Decoding the current crude oil landscape and its global ramifications!
Saudi Arabia and Russia announced an extension of their self-imposed oil production cuts until the end of this year
Oil prices experienced a slight uptick on Thursday, driven by indications from industry data suggesting a decrease in U.S. crude oil inventories during the previous week. This reduction in inventories adds to the tightening supply scenario, which is already influenced by continued production cuts in both Saudi Arabia and Russia. The pressure on supply seems to be achieving its intended outcome of driving short-term price increases. However, there is a concern about potential unintended repercussions if energy prices surge significantly for an extended period in the future.
Reason for surge in crude oil prices:
On Tuesday, Saudi Arabia and Russia announced an extension of their self-imposed oil production cuts until the end of this year. Saudi Arabia's commitment entails a reduction of 1 million barrels per day (bpd), while Russia is extending its cut by 300,000 bpd. These additional cuts come on top of the April agreement made by the Organization of Petroleum Exporting Countries and its allies (OPEC+) to continue reducing production until the end of 2024. While investors had initially expected Saudi Arabia and Russia to prolong their voluntary cuts only through October, the surprise decision entails a three-month extension.
Both Saudi Arabia and Russia have committed to reviewing their production decisions on a monthly basis, allowing for potential adjustments based on market dynamics. However, the prospect of price increases faces potential challenges. US refineries typically undergo maintenance in the September-October period, potentially reducing demand. Additionally, the market may witness increased supply from countries like Iran, Venezuela, and Libya, which could exert downward pressure on prices.
On the macroeconomic front, economic data from regions including China, the Eurozone, and the US for August has exhibited weakness. Nevertheless, optimism surrounding stimulus measures in China is expected to support oil prices, alongside the ongoing supply cuts enforced by OPEC+.
According to Tapan Patel, Fund Manager – Commodities, Tata Asset Management:
“Global crude oil prices rallied to the highest levels since November 2022 over tightening supply scenario. The benchmark NYMEX WTI crude oil prices hit $88 per barrel while ICE Brent crossed $90 per barrel reporting ninth straight days gains. Crude oil prices surged after extended supply cuts from OPEC plus nations majorly from heavyweights Saudi Arabia and Russia. The large inventory draws in US and depleted US SPR is an additional supply risk factor for oil prices in coming months”.
“Indian rupee hit fresh 11-month low near 83.24 against the dollar remained vulnerable to rising global oil prices and surge in US 10-year yields. On domestic front weaker monsoon may add pressure with poor August rain deficit numbers. Major Asian currencies traded under pressure on stronger dollar which rose to six months high near 105 amid weak China growth and on rising expectations that US Fed may opt for longer “hawkish pause” with elevated rates”.
Impact of high crude oil prices on Indian economy:
Inflationary Pressure
One of the most immediate consequences of high crude oil prices is inflationary pressure. India, like many other nations, is highly dependent on oil for transportation, manufacturing, and power generation. As the cost of crude oil rises, it leads to increased production and transportation costs, which are eventually passed on to consumers in the form of higher prices for goods and services. This can lead to an uptick in overall inflation, making it challenging for the central bank to maintain price stability.
Depreciation of Indian Economy
India is a net importer of oil, and a surge in oil prices amplifies its trade deficit. The country must spend more on oil imports, diverting valuable foreign exchange reserves. This, in turn, can weaken the rupee against major currencies, making other imports more expensive and further contributing to inflationary pressures.
Fiscal Burden
As oil prices rise, the Indian government faces a dilemma: it can either absorb the increase in costs by subsidizing fuel prices or pass the burden onto consumers by raising fuel taxes. Subsidizing fuel prices strains the fiscal budget, potentially crowding out spending on essential social programs, while increasing taxes can further squeeze household budgets, leading to decreased consumer spending and economic slowdown.
Balance of Payments
High oil prices also affect India's current account balance. The increased import bill for oil can lead to a larger current account deficit, making the country more dependent on foreign capital inflows to finance its external obligations. This reliance on foreign capital can expose the economy to external shocks and volatility in international financial markets.
Impact on Growth
The overall impact of high oil prices on economic growth is mixed. On one hand, rising energy costs can hamper industrial production and reduce consumer spending. On the other hand, it can incentivize investment in alternative energy sources and promote energy efficiency, potentially leading to long-term benefits for the economy.