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The biggest commodity story for the past 10 months has been the falling trend in crude oil prices. In 2013, prices had moved largely between $95 and $105 a barrel of Brent crude. In June, Brent was $107-108. Since then, it has slid, hitting $44-45 in January. Prices have moved between $45 and $55 a barrel in 2015. Gas and coal prices have also weakened in tandem and stabilised lower.
Low fuel prices have been the biggest factor in India's economic recovery (patchy so far). Cheap fuel is the primary cause of a lower current account deficit (CAD). It has also meant lower fuel and fertiliser subsidies, which means it has contributed to a lower fiscal deficit. Cheaper fuel means lower inflation, better operating ratios for the railways and lower costs for thermal power generators. Public sector undertakings (PSUs) in the oil marketing sector have also seen turnarounds as a result of benign price trends and decontrol of diesel and petrol.
But Indian policymakers have no control over international fuel prices. A very large share of India's fuel consumption is imported, including roughly 80 per cent of crude oil, 32 per cent of gas and 20 per cent of coal. Domestic prices are benchmarked to international prices.
There are a few reasons why international crude oil prices have fallen so sharply. One is the slow global economy, which has meant lower fuel demand in general. A slowing China, moving away from coal, has also put pressure on coal prices. Another factor is the shale revolution in the US, which has created potentially large new supplies.
Shale is expensive. Normally the Organization of the Petroleum Exporting Countries (Opec) cuts production to maintain prices during periods of low demand, However, in what could be an attempt to keep shale uncompetitive, traditional exporters like Saudi Arabia continue to pump large quantities. Iran could cease to be under sanctions soon, bringing another large supplier onto the market. Thus, despite instability and conflict across West Asia- North Africa, Nigeria, Russia-Ukraine, etc, crude oil supply is very likely to continue being in surplus over demand. If crude stays low in price, gas and coal prices are also likely to stay low. That gives India a window of opportunity for economic growth to accelerate.
However, there are possible downsides to a scenario of cheap fuel. One problem is that investors tend to assume prices will stay low permanently. Eventually crude oil, coal, gas, etc, will all move to higher price levels, probably in tandem. If downstream capacities in power, refining, transport, fertilisers, city gas, etc, are created on assumptions of permanently low prices, those investments will turn into white elephants. Precisely this happened with a lot of gas-based power capacity. It was thought during 2009-2011 that production from KG-D6 would make India nearly self-sufficient in natural gas. Sadly, KG-D6 ran into big problems and domestic gas pricing is now benchmarked to foreign contracts.
Another potential issue is that policymakers will not push hard to increase domestic renewable energy capacity while fossil fuels are cheap. India has ambitious solar and wind energy plans but there could still be a loss of focus. This would be dangerous in many ways. India has to reduce dependency on fossils and on imports. The exploration industry needs incentives to search for domestic hydrocarbon deposits, onshore and offshore. Indian fields seem expensive at the moment. Indeed, exploration activity has slowed everywhere. In India, there are regulatory and policy issues, in addition to economics.
But it takes time to explore, find viable deposits and develop oil and gas fields. India could be badly wrong-footed when prices climb, again if the exploration programme is shelved or slowed. There has been a lot of debate about strengthening the so-called New Exploration Licensing Policy with a combination of tax rebates, new technology and better revenue-sharing options in contracts, etc. Momentum must be maintained or rather regained in exploration.
As of now, low fuel prices should help spark a cyclical recovery across the conventional energy chain. Upstream producers like Oil India and Oil and Natural Gas Corporation might suffer from lower margins but they gain from having to share a lower subsidy. Refiners and marketers gain. Thermal power producers could also gain, from low coal prices, cheap gas and naphtha. There could be investments flowing into the power sector. City gas networks could be also developed. The investor should look at those investment options while bearing the cyclical nature of fuel supply-demand in mind.
