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Oil on the boil: Facing market headwinds even before the pandemic, there's no more room for policy distortions, writes Kiran Nanda

02:30 AM Jul 21, 2021 | Kiran Nanda

For long, popular belief has had it that death and taxes are the only two certainties in our lives. It’s time that this read, while death and taxes are two certainties, oil prices are the biggest uncertainty in the present age of disruptive trends. The Covid-19 pandemic has shown that the world faces a mega challenge -- to usher in a rapid move to an era of green, clean and renewable energy. The age of fossil fuels i. e. non-renewable energy sources such as coal and oil, which powered economic growth for almost three centuries, will have to fade away.

The oil industry was facing market headwinds even before the pandemic. All that the pandemic has imparted is a ‘fast-forward’ thrust, enabling distant future developments to unfold in a short time. Swivelling to the new energy future could be tough, and may require companies to make bold and risky choices. Some companies are quickly adapting to the new reality. However, not everyone is likely to succeed.

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Rude crude prices

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Oil prices, both internationally, as well as on the domestic front, are presently at multi-year highs. Crude oil has hit over $75 a barrel, as compared to less than $30 per barrel last year. Some analysts see even $100 as possible. Fuel rates vary across states, depending on respective value-added taxes (calculated on ad-valorem basis). The state-run oil marketing companies - Indian Oil, Bharat Petroleum, and Hindustan Petroleum - align the rates of domestic fuel with that of global crude oil prices, after factoring in changes in the foreign exchange rates.

Oil prices have gained about $27 a barrel since the beginning of 2021. Global demand has been rising following more vaccination worldwide, driving greater mobility and supply getting artificially curbed by OPEC+ (the group of 23 oil-producing countries headed by Saudi Arabia and Russia). A robust global recovery, especially of the US, European and Chinese economies has been the main cause of the rise in international oil prices. But Covid-19’s comeback in Asia indicates that the recovery will be uneven. The likelihood of the third wave continues to pose a big uncertainty.

The oil industry is undergoing a major churn. Prices in the short-term are on a fluctuating, rising trend due to:

(1) rising global oil prices, which includes an element of speculation

(2) high taxation by the Centre and varying taxes by states & local bodies. Also, in pandemic times, oil revenues seem to be working as a policy to meet some social ends and

(3) OPEC+ political and economic manoeuvres. In the long-term, oil has to fade away, as renewables are projected to take its place.

The government’s role in carrying out the desired change has been significant - it is set on reducing crude imports. Import dependency has been increasing due to falling domestic oil production every year, for about seven years now. India is spending Rs 8 lakh crore for the import of petrol, diesel and petroleum products. The PM’s goal is to cut import dependence by 10 per cent by 2022. This goal has become more distant since it was stated in 2016. Oil and gas imports are around 25 per cent of India’s total imports. Such high imports impact both the current account deficit and the value of the rupee. The US has also been following the same course, aggressively promoting domestic shale oil production, to end its dependence on OPEC and West Asia.

Role of government policies

The government focus seems to be more on revenue than production. Total levies and taxes form about 60 to 65 per cent of price of a barrel of oil. It is argued that as the weight of oil in CPI is minuscule, around 3 per cent, compared to about 50 per cent of food, its contribution to retail inflation is not much.

One cannot stick to statistics alone and overlook the hardships suffered by the common man, the transport sector and small businesses. The cascading effect on the entire economy on account of exorbitant oil prices is obvious. Research shows that because of increasing expenditure due to rising oil prices, people have begun curtailing essential expenditures - on health and food.

Oil exploration needs to be made more constructive. Production has been falling because oilfields are ageing. It is not only technically tougher but also more expensive to extract oil. Government taxes/levies sum up about 2/3rds of the price of a barrel of oil. This leaves meagre amounts with the producer to invest in the technology to extract more oil, while simultaneously remaining profitable. No levy is imposed on imported oil. Reducing levies on domestically produced oil can facilitate more investment and production. Substituting imports with domestic production will then gain revenue for the government. India has abundant reserves of oil and gas. A policy that leads to extracting oilfields viably can attract FDIs.

Ethanol-blending

On a positive note, the government has started aggressively encouraging ethanol-blending. It has preponed the target date of the 25 per cent blended ethanol goal to 2025. Both the public sector, as well as private companies, are evincing interest in blended ethanol. Pilot projects initiated by TVS and Mahindra will check the viability of running vehicles with ethanol engines. There is a debate on, as to which would be the right technology of the future, with cost-effectiveness in view - Lithium ion batteries or hydrogen fuel cell. Both technologies harness electricity and leave behind zero emissions, but the similarities end there.

Several big players like Toyota, VW, GM, Hyundai and Honda aren’t ruling out hydrogen as the fuel of the future, by making renewable hydrogen cheaper to produce. Titan Hydrogen is aiming to accelerate worldwide hydrogen fuel cell adoption with innovative technologies. Oil and gas companies and governments are hailing hydrogen as the solution to decarbonising parts of the economy that are not easily electrified.

Decisive steps by the companies and the government can be evaluated only once the oil sector comes completely under the GST regime. Fuel under the GST system is not likely to happen soon. Even when this happens, fuel prices will not reduce immediately. Policy distortions will have to be tackled at all levels, which will take time. There are yet no signals from the Centre and states that they are ready to cut taxes on fuel.

Potential in renewables

Seeing the huge potential in renewables, foreign investment has started pouring in. The US solar-technology firm CubicPV Inc. is investing as much as $1.1 bn to make equipment in India, drawn by government incentives. Visionary domestic companies are also fast taking to renewable, such as TATAs and Mukesh Ambani unveiling a multibillion-dollar investment in clean energy, including solar equipment production.

When Ambani told shareholders that RIL was placing a $10bn bet on the ‘energy of the future’, it shook several assumptions and triggered rethinking in many boardrooms. With strong winds of climate change sweeping the globe, the companies that are driving blindly into the future will suffer.

The UAE has made significant progress in resolving its standoff with OPEC+. A compromise is likely that could give the UAE a more generous output limit next year and enable the whole group to pump more oil in the coming months. Talks are still ongoing. Any deal would need the support of other OPEC+ nations. If the compromise is ratified at the group’s next meeting, for which no date is given, it could potentially open the path to higher output. However, the International Energy Agency (IEA) had earlier warned of another oil price war, which would cause volatility in oil markets.

Global capital is seen racing towards clean energy finance. India has also accelerated its shift to renewable energy to attract more economic, social and governance (ESG) funding. With the RBI joining the Network for Greening the Financial System, policies henceforth are likely to fully incorporate environment and climate risk management in the finance sector. These will steer limited public and private sector investments towards green recovery for a more sustainable economy.

To conclude, the oil sector is worthy of the goal of self-reliance, as it is highly strategic. Fuel taxes need to be rationalised. Oil, on the one hand, is significant for the country’s energy security and macro-economic stability but on the other, production and global supply is concentrated in the hands of OPEC cartel, which controls the price of crude. Minister H S Puri is saddled with a huge task, with people across the country protesting the soaring petrol and diesel prices.

The writer is a corporate economist

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