Be prepared for extreme volatility in crude oil
One key element of the Budget will be the management of the fiscal deficit. Reining in the Fisc has been much easier since crude oil prices have plunged. In August 2014, the benchmark Brent contract traded at around $105 a barrel. By January 2015, it was down to $45 a barrel. It dropped below $30 in late January this year. It has subsequently recovered a little to $35 a barrel. Natural gas has seen a similar trajectory of steeply declining prices. So has coal.
India imports roughly 80 per cent of its crude oil consumption (including a fair amount for export of refined products), about 30 per cent of its natural gas and 10-12 per cent of its coal. So, it has been a massive beneficiary of lower energy prices.
Long-term gas contracts have been renegotiated on better terms. The import bill for crude oil in 2015-16 is roughly 40 per cent less than estimated in the 2015 Budget, which assumed an average price of $70 a barrel. The import bill for 2014-15 was also much lower. Subsidies have been substantially reduced. The lower prices have also given the government leeway to free retail prices to some extent and it has been able to mop up higher excise on petro-products.
There is a chance that crude oil prices have bottomed out but volatility is likely to continue. Saudi Arabia and Russia have agreed to freeze production at current levels. This could put a floor on prices since most exporters don't have spare "swing" capacity.
But, Iran does have major "swing" capacity in gas and crude oil. It has been out of export markets and it could easily ramp up production by a huge amount, if sanctions are off. Although Iran has made approving noises about the Saudi-Russia pact, there is no guarantee that Iran will not pump more. Also, don't forget that Iran and Saudi Arabia are locked in a proxy war.
Second, if crude oil prices do lift till $55-60 a barrel or thereabouts, US shale production will become profitable again. That puts a ceiling on prices. Third, supply out of war-torn regions like Libya, Iraq and Nigeria could either be further disrupted, or else, make sharp gains depending on what happens in battles against ISIS, and Boko Haram. Changes in supply from such zones could also cause big swings.
On the other side of the equation, global demand is unlikely to pick up. But currency moves may be a significant factor. Crude contracts are dollar-denominated and the dollar's fluctuations could redefine the relative cost of oil. The weaker rupee has certainly nullified some of the benefit.
The crude oil prices, or the dollar's moves, are obviously not within the finance minister's control. However, the Budget must make assumptions about crude oil prices in 2016-17 since it has to allocate subsides. This will not be an easy task since crude oil may be highly volatile. On the whole, it would be better for the Budget to be conservative and assume higher international prices.
Nobody can confidently model all the complexities of crude oil price movements. The fundamentals defining demand are hard enough to understand. The factors affecting supply also involve geopolitics, which are hard to guess.
One possibility is violent movements within a range of $25-60. Above $50, shale starts coming in. At below $30, conventional production is cut. Some other possibilities would be a sharp rise, a sharp fall, and more tightly-ranged trading. It is possible to make a case for any of these price scenarios, though some seem less likely than the others. Traders will have to be prepared for all of these possibilities. So must the government of India.
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