Why is crude beyond $100/bbl and what does it really mean

On 24th February, the price of Brent Crude surged as high as $105/bbl before it closed the day below the $100/bbl mark. However, the price of crude once again rallied past the $100/bbl mark on 25th Feb, before settling lower. For now, the level of $100/bbl is proving to be a temporary resistance for the oil markets, but it is not too clear how long this could really last. It remains to be seen for how long crude can really stay below that mark.

The one thing that is driving crude prices higher is the uncertainty that is plaguing the Ukrainian region. Russia meets nearly 35% of the energy needs of the EU region and any supply disruption would mean that the price of energy is going to shoot up further. In the last 1 year, the demand for crude has been robust despite fears that the demand recovery out of COVID will be slows. That created a shortfall of 2.5 million barrels per day.

The other big reason is the fear of sanctions. For now ,the sanctions are at a very preliminary stage only impacting individuals and bond markets. For now, the Russian ports on the Black Sea are not yet blocked nor is there an embargo on Russian oil pipelines supplying to Europe. Once these restrictions come in, you could see crude prices rallying sharply higher. Oil analysts are already pegging oil at well above $100/bbl.

The big expectation was that the OPEC would increase the supply but most OPEC nations have increased supply slowly and hesitantly to avoid any major damage to price. It is almost after 7 years that the oil producers are finally getting lucrative prices for oil and they don’t want a supply glut to damage that equation at this point. That explains why supply from the OPEC and also from the US shale has been extremely calibrated at this point in time.

India may not be dependent on Russia, which is just about 2% of the Indian crude basket, but the higher oil prices would definitely be a big challenge. For one, every $10 upward movement moves up the fiscal deficit by 50 bps. In addition, since India relies on imported crude for 85% of her daily crude requirements, the incremental impact on the trade deficit is huge. It also promises a deeper current account deficit with rupee impact.

Talking of the rupee, the rupee plunged below $76/bbl on the back of rising oil prices. With oil prices buoyant, the oil marketing companies like BPCL, HPCL and IOCL were seen aggressively purchasing dollars through banks to hedge their import bills. This is likely to continue as long as crude remains high and the RBI is unlikely to intervene in the rupee levels, if that is the secular trend. That remains a big risk for FPI flows.

Lastly, let us come back to the idea of higher inflation. The RBI has been betting heavily on inflation coming down sharply in the March quarter. If crude remains at $100/bbl there is now way inflation is going to come down, unless the government is willing to drastically cut the duties. For now, with all the revenue constraints in place, that surely looks unlikely.