TUNISIA'S ZINE EL Abidine Ben Ali and Egypt’s Hosni Mubarak are history, but weeks after their exits, Brent crude remains well over $100, or Rs 4,522, a barrel ($119 on Feb. 24, 2011). Things are still unsettled in Egypt, a key conduit for oil (more than 3 million barrels passed through it in 2010). And civilian unrest has spread to several neighbours of Saudi Arabia, which has 20% of the world’s proven reserves and the highest production capacity.

Industry analysts are worried about what could happen to crude prices if protests spread further in West Asia and to Nigeria. “It will be a surefire recipe for global disaster,” says Nabin Ballodia, director at international consulting firm KPMG. Given that India imports 76% of its crude requirement, and that consumption is growing at 3.9% a year, the implications of a price rise are particularly sobering, he adds.

Crude prices are expected to remain between $90 and $100 a barrel even if there’s no supply disruption. Investment banks such as Nomura and Citi predict a range of $90 to $95 for 2011. Nomura analysts say that, going by the 109% spike in the oil price during the 1989 Gulf War, the price could touch $220 if supply is disrupted.

The price for India would be lower, as sweet Brent crude constitutes only 32% of the import basket; the rest is cheaper Oman-Dubai sour crude (it crossed $106 on Feb. 25). In its January 2011 oil and gas report, credit rating and research firm Crisil predicts that the average price will rise from $82 in 2010-11 to $85 in 2011-12.

Many analysts share this view. “The slow but gradual recovery of the U.S. economy, the onset of an early winter in Europe and North America, the growing hunger for oil in India and China, a weak dollar, and speculative buying are all signs of hardening crude prices,” says Deepak Mahurkar, associate director at international consulting firm PricewaterhouseCoopers. The Paris-based International Energy Agency, an intergovernmental organisation that advises 28 countries on energy policy, says global oil demand will rise from 86.9 million barrels a day in 2010 to 88.2 million this year.

“Even a small disruption can change industry dynamics and the global demand-supply situation, and can easily put crude in the $130 to $140 zone,’’ says Ballodia.

A Nomura report dated Jan. 6, 2011, titled Is 2011 Another 2008 for Oil Prices?, argues that even OPEC’s spare capacity—6 million barrels per day by 2011—will hardly suffice if a country like Nigeria has turmoil that disrupts supply for a few days. Nigeria produces some 2.43 million barrels per day.

Ballodia adds that the BP disaster has prompted oil majors such as Shell to go slow on expansion. “BP has sold its Vietnamese assets to stay afloat, and Shell is doing likewise,’’ he says.

Alternative fuels can’t make up the demand shortfall, as there isn’t enough investment in this sector. According to a Mumbai-based analyst, who asked not to be named, the absence of policy guidelines in India and some other countries exacerbates the problem. Moreover, he says, investing in alternative fuels only makes sense when crude prices are between $80 and $100.

So what does, say, $85 a barrel mean for the Indian economy? Bigger losses for public sector oil companies, a bigger subsidy burden, and deterioration of the economy. The Crisil report notes any hike in prices would directly and indirectly hurt a range of industries. The first to be hit will be oil refining and marketing companies such as IndianOil, Hindustan Petroleum and Bharat Petroleum, which buy crude at international prices and sell at government-controlled prices. These firms’ underrecoveries—losses from selling fuel below the cost price—will rise from Rs 46,000 crore in 2009-10 to between Rs 65,000 crore and
Rs 67,500 crore in 2010-11, and further up to between Rs 72,500 crore and Rs 75,000 crore in 2011-12, according to the report. “Marketing losses too would mount … from Rs 5,500 crore in 2009-10, to Rs 10,800 crore in 2010-11, and Rs 12,300 crore in 2011-12,’’ the report adds.

If the government absorbs 50% of the underrecoveries, as it did in 2009-10, it will increase the national oil subsidy bill substantially from an already high Rs 70,000 crore for 2010-11, as the Budget for that year had estimated. Passing on the burden to consumers would force households to cut discretionary spending, and thus slow down the economy.

There are other adverse effects, too. The National Council of Applied Economic Research, in a 2008 study of the microeconomic impact of high oil prices, found that a $10 rise in the price of crude leads to a 0.15% fall in industrial output, a drop in exports by 0.58%, and a 1.22% decline in the balance of trade over a year.

The current account deficit (when net imports exceed net exports), already high at 4% of the GDP, will deteriorate to 4.2% at $85 per barrel. Many economists argue that even if the government reins in the fiscal deficit (current account deficit plus borrowings) at 5.5% of the GDP, it may go haywire next year.

Higher crude prices hurt many industries, including aviation (aviation turbine fuel prices are linked to global prices), transport (which is at the mercy of domestic fuel prices), and fertilisers (which use naphtha and gas). Cars, too, tend to sell more when petrol prices are low.

KPMG’s Ballodia points out that 10 of the 12 members of the OPEC—which produces more than 1 trillion barrels of crude a year, or 80% of total global production (according to 2009 data), and sets global prices—are in West Asia, and account for about 75% of OPEC’s output. But some analysts expect that civilian unrest will not spread to Saudi Arabia or Kuwait (the latter is OPEC’s fourth largest producer, with 8% of the world’s proven oil reserves). “Not only are these economies different, but they’re also governed differently,” says Mahurkar of PricewaterhouseCoopers. “Hence, no parallel can be drawn with Egypt.’’

A Goldman Sachs report titled On What Happens To Oil As Egypt Contagion Flares, published on Jan. 31, notes that, regardless of political contagion, “financial contagion [is] already happening ... driving up funding costs and discouraging future investments in oil and gas in the region”.

How political events will unfold in Libya and the rest of the Arab world over the next few weeks is anybody’s guess. But whichever way things go, it seems certain that, for now, India is skating on thin ice.

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