Oil demand | Oil price hike: For Modi, there is an opportunity to close fiscal gaps, reduce oil demand and emissions, all at the same time
In nominal local currency terms, countries accounting for at least a third of global oil consumption are already paying more than they ever have. Eurozone members and India, the biggest consumers of crude after the United States and China, surpassed their previous record prices on Wednesday and Monday, respectively. Brazil, Mexico and Indonesia are all in the same boat:
With the Organization of the Petroleum Exporting Countries promising only a modest increase in crude supplies next month and an unknown but possibly large slice of Russia’s 11 million barrels per day coming off the market as Economic sanctions are starting to bite, the prospect of demand destruction is starting to rise. It’s a fancy term for what, to most of us, will look like a recession.
Oil itself usually suffers last from energy price shocks, as households and businesses have no choice but to spend money on fueling their cars, buying cooking gas or operate generators. Instead, consumers will reduce their discretionary spending and businesses will limit their investments. This situation will worsen if inflation worsens enough for central banks to start raising rates.
Governments are not, however, as powerless in the face of this as it seems. Indeed, if they move quickly, there is an opportunity to close fiscal gaps, reduce oil demand and reduce emissions, all at the same time. The answer lies in public transit.
Retail fuel prices are rarely close to the price of gasoline and diesel coming out of a refinery. Across Europe and wealthier Asian countries, taxes mean that transportation fuel typically costs nearly double what it costs in the United States. This mitigates the effect of rising prices.
Elsewhere, the fiscal thumb is on the other side of the scale. Most oil exporters and many emerging economies subsidize their dirtiest energy sources. Direct fossil fuel subsidies amounted to $760 billion in 2018, according to a study last year by the International Monetary Fund. It will likely be considerably higher this year, as the subsidy bill rises with oil and gas prices.
Already last year, high crude prices prompted some emerging market governments to reconsider reforms carried out when prices were lower after the 2014 commodity crash. In India, Prime Minister Narendra Modi’s government took advantage of of the crash in crude prices that same year to add excise duties, which now account for nearly a quarter of the government budget – but last November he cut those levies and urged state governments to reduce also sales taxes to ease the pressure on road users.
There is a similar situation in Brazil. Since 2016, the government-controlled Petroleo Brasileiro SA, with a virtual monopoly on local production, sets prices based on the cost of crude on the world market. This has often been a source of tension with the government, given the effect of the weakening local currency on the price of local oil. Former President Luiz Inacio Lula da Silva, who is challenging incumbent President Jair Bolsonaro in elections due later this year, has called on the government to act to cut costs. Congress is considering legislation that would have the same effect.
At these crude prices, this policy could be costly. In Indonesia, one of the few major emerging oil importers to heavily subsidize retail prices, the government last week took the opposite route, saying it was likely to let costs rise amid fears the current situation could not continue. either takes too much of the budget or causes the collapse of the state-owned Pertamina Persero PT.
There is a better solution. Across most of the world, public transport networks are still well below typical ridership levels, two years into the Covid-19 pandemic. This risks creating a vicious cycle, where low attendance reduces revenue, leading to service cuts which, in turn, reduce attendance.
Central governments are generally reluctant to get too involved in this area, especially since urban transport is often run by politically opposed local officials. Weeks after announcing a 9.1 billion pound ($12.2 billion) annual package to cut household energy bills, the UK government last month offered 200 million pounds to stop the grid from London transport to go bankrupt for four months.
It is a mistake. With oil prices at these levels, governments are already planning to use their budgets to ease the cost of living pressures on households. Encouraging citizens to resume underutilized public transit would be a much better use of grant funds than fueling oil demand in the midst of a supply crisis.