Why is a Distant War Burning your Wallet?

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In the late 80s, India faced a balance of payments crisis. Unable to pay for its oil imports (a fraction of what we import now), the government put out ads on TV advising citizens to save electricity and fuel.

We were advised to walk to nearby places then use the car, switch off the lights when not needed, travel by public transport, and even close the regulator on your cylinder after cooking.

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Why am I remembering these now? Because these ads are going to make a comeback soon. $95.42 was the price of Brent Crude on the 24th of February 2022. That chilly day, Russian military columns rolled into Ukraine. By the 8th of March, oil prices had hit $127.98.

They have remained above the psychological hundred-dollar mark since – burning holes in gharelu budgets worldwide. For this, we have to understand the global oil market, which is very sensitive to political events globally.

‘Crude’ oil is petroleum that is then ‘refined’ into kerosene, petrol, diesel, and other products. The price of crude directly determines the price of refined products, with the cost of refining remaining more or less the same. Most refineries in the western countries are set up to process ‘sweet’ crudes, i.e. those that have low sulphur content (which interferes with burning). Refineries in Asia usually buy ‘sour’ crudes, which have high sulphur content and high density. Sour crudes are more expensive to refine compared to sweet crudes.

The barrel ($42 gallons or 159 liters) is the unit of the oil trade. This is a result of the early history of the oil industry – which began in Pennsylvania, the USA in the mid-19th century.

The most common containers available to the oil drillers were whiskey barrels – and so the name stuck.

I would strongly recommend that you read Daniel Yergin’s “The Prize” – one of the most comprehensive books on the history of the oil industry.

As an aside, ‘sweet’ and ‘sour’ are literal terms here – in the early days, quality was assessed by actually tasting the crude oil.

There are about 200 varieties of petroleum (‘crude’) traded in the world, but benchmarks are set by three kinds, depending on where they come from. West Texas Intermediate (WTI) is the benchmark for oil contracts in the USA, based on crude oil extracted from reserves in western Texas.

North Sea Brent Crude is the one for most global markets, based on the kind of oil that used to flow from the Brent Oilfield from 1976 to 2005. The oil price in the news usually refers to this benchmark. The one that matters to us in India though, is Dubai Crude, which is based on the petroleum reserves of the UAE.

Most crudes are traded on commodity exchanges such as the New York Mercantile Exchange (usually WTI) and ICE Futures (formerly the International Exchange) based in London. The petroleum trade in the NYME usually only affects prices in the USA and Canada. Trade in the latter affects global prices – including at a petrol pump near you.

The prices in turn are determined by many factors. Global supply is only one factor. The Organization of Petroleum Exporting Countries (OPEC), is a cartel formed in the 1960s to control the price of oil and make sure that oil-producing countries make a decent profit. It was responsible for the ‘oil shock’ of 1973 when OPEC sharply cut down production.

The price of oil traded in the exchanges shot up, leading to global shortages. As the price of fuel affects the price of everything else, inflation shot up everywhere. One of the consequences to India was social and political turmoil. Instability spread throughout 1973 and 1974, even after the oil shock had faded away. It was amplified by other political grudges, endangering the rule of the then PM Indira Gandhi. Her final response was to impose the Emergency in 1975.

Time and time again, OPEC has clashed with major buyers, such as the USA and Europe. Currently, Russia, a major oil producer works in tandem with OPEC even though it is not a member. Oil traders are also sensitive to wars, natural calamities, and disruptions in the supply chain. During the pandemic, for example, Brent crude prices fell to a historic low of $19.33 per barrel. WTI’s price became negative at USD -37.63, which meant theoretically that producers had to pay somebody to pick up the oil.

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Oil trading companies preferred to fill up tankers from oil producers and anchor them at sea. This led to artificial shortages in consuming countries, causing prices to rise.

India is a net oil importer and a very big one at that. Its oilfields in Rajasthan, Assam, and Bombay High are inadequate to meet its growing consumption. Hence, 86% of India’s oil is imported, most of it from the Gulf. These imports also make up the lion’s share of India’s forex outflows. Combined with a falling rupee (now near INR 77 to a dollar), India can expect to see an additional expense of USD 70 billion on petroleum imports. This is in sharp contrast to the USA, where domestic oil production has reached levels of self-sufficiency. High prices are an incentive for its oil producers to pump more.

The consequences to us in India are frightening. A rise in household expenses will mean cutting down on vacations and travel, on new clothes and pizzas and other fizool expenses.

Unfortunately for some people, these fizool expenses are what keep the tourism and travel, food processing, textiles, and many other industries going. Millions of chulhas are under threat of going cold. Political instability will result and there will be riots. And it’s all downhill from there unless oil prices fall. India taxes oil at high rates, and tax cuts can therefore cushion the impact. But after the start of GST, states have become extra dependent on fuel (and alcohol) taxes, and are unlikely to cut them further.

Oil prices can be partially controlled in India, as the major refining and marketing companies (Bharat Petroleum, Oil India, and Hindustan Petroleum) are state-owned. It is often alleged that governments keep the prices low before election time, and let them appreciate sharply after polling day. We can complain, but the deed is done.

This is even after India deregulated the oil market in 2010, allowing companies to set their prices. However, this tactic of pleasing people (or rather, not angering them) may keep the peace in the short term, but has longer-term consequences in terms of budget deficits.

Globally, however, oil prices depend on supply and demand – and on oil traders who are not bothered about government budgets. Prices had been falling steadily in late 2020.

However, Russian saber-rattling since the 1st of December 2021 has reversed this trend. Traders expect Russian oil to be eventually sanctioned from the market, restricting global supply. OPEC countries have so far refused to raise production to offset this loss. Which they can, by the way, but the record oil prices suit them. Years of low oil prices have bored holes in their national budgets, which they expect to repair. Ukraine’s national tragedy is many OPEC nations’ jalsa – such is the nature of internal affairs.

Therefore, from a low of USD 68.87, the oil began to rise steadily till 24th February 2022 when it touched USD 95.42, a whopping jump of 138%. The pain is expected to spread with speculation that oil prices will reach USD 200 per barrel. Nuclear-armed Russia has warned the world that if it is not allowed to swallow up Ukraine, oil might reach USD 300 even.

Not just oil, the prices of other things have also surged, such as gas, wheat, edible oil, and fertilizer. Indonesia, the largest producer of palm oil, has banned exports. Pakoras – so essential to our economy – are going to get pricier.

This season of record heat might fade once the rains come, but the economic heat will last a long time. You may want to follow the advice of those 90s ads. Follow them anyway. Less oil (both edible and inedible) and more exercise are good for you. I will dare to give you one more piece of advice. Try not to dip into your savings or liquidate investments, unless you have a personal emergency. Bad times are a time to stay invested. If you liquidate, the following good times may not be enough to repair the holes in your finances.

Eventually, the war will end and oil prices will go back to a lower place, but perhaps nowhere near the antebellum USD 60 per barrel. But if India misses its lessons now – as it missed them in 1973 – the economic pain will linger. Now is the time to invest even more heavily in renewable energy. India is on track to be 50% free of fossil fuels by 2030 according to its climate goals. With the ‘Special Military Operation’ exposing the weaknesses in the global fuel market, India needs to roll up its kurta sleeves and speed up renewable-zation.

With a massive coastline, summer and winter winds, unrelenting sunshine for 8 months of the year, and a large number of rivers, India can switch faster than expected to renewable energy. Nuclear energy, in which India has acquired multidisciplinary expertise, is not to be scoffed at either. And I may be even so bold as to say that India’s demographic dividend can be encashed.

Riding a stationary bike for 8 hours can generate 100 watts of electricity, so imagine an army of people simply pedaling away – and gaining employment in the process. It may sound like a silly idea now, but once upon a time, so did the concept of a horseless carriage.

To quote a certain former PM of the UK, “never let a good crisis go to waste”. Indeed, our energy independence, strategic autonomy, and climate sustainability depend on it.

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Sanjay Dangi
Sanjay Dangi
Sanjay Dangi, Founder & Director of Authum Investments

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