Good times for refiners

Geopolitics apart, stable and low crude oil prices will benefit

India has been lucky on the energy front since late 2014 when global prices declined drastically. Geopolitics could have an adverse effect on that situation. Crude oil prices were trending around $106  a barrel for the Indian oil basket (a weighted average of Oman, Dubai and Brent) when the Bharatiya Janata Party (BJP) took office in May 2014. Prices started falling in September 2014 and continued falling until a low of $28 in January 2016. Since then, there have been several rallies, which have usually aborted at a ceiling of $54-55. The Indian basket is currently priced at $46-47. Coal and natural gas have followed similar trends of soft prices. 

The reasons include slow global growth. Plus the adoption of solar and wind has reduced demand for thermal coal, gas and naphtha. Energy efficiency has generally improved. Another huge factor is the shale revolution, which has made the world’s largest oil consumer, the USA, into a net exporter. Anytime crude oil prices rise above a certain level, new shale supply hits the market. 

The global economy is gradually picking up, meaning more demand. The Organization of the Petroleum Exporting Countries (Opec) has been trying to negotiate production cuts among members to shore up prices. But, the major upside risk of higher crude oil prices comes from geopolitics. West Asia is volatile. Iran has poor relationships with many nations. Russia is in a conflict with the Ukraine. Gas supplies out of landlocked Central Asia are hard to evacuate due to conflict in Afghanistan and a stand-off between India and Pakistan. 

The recent face-off between Qatar and a coalition of Arab states led by Saudi Arabia may be flashpoint. In the worst case, it may affect gas supplies to India and pushing crude oil prices up. Qatar is not a big player in crude oil but it is one of the largest gas exporters. 

India imports gas, crude oil and coal. Energy is the largest item on the import bill. In 2016-17, India imported Rs 5.4 lakh crore (crude oil, products, liquefied petroleum gas) and exported Rs 1.9 lakh crore worth of products. 

Low crude oil prices have led to a better trade balance despite low (non-petroleum) exports. Low prices allowed the Centre to decontrol retail prices and also lets the Centre and states impose taxes and cesses to raise revenue.  If prices climb beyond a certain threshold, taxes and cesses would have to be reduced due to political considerations. In the worst case, the government may have to impose price controls, and be forced to absorb under-recovery losses. 

The petroleum value-chain is straightforward. If crude oil and gas are cheap, refining and marketing margins tend to be good. If crude oil is expensive, refiner margins shrink. Ideally, oil companies integrate all the way from exploration and production to owning retail pumps.  That has not happened in India.  

The past three years have seen oil-marketing PSUs (public sector undertakings ) repair finances and investors have responded. Indian Oil (up 60 per cent in the past 12 months), Bharat Petroleum Corporation (up 20 per cent), and Hindustan Petroleum Corporation (up 475 per cent) have all beaten the National Stock Exchange’s Nifty (16 per cent). Reliance Industries (45 per cent) which is integrated across the value chain, though it produces little gas, has done okay. Oil and Natural Gas Corporation (up 5.5 per cent) is primarily a gas producer and has underperformed the Nifty. Oil India (down 4.5 per cent after bonus adjustment) has underperformed. 

If crude oil prices climb steeply, the equations change. There’s a sweet spot — a price range where refining margins will still be fine while producers make higher profits and the government doesn’t find it politically impossible to continue taxing fuels. If prices rise beyond that point, things will go awry. Fundamentally, there isn’t much reason for a big spike in prices, due to shale and also due to large inventories lying offshore in tankers. But, as mentioned above, there could be geopolitical reasons for markets to get nervous or even panic. Energy stocks go through periods of high volatility if crude oil prices move around sharply. While the Qatar situation continues, it adds another potential trigger. If the ceiling of $55 is broken, there could be a major impact on stock markets. But geopolitics apart, we can look forward to more of the same in terms of stable, low crude prices and good times for refiners.