Elevated crude oil prices may lead to demand destruction

Oil frothed up to cross $100 a barrel on Thursday after Russian forces began military operations in Ukraine, ending months of international diplomacy to diffuse the latest round in a crisis that started in 2014. As Brent Crude traded at 105 a barrel at 1630 IST, up from the previous close at 8.45 per cent, analysts warned that a protracted conflict in Ukraine could have major implications for India, the world’s third-largest oil importer.

This will not only add to inflationary pressures but may also lead to reduced demand for fuels like petrol and diesel, with consumers moving to alternatives like CNG.

“The spike in crude oil due to events in Ukraine can have a huge impact on the Indian economy if it continues for a prolonged period. This rally will also impact liquified natural gas (LNG) prices, as much of India’s LNG contracts are linked to crude. India’s current oil import bill is hovering around $11.5- 12 billion per month, putting pressure on the balance of payments situation and current account deficit targets,” leader energy sector at Deloitte India, Debasish Mishra, told Business Today.

This has also stressed margins at the oil marketing companies (OMCs) like Indian Oil Corporation Ltd (IOCL), Hindustan Petroleum Corporation Ltd (HPCL) and Bharat Petroleum Corporation Ltd (BPCL).

“The OMCs have not fully passed on the impact of rising oil prices perhaps due to the state elections. They need to increase prices by at least Rs 5-6 per litre for normalised margins. However, it may adversely affect demand to accelerate the move towards viable alternatives like CNG, and to that extent, there is a good scope for the government to lower excise duty on oil,” remarked energy analyst financial services firm IIFL Securities, Harshvardhan Dole.

A prolonged conflict in Ukraine could result in crude prices reaching up to $120 a barrel, said analysts. And that is the point where demand destruction may set in. In the past, spikes in oil prices have led consumers to look beyond expensive fuels like petrol and diesel. Recently, commercial vehicle maker Ashok Leyland launched a CNG truck in its intermediate segment. Similarly, there is a significant number of passenger vehicle users moving to CNG in especially major metro cities.

Inflationary concerns

Once high oil prices and elevated refinery margins are passed on to consumers, it may have a bearing on retail inflation, reported at 6.01 per cent for January.

“Already the headline inflation is near the upper tolerance level of the Reserve Bank, with the Wholesale Price Index (WPI) inflation staying in double digits. A further spike in inflation would hurt the already stressed or subdued private consumption, which will have a cascading impact on the overall economy,” cautioned research analyst at brokerage Choice Broking, Rajnath Yadav.

As per estimates, a $10 increase in crude oil prices, can impact GDP growth between 0.3-0.35 per cent. Since the Economic Survey 2021-22, while projecting FY2023 GDP growth had taken an underlying assumption of oil prices staying around $70-75 a barrel, prevailing prices of the commodity have the potential to negatively impact it by nearly 1 per cent.

The country paid $82.4 billion for crude oil imports in the nine months through December 2021, a 108 per cent rise over $39.6 billion paid over the same period in 2020, showed official data.

“If crude prices continue to rise upwards, there is a strong risk of government mulling reintroduction of the administered price mechanism (APM) to extend subsidies through oil marketing companies (OMCs),” argued IIFL’s Dole.

Therefore, the central government has no option but to walk a tightrope – contain inflation and balance growth.