Crude oil: The mother of all shocks awaits Modi govt in 2018. Is it prepared?

No expert can dare to try and accurately predict the price of crude oil. Barring a few exceptions, crude prices have always been unpredictable.

On Wednesday brent futures crossed $67 a barrel -- the highest since 2015. Compared with that, in February 2016 the price fell to $27 a barrel.

This jump has prompted the question: Will crude breach the $70 mark?

The answer: Depends on whether you look at the technical aspect of the business or its geopolitical intricacies. Technically, even crossing $65 should not have been possible.
Global oil demand is expected to rise by about 1.3 million barrels per day in 2018, according to International Energy Agency. At the same time, output from outside Organisation of Petroleum Exporting Countries is set to rise by 1.6 million barrels a day. This means that all things constant, there should not be any rise in the price of crude oil in the current year. Moreover, with every rise in the price of crude oil, shale oil companies in the US begin to pump out more.

Yet, hedge funds are increasing their bets on the rise in crude oil prices. And they have reasons for doing so.

Iran that produces about 3.8 million barrels per day and exports 60% of it, is witnessing mass protests by people against the government. Even though protests have had no impact on Iran's oil production, given the nature of protestors, what if workers in oil fields resort to strikes?

Given the interest of US President Donald Trump's interest in the anti-government protests in Iran (read his tweets), one would not be surprised if the situation goes out of control in the West Asian country.

One also cannot ignore the 'no-impact' of the restart of North Sea Forties pipeline system (FPS) on the oil prices. The FPS is a major export pipeline from more than 80 assets in the UK North Sea and was shut leading to a cut of 450,000 b/d of supplies for two weeks in December after it developed cracks.

Last but not least, 2017 saw less than 7 billion barrels of oil equivalent discovered globally -- the lowest since the 1940s. This fall in new discoveries is largely due to capital expenditure cuts by oil companies over the last three years, as their revenue per barrel of oil decreased.

Various hedge fund managers and oil experts believe that shale oil production cannot meet cut in production at least in the next two years.

“Tight rock is not going to solve the global supply-demand issue,” Bloomberg quoted Adam Waterous, CEO, Calgary-based Waterous Energy Fund as saying. “It's going to take a long time for those mega-projects to come back on.” Waterous added.

Why India should worry

Despite a fall in private sector investments in the last three years, the Indian government has managed to push the country's GDP growth. Low crude bills were one of the biggest reasons.

When crude oil prices halved between 2014 and 2016, the government increased excise duty on petroleum products and generated a windfall revenue that went up from Rs 1.3 lakh crore to Rs 2.1 lakh crore. Not just this; dividends from downstream oil PSUs rose Rs 0.9 lakh crore.

The Gross Fixed Capital Formation (GFCG), a proxy for private investment in the country fell to 29.5% in 2016-17 as against 30.9% in 2015-16. It further fell to the level of 27.5% in the first quarter of 2017-18. In the second quarter of the current fiscal the GFCF was 28.9% of the GDP. The third quarter does not look promising either as new investment proposals by India Inc fell to a 13-year low of Rs 76.8 thousand crore in the October-December quarter of 2017.

The government expenditure, represented by Government Final Consumption Expenditure, during 2016-17 went up to 11% as against 9.8% in 2015-16. In the second quarter of 2017-18 the GFCE grew by 12.5% of the GDP. Clearly, the government is spending more and more to keep India's GDP growth from falling.

But it is not going to be possible in the face of rising crude oil prices, as India imports around 80% of its oil needs and the government is already walking a tight rope due to fall in revenue after implementing Goods and Services Tax. The Ministry of Finance has already announced additional borrowing of Rs 50,000 crore through long-term securities from markets to meet expenditure in the last quarter of the current fiscal. To make things worse retail inflation is on the verge of crossing the comfort zone (4% - 6%) of Reserve Bank.

According to an estimate by Nomura, a sustained $10 per barrel hike in crude oil prices can impact consumer price inflation by as much as 0.6-0.7% points.

Having to deal with high inflation would be the last challenge that Indian government would want, especially in the terminal year of its rule before it seeks fresh mandate from people.

In the given scenario, Modi government can only hope that it does not have to deal with problem of expensive crude oil.