In today’s newsletter, we will discuss what the drastic drop in global oil prices means for Indian consumers.


The Story

But before we get to the heart of the story, some background for people who might not have been reading us this past week.

Most of the world’s oil is controlled by a very small group of people- the Middle Eastern cartel called OPEC, US, and Russia. And with great resources comes great responsibility. Their job is to manipulate the oil supply to ensure prices the world over remain stable.

Unfortunately, with Coronavirus having taken centre stage, demand for oil isn’t exactly like it used to be. And in a last-ditch effort to keep prices stable, OPEC decided to push for more production cuts. However, Russia disagreed, leading to one of the most brutal price wars in history. You can read more about this here.

Anyway, oil prices have been tumbling now and it’s hovering at about $35 a barrel now (it was $65 last December).

And of course, this is horrible news for all the nations that export oil. Thankfully, we’re not one of them. India imports over 80% of its crude oil requirements, making us inadvertent winners in this price war. According to a Care Rating report, India’s crude oil import bill during FY 2018–19 was around $112 billion. And for each dollar reduced per barrel now, this bill drops by $1.45 billion, year on year.

This kind of decrease is substantial because it helps us in reducing the big bad number everyone’s scared of — the Current Account Deficit.

Current account deficit or CAD is a measurement of a country’s trade where the value of imports exceeds the value of exports. When the country as a whole starts importing more than it exports, this gap increases. While it is beyond the scope of this story to explain all the intricacies involved, let it be known that a disproportionate increase in CAD is a bad omen for the economy and so the government does everything in its power to reduce this deficit.

Also, there is another more obvious benefit when oil prices tank. If the price reduction is passed on to customers in the form of lower petrol and diesel prices, we get to save on fuel. However, petrol and diesel prices in India haven’t yet been reflecting the drop in global oil prices. In fact, crude oil prices have halved since the start of 2020, but retail prices have declined by only around 7%.

What’s the reason for this mismatch?

One variable impacting the mismatch — Rupee. The value of the rupee has depreciated by about 3.6% vis-a-vis the U.S. dollar this year. And this is kind of important because we buy a large part of our oil using dollars. So a devalued Rupee means we have to spend a lot more money to buy the same amount of oil we used to. This effectively wipes out some of the gains that we might have made from the drop in oil prices.

There’s also the possibility that the government might not choose to pass on the benefits of lower prices to consumers at all. Instead, they might decide to raise taxes on petrol and diesel- money which will go directly into central and state coffers. With the sorry state of the Government’s finances, this wouldn’t be surprising.

And even if the Government desists from raising taxes, Oil Marketing Companies (like BPCL and IOCL) might choose to retain most of the gains. Because when prices rise and public pressure forces governments to act, the government asks the OMCs to take a hit on their margins so people can continue buying oil at a modest price. Granted the government does reimburse some of this money, but it’s not very reliable. So when prices dip, it’s an opportunity for OMCs to shore up their margins by keeping some of the gains themselves.

Point of Interest: The governments can force OMCs to absorb the losses because they have majority ownership in most of these companies.

In any case, it’s too soon to see the effect of falling oil prices on your fuel bill primarily because daily fuel prices are calculated based on a trailing average of the past 15 days. Meaning for the price to drop at your nearest petrol station, we need the prices to stay low for at least the next few days, so that the 15-day average can tumble. Its math, people. Do the numbers.

Until then…

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