By Uttam Gupta, New Delhi
05/01/2017
After protracted wrangling, members of the Organization for Petroleum Exporting Countries (OPEC) agreed on November 30, 2016 to reduce their combined output by 1.2 million barrels a day. Likewise, 11 non-OPEC countries led by Russia decided on December 10, 2016 to knock off over 550,000 barrels from their supplies. The agreement is effective from January 1, 2017. These developments need to be viewed in the backdrop of a steep drop in the price of crude from its peak of US$ 114 per barrel in mid-2014 to US$ 27 per barrel in February, 2016 and had recovered only marginally to US$ 40 per barrel by November-end. The price of LNG which follows the trend in crude also plummeted from a high of US$ 13-14 per mBtu (million British thermal units) to USD 6.5-7 per mBtu during the same period.
The low price realization from the sale of oil and gas had led to substantial erosion in profits/surpluses of exporting countries devastating a number of economies (overwhelmingly dependent on earnings from oil export), viz, Venezuela and Nigeria and destabilizing budgets of even most prosperous countries such as Saudi Arabia. These countries were desperate to reverse this trend.
The price is primarily a function of global demand-supply balance. If it is easy, the price will decline; this is precisely what happened during the last 30 months (June 2014 to November 2016). On the other hand, if the balance is tight, the price will increase. This is what OPEC and non-OPEC countries are trying to achieve by their joint and concerted action to cut supplies.
Already, consequent to the agreement, the price of crude has shot up to USD 54 per barrel, 35% higher than the pre-agreement level of USD 40 per barrel and 100% more than the rock bottom of USD 27 per barrel in February, 2016. The pace of increase will gather momentum after the deal takes effect from January 1, 2017. The price of gas too is projected to increase by a minimum of 25% during 2017.
India imports 80% of its oil requirements and nearly 40% of gas consumption. During the last 30-month phase of price deflation, India had enjoyed a virtual “honeymoon” saving huge sums on the import of oil and gas. Besides enabling a significant reduction in the price of all petroleum products to consumers, this boosted tax revenue, lowered subsidy payments, helped the Government rein in the fiscal deficit and thus achieve macro-economic stability.
GOVT GOT A BONANZA
Beginning January 1, 2016, the Government also got a bonanza due to a 50% drop in the price of LNG under the “renegotiated” long-term (25 years) contract for its supply from RasGas, Qatar (30 million standard cubic metre per day). This, in turn, helped reduce the cost of power and fertilizer (mainly urea). In fertilizers, this translated to a lower subsidy outgo as selling price is controlled at low level.
With a rebound in crude price, these gains will get neutralized. To prevent an increase in the price to consumers, especially that of LPG and kerosene which continue to be subsidized, the Government will be under pressure to reduce taxes; alternatively, it will have to shell out more towards subsidy. Either way, there will be a risk of fiscal destabilization.
The Government, therefore, will need buffers to absorb the oil shock. But buffers won’t be readily available. For instance, the tax bonanza under the Income Declaration Scheme-II has already been committed by Prime Minister Narendra Modi to Pradhan Mantri Garib Kalyan Yojana (PMGKY). A lot more funds will be needed to step up Government investments in schemes for roads, highways, irrigation and homes.
The other source could be tax buoyancy under the Goods and Services Tax (GST). But in view of the tough posturing by Opposition parties which are unhappy with the demonetisation decision and its implementation, it seems unlikely that the GST would be kicked off before September 2017.
There is an urgent need to look for sustainable solutions. This could be best done by implementing the pending reform schemes. The Government should stop giving the LPG subsidy to the better-off and rich citizens of India. Under the Pratyaksha Hastaantarit Laabh (PAHAL), it should go only to the poor. The Government should also withdraw the kerosene subsidy which is siphoned off for mixing kerosene with diesel.
The Government should open up the retailing of all petroleum products, including diesel and petrol (already decontrolled; no subsidy is payable) to the private sector. This will unleash competitive forces resulting in a lowering of the market price. It will benefit everyone, including those who are not covered by the subsidy dispensation.
FERTILIZER SECTOR CRYING
The fertilizer sector has been crying for reforms for too long. The present Government had proclaimed its commitment to remove the price control and introduce Direct Benefit Transfer (DBT) for better targeting. The DBT should be expedited. This will drastically reduce the subsidy and make subsidy payments less vulnerable to an increase in the oil price.
Reforms in the power sector, viz, a competitive tariff setting, giving freedom to consumers to choose their supplier and curbing T&D losses (a euphemism for theft) have so far been held hostage to populism and political expediency. These reforms should be put on fast track for imparting much-needed resilience to the sector.
Prime Minister Modi has done little to tackle these subsidy monsters head on (sans limited headway in LPG). Thus far, they were tamed courtesy the low oil price. But the latter will grow in size and ferocity posing a serious threat to fiscal consolidation, macro-economic stability and people’s welfare in India. It is time to act now.
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