The world has more oil than it needs, as the coronavirus pandemic has shaved off 30 mbd (million barrels a day) of demand – broadly the total output of the US, Russia and Saudi Arabia combined. Prices are unlikely to breach the $40-a-barrel and even when the world has fixed the disease it may double down on kicking its oil habit. Cheap oil should be good news for India, which imports most of its supplies. It should give the government more room to find funds for the poor battling a three-week lockdown of the country. But, oil is slippery! Subhomoy Bhattacharjee lists six factors that help and hurt India when oil is in plenty.
Subhomoy Bhattacharjee, Business Standard
The government and the central bank moved quickly last week to help the economy as India manages life under a 21-day lockdown to stem the spread of the coronavirus pandemic. Their decisions bring opportunity for some businesses as others miss out.The members of the Organization of the Petroleum Exporting Countries ‘Plus’ (Opec+) will meet Russia on Thursday to discuss a reduction in oil production. US President Donald Trump said on Twitter that the cut would be to the tune of 15 million barrels a day (mbd), but market trackers, Saudi Arabia and Russia have not confirmed that yet.
Opec met on March 5 for a deal to cut production and stabilise prices, but the outcome of that meet was a Saudi-Russia spat, which pushed global crude oil prices to a 17-year low by the middle of last month. Brent crude reached $24.72 a barrel and WTI $20.48 a barrel. The price crash was thought to be the worst that could have happened, but then came the knockout punch of the coronavirus outbreak.
The pandemic shaved off 30 mbd (million barrels a day) of demand – broadly the total output of the US, Russia and Saudi Arabia combined. There is no clarity at this stage on when demand might recover. Prices recovered over the weekend, rising to $33.21 a barrel. But they are unlikely to breach the $40-a-barrel. Is cheap oil good for India? Here are six factors to consider before you make a judgement:
Simply put, the oil price drop is possibly the only positive news for India’s economy at this juncture. The country’s current account balance is barely negative according to the Reserve Bank of India (RBI) data, at 0.2 per cent of gross domestic product (GDP) in the December quarter of 2019-20. India had a current account deficit (CAD) of 2.7 per cent in the same quarter the previous year. On a sequential basis, it shrank from 0.9 per cent of GDP in the September quarter.
The present CAD situation will help the finance ministry, should the import of medical equipment surge. Though the Indian rupee’s depreciation — it has dropped 3.34 per cent against the US dollar since March 7 — will hurt CAD, one must consider that the RBI held $475.6 billion in forex reserve as on March 27, 2020. India’s forex reserve has increased by $62.7 billion since March 2019 — that is no small comfort for an emerging economy often hit hard by oil prices. The total foreign portfolio investments (FPIs) in India are about $300 billion, so the present level of reserves provide an adequate buffer. On the flip side, a low CAD means the economy’s capacity to draw foreign investment is also limited.
Low oil prices help cool inflation. The RBI on Monday released its quarterly data on household inflation expectations and the 'Industrial Outlook Survey of the Manufacturing Sector'. The first report said, “median inflation expectations have declined by 10 basis points and 20 basis points, respectively, in comparison with the previous survey round”. Earlier surveys had pointed to rising inflation exceptions, so the reversal is significant.
The softening of expectations is for households, for three months ahead and one year ahead. It implies that households expect price levels to remain soft, even as the 21-day lockdown in force across the country to stem the spread of coronavirus has held up the movement of goods and created shortages in some places.
RBI Governor Shaktikanta Das had said while releasing the seventh bi-monthly Monetary Policy Statement for 2019-20 that the monetary policy committee expected the inflation to come down. But he had refrained from issuing any estimate for the year. One might argue that oil nowadays plays a less important role in setting price expectations than other sectors. Its weight on consumer price index (CPI) has come down. But the lockdown is clearly a period when transport was supposed to have an outsized impact on price levels. The softness in median estimate for one year means the CPI could remain muted for a long time, and that would impact all indices that incorporate it.
The other survey, ‘Industrial Outlook Survey of the Manufacturing Sector’, is also dismal. “A comparison of results for common respondents to both round 89 [of the survey] and the quick survey reflected (a) very sharp deterioration in sentiment across all sectors for the March quarter of 2019-20; and (b) stark pessimism for the June quarter of 2020-21, when compared with their assessment in the regular round of the survey,” it states.
Cheaper oil can hurt the government’s purse, too. Close to 90 per cent of the total excise duty the government generates comes from oil. Excluding customs, oil revenue accounted for Rs 2,63,812 crore in 2018-19. While the government on March 14 raised excise duty on petrol and diesel by Rs 3 a litre each, the receipts for 2019-20 would still possibly be about Rs 14,000 crore lower than last year. As demand falls further, the government’s receipts in 2020-21 could decline more and fall way short of the estimated Rs 2.4 trillion.
The finance ministry has raised the limit for imposing a special additional duty to Rs 18 a litre for petrol, and Rs 12 for diesel. But it would be difficult to raise prices at the bunk now. A $1 drop in crude oil price should normally lead to a drop of 50 paise in retail prices. But the Centre and states have already used up this space to shore up their finances. A shortfall in the receipts might be inevitable at a time when the government is under pressure to help the poor. Cheap oil is unlikely to ease the government’s fuel subsidy burden, as it has committed itself to providing free cooking gas refills to about 83 million people till the end of June.
Cheaper oil and related products like naphtha should bring down fertiliser prices. That should ideally have helped farmers. But two factors may hold that up. First, the government was to clear its dues to fertiliser companies in April, but that may not be possible now, given its stretched finances. This might hurt fertiliser production when farming activity starts in the monsoon season. And second, low inflation could hurt more: The adverse terms of trade in agriculture had begun to reverse after many years, but if inflation remains muted, the recovery in pricing power will be disrupted, especially as farmers are battling the lockdown.
State-owned Bharat Petroleum Corp Ltd (BPCL) was to be privatised this financial year, but that big-ticket disinvestment now is almost certainly off the table. The pricing power of global oil companies was declining when the coronavirus pandemic hit the world economy. Global oil demand was expected to fall in 2020 — the first full-year decline in more than a decade — but now the world has more refining capacity than it needs and storage capacity is filled to the brim.
In the first quarter of calendar year 2020, the refining intake was lowered by 1.2 mb/d based on February estimates, and that was even before the pandemic started pulling the world economy down. No company would have the capacity to bid for BPCL, India’s second-biggest oil refiner, even if demand improves. The government has extended the deadline for BPCL bids to June 13. BPCL can offer its marketing network in the country as a strong positive, but monetising this would depend on how quickly the Indian economy recovers. The price offered would be subject to these considerations, as the pandemic creates a stronger pivot for the world economy to swing away from fossil fuels to renewables.
Impact on India’s oil companies
Markets indicate that the fortunes of downstream oil marketing companies in India are unlikely to improve anytime soon. On the National Stock Exchange (NSE), the stock of Indian Oil Corporation Ltd (IOCL) has shed close to 53 per cent of its value since its 52-week high of Rs 170.75, hit on June 3 last year. IOCL’s decision to declare a force majeure on its supplies from Saudi Arabia has only added to the perceived agony of the company.
Here are some reasons for the bleak outlook
Coronavirus has dried up demand from road transport and airlines. A CRISIL estimate reckons the consumption growth of petroleum products will range between 2 per cent and 3 per cent in 2020-21, assuming the nationwide lockdown ends on April 14. Any delay would worsen the numbers. In the December quarter, IOCL’s net profit had jumped 251.08 per cent on a consolidated basis year-on-year to Rs 2,695.09 crore. This was even as its revenue from operations fell 10 per cent to Rs 1,46,952.50 crore during the same period.
The prices of all petroleum products have begun to sink, hurting the revenue of companies like IOCL, BPCL and Hindustan Petroleum, as inventory costs shoot up. The companies are unlikely to find fresh storage space soon and may have to lower their production. IOCL has a refining capacity of 80.7 million tonnes per annum, but it had to declare a force majeure on its supplies from Saudi Arabia, UAE, Kuwait and Iraq. India, along with Japan, China and South Korea, forms the largest demand bloc in the world for oil.
Outlook for upstream companies
For upstream oil companies ONGC and Oil India Ltd, the portents appear even worse. The ONGC stock has also lost a lot of its value on the NSE. There are just no upsides for domestic oil explorers, for the following reasons:
The oil sector’s fortunes are unlikely to improve substantially even after the world has sorted out the pandemic. Except Goldman Sachs, few other analysts expect oil prices to exceed $40 a barrel. At that price, overseas oil supplies become very competitive. Just as US shale companies have found they cannot compete unless oil prices exceed $50, it will be extremely difficult for any Indian company to establish a credible exploration plan to compete likewise.
ONGC has also estimated that it would see a dent of close to Rs 4,000 crore in its top line this year because of a cut in the administered price of natural gas. The petroleum ministry on April 1 slashed gas prices by 26 per cent. The domestic price is now $2.39 per million British thermal unit (mBtu), compared with $3.23 earlier. India sets the price of natural gas every six months according to a formula, instead of allowing it to move naturally. But, according to the government’s own estimate, ONGC’s cost of producing gas is about $3.8 mBtu. Natural gas makes up about half of ONGC’s bottom line. In the December quarter, ONGC’s standalone pre-tax profit halved to Rs 5,999 crore from Rs 12,063 crore in the same period the previous year.
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