken supply chains (which will push prices higher).
Nevertheless, the lockdown will eventually be lifted, and the economy will inch its way towards normalcy, at which point, the Union and state governments will have to make a difficult decision. By keeping excise duties and other taxes at the current level, it could earn more and use the earnings to fund the necessary fiscal measures to help the economy rebound. Or it could lower them to help consumers, so that they have additional disposable income that they can spend on goods and services, which is equally important to revive the economy. Specific circumstances of the removal of lockdown restrictions and the state of the government finances will probably dictate that decision.
One area in which India can definitely use the lower oil prices to its advantage is to stock up on the commodity for future use. Like many other countries, India maintains strategic petroleum reserves (SPR), which is an inventory of oil for emergency purposes. To mitigate supply-side risks and cover for vulnerability to external oil shocks, India holds an emergency oil stockpile in underground salt caverns, which can provide around 4.5 days of import cover. There is additional capacity for five days of oil import cover, which must be filled up at this time when oil prices are at historic lows. Indian petroleum refineries hold an additional 65 days of import cover.
To its credit, the government has promptly taken steps to ensure full capacity utilisation at this time by directing State refineries to place their excess crude supplies in these caverns for which they will be reimbursed. However, this was the lowest hanging fruit, and it is time to reach for the higher ones. India has been delaying the start of phase two of its SPR plans, which was to add another 12 days of oil storage capacity. This was to be done in partnership with either ADNOC (Abu Dhabi) or Saudi Arabia’s Aramco. It is probably the right time now to get this off the drawing board.
Alternatively, we can also look at options outside India. We could persuade the Sri Lanka government to kick-start the utilisation of oil storage facilities at Trincomalee. This could be done in a mutually beneficial manner. We could also shop around for storage space in Oman (Ras Markaz) or the United Arab Emirates (Fujairah). Right now, we are in a bizarre situation where the storage space is more expensive than the commodity itself, but things will revert, and any investments now will help India in the long run when oil prices rise again.
Finally, the private sector should look at this as an opportunity to lock into long-term contracts with oil suppliers based at current prices. The government can help the struggling Indian airline industry, for instance, by providing it lines of credit to enter into or renegotiate oil contracts.
These are far from ideal circumstances, but we must think strategically about the long-term and try to seize the small opportunities that are presented.