December 6, 2022

Explained: Why oil prices jumped to an eight-month high and what it means for India – Times of India

NEW DELHI: Oil prices on Friday jumped to an eight-year high after the US warned that Russian President Vladimir Putin could order an invasion of Ukraine imminently. The invasion could trigger sanctions from US and Europe and disrupt energy exports from the world’s third-largest oil producer.

Context:

Russia could invade Ukraine at any time and might create a surprise pretext for an attack, the United States said on Sunday. National Security adviser Jake Sullivan has urged Americans to leave Ukraine within the next 48 hours.

Prospect of military action by Russia for the world:

The prospect of military action by one of the world’s largest oil exporters raised the chances of further supply disruption as oil producers are already falling behind rising demand. Petroleum inventories around the world are dwindling. Demand for oil has outpaced production as economies rebound from the worst of the pandemic. Since Russia supplies much oil and gas to the rest of the world, supply could be cut off if tensions escalate to the point of an invasion.

The problem:

Global oil demand has picked up to levels seen before the pandemic, which producers are struggling to meet. And with members of the oil cartel OPEC+ routinely falling short of their rising monthly production target, one cannot afford any more disruptions to the world’s oil supply.

What’s the price?

Brent crude futures was at $95.56 a barrel by 0235 GMT, up $1.12, or 1.2%, after earlier hitting a peak of $96.16, the highest since October 2014.
“If … troop movement happens, Brent crude won’t have any trouble rallying above the $100 level,” OANDA analyst Edward Moya said in a note.
What is the geopolitical tension?
The Russia-Ukraine conflict:
Russia is preparing for an attack on Ukraine, and global markets are in turmoil due to supply chain disruptions as fallout.
Russia has over 130,000 troops massed near Ukraine, which is not part of the Atlantic military alliance, and the US – while keeping open the diplomatic channels that have so far failed to ease the crisis – has repeatedly said an invasion is imminent. Moscow has ‘officially’ denied that it plans to invade neighboring Ukraine, but apart from soldiers, it has moved tanks, missiles, and even fresh blood supplies to the border. Russia is demanding that Ukraine never be permitted to become a member of the NATO military alliance, and has also said it wants the organization to roll back its presence in Eastern Europe.
” Russia is the largest non-open supplier of crude and gas to the world. Any war can possibly mean Russians declare “force majeure” on their oil contracts with their buyer clients. Insurance costs are likely to go up on tankers, pushing prices higher,” said Vijay Bhambwani, Head of Research,Behavioural Technical Analysis at Equitymaster.
The fallout: Russia exports about 5 million barrels a day of crude. About 60% of Russia’s oil exports go to Europe, and another 30% go to China.Russia is not only one of the world’s largest oil producers but it is also the largest exporter of wheat. Ukraine and Russia together account for nearly 29 percent of the global wheat export market. Apart from this, Russia is also a major exporter of aluminium, palladium, nickel, steel, wood fertilisers. If the country withholds supply of potash, food prices could soar as crop yields would drop, resulting in more inflation. Moreover, any action by Russia could is almost certainly likely to trigger economic sanctions form the US. and its European allies. That could lead to oil and gas shortages around the world and, most likely, higher energy prices. It will also raise the prices of these other commodities as Russia can trigger shortages and/or create a glut in the commodities markets. If these basic commodity prices rise, it means corporate raw material costs will go up and profits will take a hit.
“Any disruptions to oil flows from Russia in a context of low spare capacity in other regions could easily send oil prices to $120,” Natasha Kaneva, JPMorgan’s head of global commodities strategy, wrote in the report last week.
Why it is aCatch 22: Oil and natural gas prices are already too high in the United States and Europe.
“On several occasions in 2021, US President Joe Biden lobbied OPEC to increase output in order to ease surging fuel costs. The optics of doing that while supporting sanctions that would directly choke off oil supply and push up prices are awkward to say the least. So, leaders face a Catch-22: Oil sanctions severe enough to hurt Russia would also cause economic misery at home, whereas sanctions mild enough to be tolerable for voters would probably have no effect. While sanctions in some form are likely, we expect Western leaders to steer clear of Russian crude exports,” writes Dave Meat, CFA, director of research, energy and utilities, for Morningstar.
Goldman Sachs too doesn’t see a significant impact as sanctions-driven disruption would be “mutually-assured destruction” as “it’s not in the interest of anybody to stop the flows of energy through Ukraine.”
While the White House has said no punishment is off the table, Europe’s dependence on Russia for energy make them vulnerable given Russia’s history of threatening to cut off gas supplies to its neighbors, which could potentially undermine the West’s ability to execute coordinated sanctions.
There is also the risk that Russian President Vladimir Putin could retaliate by weaponizing exports of oil and natural gas. Higher natural gas prices would further drive up oil demand as factories and power plants switch to oil instead.
“Russians are using natural gas like a bargaining chip by denying gas to Europe via the Yamal pipeline. This is forcing consumers like power producers to burn oil instead of gas to generate electricity. That’s driving oil prices higher,” said Bhambwani.
Middle East angle: Key oil-producing countries have also not really increased crude oil supplies despite rising demand. OPEC+ had agreed to sharp cuts in supply in 2020 owing to Covid-induced travel restrictions, but the organisation has been slow to boost production since. The alliance has come under increasing pressure from oil-consuming countries to to boost supply, as demand has proved stronger than expected but the cartel’s supply lagged behind its targets by 900,000 barrels a day in January, against a shortfall of 790,000 barrels a day in December.
“The bloc’s prolonged underperformance has effectively taken 300 million barrels, or 800,000 bpd, off the market since the start of 2021,” the IEA said in its latest report. The UAE and Saudi Arabia are the two oil producers with the most spare production capacity but the supply shortfall could deepen if OPEC+ continues to struggle to raise output. The IEA has called on both Saudi Arabia and the UAE to pump more barrels to help pacify the market.
“If the persistent gap between OPEC+ output and its target levels continues, supply tensions will rise, increasing the likelihood of more volatility and upward pressure on price..”But these risks, which have broad economic implications, could be reduced if producers in the Middle East with spare capacity were to compensate for those running out,” the IEA said.
According to IEA, global oil supply is expected to rise by 6.3 million barrels a day in 2022 if OPEC+’s pandemic-era supply constraints are fully unwound as planned. Global supply rose by 560,000 barrels a day in January to 98.7 million barrels, with oil producers outside the alliance contributing the lion’s share.
Other reasons for rising oil prices
These include consumption being strong despite the spread of the Omicron variant of the coronavirus. Add to that more supply constraints like drone attacks on oil facilities in UAE, a major oil producer, outage on a major oil pipeline linking Saudi Arabia and Turkey as well as spare capacity dwindling with insufficient investment in new production.
“Saudi Arabia has claimed irrefutable evidence against Houthi rebels based out of Hodeidah and Salif ports in Yemen. Houthis have been firing missiles and launching drone attacks on Saudis and UAE from there. Saudi air force is expected to start bombing raids on these two towns soon, said Bhambwani.
According to a report by Bank of Baroda even though the US can sell from its strategic petroleum reserve, its supply is limited as crude inventories may have fallen to 593 million barrels.
What does this mean for India?
If prices increase globally to beyond $100 a barrel, Indians need to brace for a huge spike in petrol and diesel prices in March, after the state polls as India imports more than 80 per cent of the oil requirement. Between April and November 2021, India’s oil import bill more than doubled to $71.1 billion.
” The rise in the price of crude has a direct impact on Indian fuel prices because India imports 85% of crude oil requirements. Currently India is holding election in 5 states and that is the reason why prices are not increasing but once it is over we may see a big increase in the fuel prices The rise in fuel prices will also having a direct impact on inflation as transportation cost increases the prices across all daily needs,” said Kshitij Puruhit, Lead commodities and currency expert at CapitalVia Global Research.
When oil price rises, so does inflation, as one has to shell out more for fuel. Major global central banks like US Federal Reserve and Bank of England have already begun tightening their monetary policies and the Reserve Bank of India is also expected to raise rates in the current year. According to a report by Bank of Baroda, a 10 per cent increase in crude oil will lead to an increase in the Wholesale Price Index (WPI) in India by nearly 0.9 per cent. The report predicts that increasing oil price may even result in a rate of inflation based on WPI at 12 per cent and 6 per cent for FY22 and FY23, respectively.
” Once the polling is over, we can see the fuel prices moving up because in the past also state level elections have resulted in a freeze on the retail prices but as soon as the polling is over, prices start getting revised and retail prices starts adjusting to the international prices,” Dr Sunil Kumar Sinha, Principal Economist & Director Public Finance, India Ratings & Research told Economic Times in an interview.
He added that if a 1% rise in global oil price is passed through into the domestic economy, it increases retail prices by about 7 to 8 bps and wholesale prices by 13 to 14 bps. And this is just the first round effect. So at a time when inflation is already elevated, rising fuel prices will impact the economy across the board-– be it households, businesses or transportation.
” Crude prices could spike up to $100 a barrel, triggering inflation in India and worsening global inflation. Moreover, this price rise could lead to steeper rate hikes in the US, which might trouble emerging markets like India. Also, the Indian budget has assumed an oil price of $65 in its budget projection, and if oil prices rise, there will be a need for government subsidies,” said Sonam Srivastava, Founder at Wright Research, SEBI Registered Investment Advisor.
A surge in crude oil prices could also increase India’s expenditure, which will adversely affecting India’s fiscal deficit – the difference between the government’s total revenue and total expenditure. Fiscal deficit indicates the amount of money the government has to borrow to meet its expenses. A rise in fiscal deficit could negatively affect the economy as well as markets.
The rise in crude oil prices will cause the rupee to depreciate further. “The rupee is expected to depreciate further today, due to rising crude oil prices and stronger dollar. Additionally, risk aversion in the global markets may strengthen the dollar further.” said ICICI Direct in its report.
ATF prices rise: Jet fuel rose to record levels across the country at the beginning of February following a steep 8.5 per cent hike necessitated due to a spike in international oil prices.ATF price was hiked by Rs 6,743.25 per kilolitre or 8.5 per cent to Rs 86,038.16 per kl in the national capital, according to a price notification of state-owned fuel retailers. So, any further hike in international crude means high fuel prices will become a bigger concern for airlines amidst pandemic-induced weak demand.
With inputs from Bloomberg

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