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Crude oil reality for Indian investors

For over a century, capacity creation in crude mining and refining has been driven by the higher prices that occur when demand exceeds supply

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Devangshu Datta
4 min read Last Updated : Jul 19 2018 | 5:54 AM IST
India’s energy sector is affected by swings in crude oil prices, since the country is a major net importer of crude and gas. The domestic energy sector is also subject to major government interference of a type that causes poor financial performance.

Primary producers like ONGC and OIL are not allowed to maximise profits when prices are high. Downstream, refiners and marketers are not allowed to maximise profits when prices are low. Meanwhile, the solar and wind industries have received lots of policy support. This has led to an oddly frustrating problem for Indian investors. There is no easy way to benefit directly from rising crude prices. There is also no easy way to benefit directly from rising renewables capacity, due to the lack of listed renewables businesses with decent financials.

Consider the following scenario. Suppose crude demand rises through the next few years and then falls sharply, and permanently? This strange situation may actually arise. 

Energy demand is driven by two major segments. One is transportation. The transport sector consumes over half of all crude and gas production. The other segment is electrical power, which is generated by a mix of thermal (coal and gas), renewables (mainly solar and wind), hydel, nuclear, etc.

There are big changes occurring in both sectors. Transport is shifting to electrical energy, and becoming more fuel-efficient. The electrical power sector is seeing higher contributions from renewables. Some projections suggest a 25-30 per cent drop in global crude demand by 2030, assuming that autonomous, all-electric vehicle development stays on track and renewables capacity creation continues. 

In Denmark, California, Germany, etc, renewables already provide 50 per cent or more, of grid power. Electrical and hybrid vehicles have also become mainstream. Autonomous vehicle usage has also increased and autonomous vehicles use less energy, in addition to being hybrid, or electrical. 

Autonomous vehicles will use even less energy as they become more common because they can communicate with each other, in real-time. Hence, there is less need for constant gear-changes, and sudden braking/acceleration, which means more energy-efficiency. Autonomous vehicles also reduce the need for personal transport. 

For over a century, capacity creation in crude mining and refining has been driven by the higher prices that occur when demand exceeds supply. But mining and refining are long-gestation projects, with new mines and refineries taking up to a decade to breakeven. So this relationship, where rising demand triggers new capacity creation, is breaking down.

Investors pulled out of the sector in the last five years because there were low prices between 2014 and 2017. Investor interest remains muted now, even though prices are rising. Investors fear that crude demand will fall permanently before any new facility can recoup its investment. This could mean a capacity crunch since the demand for crude could grow until 2020 or 2022.  

Crudes prices may therefore, spike sharply for two-three years and then fall equally sharply. India will suffer in the short-term if this happens. But the next time petro-prices trend down, the drop in demand could be permanent, rather than cyclical. 

The thrust into renewables and electrical vehicles will create investment opportunities in new areas. There will be demand for exotic alloys, and metals like nickel and cadmium, as battery technology improves. There could be explosions in new types of software, in vision-processing equipment, sensors, etc. And of course, there would be new leaders in automobile design and manufacturing. 

But all that is far into the future. For now, investors need to keep looking for ideas in the renewables space, and to seek plays on a weaker rupee and plays on crude and gas in the commodity futures market.

Topics :Investment

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