How India can minimise the damage from OPEC+ production cuts

This is a blow to global growth, the fight against inflation, and financial stability. OPEC+ should, now that they have taught short-sellers a lesson, consider stepping up production so as not to kill growth and the demand for oil.

While OPEC takes the flak for higher oil prices with its publicised production cuts – the second since last October – another culprit escapes attention: US shale producers. While the global oil price crash in 2014 hurt American shale producers, who had increased output to make the US the world’s largest producer of crude, their refusal since to step up production significantly has contributed to the rise in oil prices.

The price of oil that makes shale oil production viable is generally recognised to be around $60 to $65 a barrel, which means that since oil prices recovered from their slump, the US shale oil industry has focused more on servicing shareholder returns than on stepping up production.

The World Bank’s annual publication, Global Economic Prospects, sees a lost decade ahead for the world’s developing countries, given the current economic environment of unabated inflation, high interest rates, pressure on developing country exchange rates to depreciate against the dollar (in which oil and other major commodities are denominated and debt servicing has to be carried out), and a policy-induced slowdown or outright recession in the advanced economies.

Higher oil prices tend to widen the current account deficit of countries like India, which import oil, and depreciate local currencies. To combat the resultant increase in imported inflation and to prevent further depreciation of the currency, developing country central banks feel obliged to raise their policy rates of interest. Higher rates disincentivise investment and growth. Further, increases in rates depress the value of assets held by banks, creating the potential for financial fragility.

While increasing the global supply of oil is not directly in India’s hands, it is up to New Delhi to adopt measures that would minimise the damage from higher oil prices. The government has removed the windfall gains tax on oil companies and slashed export duties on refined product exports. This is all to the good. It offers a cushion for oil companies to absorb some of the price increases without passing them on fully and immediately to consumers.

The government must refrain from trying to use the exchequer to cushion the impact on consumers. A rise in the fiscal deficit, to take on a fuel subsidy burden, would feed excess demand across the board and generalise inflation. Calibrated increases in fuel prices would moderate fuel consumption and limit the impact on prices to some extent.

In the meantime, India must step up oil imports from Russia and make efforts to upgrade more refineries to handle the Urals-grade crude coming in from there.

While the G7 has imposed a price cap of $60 a barrel on oil from Russia, this is not being enforced with any degree of rigour. It has been reported that Japan, a member of the G7, has started to import oil from Russia at a price above the prescribed limit. There are also reports that some countries pay a premium, through indirect channels, for Russian oil over the formally invoiced price. Some are even using tanker fleets that don’t avail of insurance and reinsurance from Western sources to circumvent the price cap on Russian oil exports.

Reversing the production cut by OPEC+ is one way to prevent harm to developing countries’ prospects. Another is increasing the output of American shale frackers.

A third – and the most sensible – option is to find a negotiated settlement to the hostilities in Ukraine, which would cool off oil, food and fertiliser prices. These are not mutually exclusive options but complementary ones. India must pursue all three by helping to shape public opinion around the world.