A Crude End To India’s Russian Oil Fest? – Analysis


By Aditya Bhan

Amidst the ongoing conflict with neighbouring Ukraine, Russia’s Finance Ministry stated that revenues from oil exports declined 46 percent on-year in January, with discounts of US $15-20 per barrel offered to buyers in China, India, and Türkiye. In addition, the shipping cost of US $15-20 per barrel is levied.

But according to traders, the entry of more ship operators raised tanker availability and eased freight rates in February. On the other hand, Indian importers—who have absorbed in excess of half of Urals seaborne exports in recent months—are willing to pay higher prices. This is due to increasing competition from Beijing, which is also eager to import more Russian crude due to rebounding domestic demand in China.

Also supporting the price of Urals was the news of a cut in Russian crude production and exports. Russia had already declared plans to reduce its oil production by 500,000 barrels per day in March 2022, amounting to 5 percent of its output or 0.5 percent of global production. Moscow may now be planning to cut oil exports from its Western ports by up to 25 percent in March versus February.

A protracted conflict and Chinese manufacturing

Upon completion of a year since the beginning of the Ukraine crisis, the presidents of both Russia and the United States (US) asserted that they remain committed to the fight. While the former readied Russia for an extended military campaign to be prosecuted “step by step”, the latter insisted that “we will not tire” in the endeavour to preserve a democratic Ukraine. For whatever it is worth, President Volodymyr Zelensky of Ukraine stated during a news conference in Kyiv that his country’s victory was “certain” and inexorable. However, none of the leaders clarified what an achievable victory would constitute while attaching their legacies to a war with no identifiable culmination.

According to former American Intelligence Officer and the Director of the Russia Programme at the Carnegie Endowment for International Peace in Washington, Eugene Romer, “(Russian President) Putin is as committed as he’s ever been to his grand victory” while the “Ukrainians are as committed as ever to defeating Putin, even if it will be at a most terrible price”. Asserting the inevitability of victory, however, is way simpler than gathering the means and assistance needed to attain it. And with the war showing no sign of concluding, other determinants of oil prices including Chinese demand, come to the fore.

In February, China’s manufacturing activity surged at its quickest pace for more than a decade, fuelling expectations of a sharp recovery in oil demand. In fact, China’s official manufacturing purchasing managers’ index (PMI) increased to 52.6 in February, from 50.1 a month earlier. The number of experts with a bullish oil demand forecast is consequently on the rise. According to a market strategist at IG, for instance, “another round of upside surprise in China’s PMI further provides conviction of a stronger than expected recovery, which supports a more optimistic oil demand outlook”.

The price cap

On 5 December 2023, the G7, Australia, and 27 European countries collectively implemented a price ceiling on Russian shipborne exports of crude oil, targeted at reducing Moscow’s ability to fund the conflict in Ukraine and maintain stable prices globally. The price cap was in addition to a European Union (EU) embargo on purchasing seaborne Russian crude oil as a step aimed principally at granting third-party nations an avenue to still purchase Russian oil if it is not priced in excess of the price ceiling. After much deliberation, the price ceiling was set at US $60 per barrel, with a review to be conducted every two months beginning in mid-January.

Despite the topic being one of constant discussion between Washington and New Delhi, the latter’s decision to import large quantities of Russian crude oil has not yet become a major bone of contention because the purchases have largely occurred at steep discounts to the price ceiling of US $60 per barrel. In fact, Russia became India’s single largest supplier of crude oil last year as the Western sanction barrage against Moscow prompted the latter to find new markets.

However, India’s ability to gain from cheaper oil now faces the hurdle of stricter enforcement of measures related to the price cap. Indeed, India’s unwillingness to comply with the price ceiling has caused payment-related difficulties for the country’s oil-marketing companies. Indeed, refinery and banking officials cite the increased steps and verification now required to establish that imports abide by the price ceiling as potential hindrances to imports.

A crude outlook

In 2022, the supply-side disruption to global oil supply due to the Ukraine conflict was mitigated partially by soft Chinese demand. Given that this is changing, the pace and degree of the Chinese recovery will be an important determinant of oil prices in 2023. While the prevailing prices largely factor in the impact of the ongoing war, uncertaintyregarding Chinese demand is likely to persist for the foreseeable future. The probability of a large-scale destabilisation is low given that there is a gradual worldwide migration toward cleaner and greener technologies and sources of energy.

Given the lack of significant price disruptions over the past few months, the odds seem to be in favour of oil prices trading in a narrow but higher band of around US $85-90 per barrel. In fact, price movement may mimic ordinary conditions, as in the absence of war, but for the higher transportation costs associated with altered trade routes. This would certainly not resemble the worst-case scenario for New Delhi. But when combined with the more stringent implementation of procedures related to the price ceiling, the availability of crude oil at extremely cheap rates may soon become a thing of the past.

Implication and imperative

A rise in crude oil prices would tend to expand India’s Current Account Deficit (CAD) and pose a strain on the country’s forex reserves which, in turn, would exert a downward pressure on the value of the INR in the international currency markets. Although the Indian economy and its growth trajectory have remained largely resilient thus far, the prevailing geopolitical uncertainties may inhibit economic activity and derail the growth momentum of Asia’s third largest economy, which could manifest in softer corporate earnings and household expenditure.

The inflationary impact of costlier imports would be felt across 35 crore Indian households, but more so among those in the lower to middle-income categories. The strain would manifest in terms of elevated fuel prices as well as in the cost of everyday products, as companies can be expected to transfer most of the increase in raw material prices to households via higher product prices.

In any such situation, a significant fiscal expansion runs the risk of creating a twin deficit problem of coexistence of elevated fiscal deficit due to lower excise revenue, with high CAD. Nevertheless, the government may have to slash excise duty on diesel and gasoline to restrict the inflationary burden on households. The risk can be somewhat hedged by pre-emptively entering into forward contracts with willing suppliers before higher spot prices push oil derivative prices higher as well. However, the adverse impact would have to be shared by various stakeholders in the economy, and it would be unrealistic to expect the government to single-handedly absorb the same. Hence, carefully calibrated fiscal and monetary responses would be required to save the day.

Observer Research Foundation

ORF was established on 5 September 1990 as a private, not for profit, ’think tank’ to influence public policy formulation. The Foundation brought together, for the first time, leading Indian economists and policymakers to present An Agenda for Economic Reforms in India. The idea was to help develop a consensus in favour of economic reforms.

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