Skyrocketing Crude Oil Price – A Roadblock to India’s growthAug 30, 2018(18:59)
“Rising oil prices is one of the biggest risks to the Indian economy for the fiscal year 2018-19 as it could crimp real incomes and spending” points out the Economic Survey 2018.
While the oil prices started to move higher from the second half of 2016 itself, the situation turned alarming in this year when the oil prices rallied beyond $ 70/bbl and even hit $ 80 per barrel in May. It was the mix of supportive factors ranging from supply disruptions, geo political tensions in oil producing nations, robust demand amidst strong global growth forecasts and production cuts by OPEC and Non OPEC countries that led to the spurt in the oil prices.
Now the rise in the oil prices may be a big boon to oil exporting nations but it is not the case with a nation like India. An increase in the oil prices send shivers down the spine of the Indian government. The reason for this huge brouhaha is that a developing country such as India is majorly dependent on crude oil to steer her engines of growth and imports about 75% of its total oil requirement. India’s appetite for crude oil is on the rise as the needs of our burgeoning population keeps growing every day.
What factors sent oil prices for a boil?
Before we get into the repercussions and the outlook on the oil prices, let us take a quick recap of the factors which were primarily responsible for the up move in the oil prices.
Global crude oil market is currently tightened wherein the OPEC & Russia led production cut had reduced the global inventory levels supporting the higher price outlook for crude oil. At the same time, re-imposition of sanctions on Iran’s is also lending support to the price on higher notes. Iran is the third largest supplier among OPEC group and supplies around 3.82 Mbpd on an average basis which is around 13% of the total OPEC’s supply. During 2016 sanction era, around 2.5 Mbpd of crude exports from Iran were halted and market is fearful for the same reduction from the global supply chain resulting in to the shortfall in already tighten market. At the same time other top oil producing nations in the world like Saudi Arabia, USA, Russia, , Iraq, UAE, Libya and Venezuela have witnessed erratic supply disruptions. Libya, one of the major oil producing nations has suffered severe setbacks in oil production due to attack of oil fields by armed factions. Economic and humanitarian crisis have drastically lowered oil production in Venezuela. As the supply from these countries decreased, the price of crude oil rose automatically as per the demand and supply theory.
Impact of Iran Sanctions on India
The recent sanctions over Iran will definitely have its repercussion on India as country expects to double its crude imports to 396,000 bpd approximately in 2018-19 from about 205,000 bpd in 2017-18 as per Petroleum Planning and Analysis Cell (PPAC). Separately, India is inclined towards Iranian crude due to various advantages such as lower shipping cost, credit period of 90 days as compared with other Gulf countries at 30 days which indirectly increases the Gross refinery margins of refiners. But since the crude oil prices had rattled, most of the Middle East producers are keen in stabilizing the prices at higher level and acquiring new Asian market. Thus, the market is expected to get more competitive in terms of heavy grade crude prices which are feed for most of the Indian refiners.
Rising Crude oil price and India’s ballooning CAD:
India, is the world’s 3rd largest oil consumer and “a $10 per barrel increase in the price of oil reduces growth by 0.2-0.3 percentage points, increases WPI inflation by about 1.7 percentage points and worsens the current account deficit by about $9-10 billion dollars,” according to Economic Survey 2018. As we meet our energy needs mostly through imports, increase in crude oil prices will widen the current account deficit (CAD) to 2.5% of the GDP in the current financial year. This leads to a vicious circle of increasing fiscal deficit, inflation and an economic slowdown. RBI raises interest rates so as to combat inflation which further leads to a reduction in the pace of economic growth.
Tug of war between crude oil and the stock market:
The performance of the Indian stock market is a function of various individual factors including crude oil. To assess the exact amount of ratifications on the stock market only based on an individual factor is not an easy task. Most of the companies however are affected by the movement in the oil prices in one way or another, with high crude oil or its derivatives affecting the profit margins adversely. In particular companies from refining, airline, paints, tyres, footwear, lubricants, cement, logistics, construction materials and chemicals for whom crude or its derivatives are major input costs, are the ones which are more exposed to the movement in the oil prices. Increase in global oil prices led to underperformance of domestic equities in 2017. It also causes rupee depreciation thereby hurting investor sentiment. While the high oil prices increase the cost of logistics and transportation it also leads to higher inflationary pressure in the economy, which can lead to higher interest rates ,thus sending the borrowing costs higher for the companies . While higher oil remains net negative for the broader markets, there are few segments that can get benefitted out of the dearer oil.
Talking about some individual names like Reliance Industries which derives more than half of its profit from refining and hence benefits from rising crude price. We expect that steady oil price will improve its profitability. Similarly, Chennai Petroleum Corporation is also likely to benefit from rising crude price as it is expected to will improve GRMs and lead to inventory gains for the company. Exploration companies like ONGC, Cairn India and Oil India are also likely to see a recovery trend after a long consolidation. Recent discoveries and the sale of oil to other refineries is also likely to add to the margins. Aviation Stocks are of course vulnerable to the rise in the oil prices as a rise in ATF prices will have a negative impact on operational margins of aviation stocks , however the increased demand in the sector is likely to boost the revenues. At the same time companies such as Engineers India, which provides engineering consultancy and engineering-procurement-and-construction services to the oil and gas and petrochemical industries, are likely to get benefit from the surge in the oil prices.
OMCs shall benefit because of their inventory higher valuations. As petrol and diesel prices are deregulated now, these companies have the flexibility to transfer the hike in prices to end users, however the extent up to which the pricing can be passed on to the customer remains uncertain in the wake of upcoming elections. In the recent past however, sectors like Oil & Gas and FMCG benefited the most due to rise in crude oil price which led to their increase in market cap and weightage in Nifty that in turn helped Nifty to move higher.
Nifty 50 Index versus Brent Crude Oil Movement (1999-2018)
Brent Crude oil came down sharply from $80 per barrel to $70 per barrel and has bounced from the recent lows while Nifty is bucking the trend making new highs on a daily basis. We infer that Nifty and Crude oil move in the same direction unless major price shocks in crude oil like the one in Jun-Jul 2008 wherein crude reached $150 or approx $30 in Jan 2009, $115 in 2011 or approx $32 in 2016; We don’t see any major impact on Indian stock market’s broader indices price movements.
Where do we go from here?
Currently, global oil market is rattled by both bullish and a bearish force, wherein the supply reduction from Iran is likely to keep the market tighten but at the same time global demand outlook is also dubious as an implication of trade war between US & other economies.
As per the various agencies, global crude oil market is not likely to balance till the end of this year and rising geopolitical uncertainties are expected to keep the price outlook on upfront for crude prices. Also, US sanctions against Iranian oil exports will take effect from November onwards but its impacting shadow could be seen in month of Aug as imports from Iran were lower. Although it would be premature to assess the impact but definitely it would be a challenging for India to sustain from its third biggest crude supplier. Also the weakening of Indian rupee will weigh on imports costs along with having an impact over gross fiscal deficit through higher subsidies on kerosene and liquefied petroleum gas. The gross fiscal deficit could also increase in case the government decides to pass on the minimal effect to consumers by reducing tax on petroleum products (diesel, petrol).
Investment behavior changes as oil price rises, as the investors are left with very little to invest. Inflation and rising fuel prices snatch money away from investors making them frugal. This in turn hits many sectors and eventually results in economic slowdown.
Government of India’s goal is to reduce crude oil imports by 10% by 2022. The Government plans to reduce dependency on crude oil import by encouraging electric vehicles in the country. By the year 2030, the NDA government wants to be 100% electric vehicle nation. We have to wait and watch if this can be achieved in the given period of time. By reducing our oil import, India can save huge money that is spent on petrol and diesel subsidies. India to build 2 new caves to store strategic petroleum reserves (SPRs) to maintain country’s supplies to avoid oil supply shocks in the future.
With all these long term planning in place it will be interesting to watch how the crude oil prices remain in the short to medium term because it’s not only the mathematics of the government of India that can take a toss but also the fate of millions of Indian stock market investors that is closely knitted to the movement in the oil prices.
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