Brent Crude crosses $110/bbl on Ukraine worries

On 01st December 2021, Brent Crude at $68.87/bbl. Exactly 3 months later, the price of Brent crude has surged by a whopping 60% to $110.42/bbl. Just 3 months back, the Omicron variant had just about reared its head and the estimate was that slack demand would depress oil prices further. Historically, the price of oil have tended crumble when the demand for oil suddenly dropped. What happened in reality was the exact opposite.

Three factors played a role in this rally. Firstly, the Omicron variant proved to be a lot more benign than expected and hardly reduced demand. Secondly, OPEC struggled to raise supply commensurate with growing oil demand. Lastly, and the biggest driving factor was the emerging war situation in Ukraine. Russia supplies nearly 35% of the energy needs of Europe and the sanctions could create massive supply chain constraints. That explains the oil spike.

The last time we saw such elevated prices on crude was nearly 8 years back in mid-2014. These levels have not been seen after that. Meanwhile, the US was expected to release a big chunk of oil from its strategic petroleum reserves (SPR), but the release of 30 million barrels was grossly insufficient and only left the markets disappointed. Now, the OPEC and the IEA have warned of grave risks to energy security due to the Russia – Ukraine standoff.

The release of 30 million barrels by the US from the SPR was part of the 60 million barrels release committed by the International Energy Agency. However, the analysts believed that when the global oil market is undersupplied by 3-4 million barrels per day (bpd), the release of 60 million barrels from SPR would get absorbed in no time. That is why the markets were disappointed and led to a further spike in the price of oil on Tuesday and Wednesday.

Russia produces around 11 million barrels per day (bpd) of oil which makes it the second largest oil producer in the world after the US. Even Saudi Arabia comes only in third place. In addition, nearly 60% of Russia’s oil output goes to Europe while 20% of its output goes to China. That demand will get transmitted to other countries leading to a severe oil shortage. The current stringent sanctions are only going to make matters worse.

What does $110/bbl crude mean for India?

One only needs to look at the plummeting Sensex and the FPI outflows to understand. Here is why high crude prices are hitting Indian economy hard.

a) Each $10/bbl spike in the price of oil tends to impact inflation by 30-40 bps on the upside and has a direct and indirect impact on price levels

b) It is estimated that every $10/bbl increase in the price of Brent Crude pushes up the fiscal deficit by 15-20 bps as a percentage of GDP. This is likely to impact bond yields and also the external ratings of the Indian economy.

c) Thirdly, the trade deficit is also negatively impacted by a spike in crude prices since India relies on imported crude to meet nearly 85% of its crude requirements. 

d) Lastly, the rising price of crude has created a piquant situation for government revenues. In the last 6 years, the government relied heavily on excise levies on petrol and diesel to boost its revenues. With Crude at $110/bbl, that avenue is closed and even if the government wants to push back some of the benefits, it cannot do so due to budgetary constraints.

High crude prices, as rightly pointed out, does pose a huge risk to the global energy security situation and likely to entail a big chunk of imported inflation for most oil importing nations. However, for India, the problems could just about get magnified.