Imagine you're a manufacturer and have no control over the price of one vital raw material. In successive years, the price per unit of that item is $70, $85, $112, $108, $105, $84, $46 and $43. It would be reasonable to assume that profits will rise as the prices fall.
That price series represents the average price per barrel of the Indian crude basket in every financial year starting from 2009-10. The latest price of $43/ barrel is the average between April and August 2016. Since India imports 80 per cent of its crude, the impact of lower prices is hugely positive. India also exports refined petroleum products and the refining margin rises when the price of crude is low. So, it’s win-win, since exports also benefit from lower crude prices.
The net petro-import bill (after accounting for product exports) dropped from a peak of $98 bn in 2012-13, to $47 bn in 2015-16. The net import bill for April-August 2016 is $19.6 bn. The current account deficit peaked at 4.8 per cent of GDP in 2012-13. It was down to 1.1 per cent of GDP by 2015-16.
Falling crude prices have also led to falling natural gas prices and international coal prices have been lower as well. Since India is a substantial importer of gas and coal, these are additional benefits. Downstream, lower energy prices have enabled entire industrial sectors to cut back costs. Struggling PSUs such as BPCL and HPCL and Indian Oil have seen turn arounds and the civil aviation industry is also doing much better.
Improvement on the trade account and on the current account can also be explained by the one factor of falling energy prices. Also, instead of a massive subsidy payout, the government has actually been able to generate revenues by keeping excise duties high rather than passing on price cuts.
Unfortunately that situation of moderate to low energy prices might not last too much longer. It is unlikely that crude prices will spike back to the triple digit level but it is possible that prices will rise to the $60/ barrel level soon. At any rate, the petro import bill in 2016-17 will not dip substantially lower than 2015-16.
Crude prices have started moving up in the last fortnight, as Opec tries to negotiate a production cutback. Russia (not an Opec member) is also supposedly going to cooperate in this with Opec. If the production cutbacks hold, and crude prices move higher, so will gas and coal prices. This could lead to a rerating of the PSU oil and gas sector.
The GoI can opt for several different responses, including doing nothing. It can cut excise duties and let retail prices stay at the same levels. It can pass on price increases. It can revert to price controls and subsidy. It can tell upstream producers (and gas transporter, Gail) to share in the subsidy burden. The marketer/ refiners will tend to lose valuation if crude prices rise. The producers, OIL and ONGC may gain. That would depend on whether they are allowed to raise prices or forced to subsidise the downstream players. Private sector refiners and explorers will be better placed but they will see erosion of refining margins.
Let us hope energy prices stay down. But, if Opec is serious and the agreement with Russia holds, prices will move up. Anyhow, this is a cyclical situation and traders should stay braced for that eventuality.
The author is a technical and equity analyst
