Is India ready for another oil crisis?

Last Updated: Apr 27, 2010, 09:19 AM IST

Anil Kumar Satapathy

“Gote Magh re sita jaye nahi”, so goes a famous Oriya saying, which highlights the need for lasting solutions rather than makeshift arrangements to a problem. Unfortunately, when it comes to energy crises, Indian leaders always opt for temporary solutions, leaving the larger problem unaddressed. The present situation is no exception.

When the boom years came to a temporary end in 2008 with the worst oil crisis the world had ever seen, the Indian government, like several others around the world, appeared clueless on how to manage its oil economy. In those crisis days, the key challenge of the government was to keep the country’s oil economy afloat in an extremely adverse global scenario without letting inflation go northwards.

However, it seemed to have failed the test as inflation rose to a 13-year high in July 2008 when crude oil price was hovering around USD 140 a barrel.

Thanks to the economic crisis, oil prices plummeted. So did inflation in many countries. But as the global economy is steadily recovering and emerging countries like India and China are fast returning to high growth trajectory, with demand rising again, sending the prices of many commodities, including oil, to new highs.

Crude oil price is now hovering around USD 85 a barrel. It has jumped over 25 percent since February and is well on its way to cross USD-100 mark in near future. This sets the alarm bells ringing again.

Reasons of oil price rise

Like all other commodities, the price of oil is also fluctuated by the demand-supply factor. If supply does not catch up with the soaring demand, prices are bound to rise. The sharp rebound in emerging markets has spawned a new wave of demand for fuel. Developed economies too are showing signs of a revival. The improved car sales figures in the US underscore this point. However, the oil producing nations have not revised their output target to meet the rising demand. This demand-supply mismatch is the main reason for the recent rise in prices.

Moreover, there is an intrinsic relation between dollar and commodities including oil. Whenever the dollar declines, prices of petro products would increase. The reason: Oil is traded in dollars. When the dollar falls, oil investors/speculators tend to increase the price of the commodity so as to get the same value.

Effect on India: Inflation

Oil prices and inflation have a cause-and-effect relationship. As oil prices move up or down, the prices of other produces/services also follow the same path. This is because oil is a major input for many services. So if the input prices rise, the output prices would also go up.

India is already under the grip of the inflationary monster. As per the latest data, food inflation rose to 17.7 for the week ended March 27. All eyes now are on the upcoming rabi crop. However, a below normal rain in May-June period will seriously affect the crops – threatening to further push up prices.

With this being the case, what should India do vis-à-vis oil pricing? Is the government prepared to face up to a scenario where rabi crops are below the expectations and oil prices are above $100 a barrel? Simply put, are we ready to tackle an economic catastrophe that is in the pipeline?

Affect of oil prices on OMCs

The oil marketing companies have long complained that under the current pricing mechanism they are forced to sell oil below the prices at which they are sourcing it from the international market.

According to government estimation, the oil marketing companies have suffered revenue losses worth Rs 45,000 crore due to under-recoveries last fiscal, which could increase to Rs 70,000 crore by the current fiscal unless a price hike was effected.

State oil firms are currently losing Rs 6.12 per litre on petrol, Rs 4.60 per litre on diesel, Rs 18.42 per litre on PDS kerosene and Rs 265.27 per 14.2 kg LPG cylinder. The Kirit Parikh Committee, appointed by the Prime Minister to study the fuel pricing policy of the country, has suggested cutting down subsidies on cooking gas and kerosene and freeing prices of diesel and petrol from the clutches of government regulation.

Though the Petroleum Ministry is pressing for the implementation of the Committee’s recommendations, the government appears indecisive on what to do. The critics of deregulation say if the government leaves price fixing to the market forces, it will have cascading effects on inflation.

There was, however, a section which chooses to differ with the theory.

“Crude has doubled from USD 40/barrel a year ago to USD 80/barrel today. Yet countries without price controls, which have passed on the full cost to consumers, have far lower inflation rates than India. Clearly the theory of oil prices cascading into everything else is a myth. Cost-plus pricing may have been common in the bad old licence-permit Raj, but not in a deregulated market,” Swaminathan S Anklesaria Aiyar argued in an article published last month.

Solutions?

India meets a large chunk of its crude oil demand through imports. Hence any price movement is bound to create ripples in the domestic front too. Indians not only had to suffer the financial crisis, but also has had to bear the brunt of high inflation. Another crop loss coupled with high oil prices will took the sheen away from high growth figures of the economy.

The government has so far refused to act boldly on the fuel pricing front. Over the years, successive governments have played to the gallery rather than making moves in the right direction. The government should give utmost priority to energy security and invest heavily in oil exploration, as well as look for other sources of energy. It could also aggressively tap the resources of other countries, possibly in Africa, and set up reserves to meet emergency situations.

True, it is unlikely that the government can do anything now on an ad hoc basis vis-à-vis the energy challenges. Securing a steady source of energy needs long-term planning and clinical execution. A continuing, persistent and well though-out strategy is needed if we want to secure the future of our country. It’s high time India started thinking as a major global power with ambitious plans.