Vijay Kumar Gaba: Brent

Wednesday, September 20, 2023

Achilles heel showing some signs of soreness, again

Reliance on imported energy, especially crude petroleum, has been one of the weakest aspects of the Indian economy for the past many decades. Though we have made significant progress in the adoption of renewable and clean sources of energy, about 70% of our primary energy demand is still met by coal and crude oil. Renewable energy meets less than 5% of the primary energy and is mostly replacing traditional biomass in the overall primary energy mix.

India meets most of its petroleum requirements through the import of crude oil. Notwithstanding the ethanol blending policy, in FY23, over 87% of the domestic petroleum consumption requirements were met through imported crude oil; up from 83.8% in FY19.

Despite incentives and many policy changes, domestic oil production in India has consistently declined since peaking in 2011. The current annual production of crude oil in India is around 620 thousand barrels a day; the same level it was in 1995-96, before the New Exploration Licensing Policy (NELP) in 1997.

Recent reports are indicating that this winter global crude prices could see a material surge. According to OPEC, the global oil demand will rise by 2.44 million bpd in 2023 and 2.25 million bpd in 2024. The US EIA also expects the oil demand to hit record highs in 2023. OPEC and allied producers like Russia persist with their production cuts of 1.3 million bps until the end of 2023. The US EIA expects global oil inventories to decline by almost half a million bpd in 2H2023, exerting pressure on crude oil prices.

The higher crude prices could impact the Indian economy adversely. Since the election season is about to begin (5 key state assembly elections in 4Q2023, followed by the general elections in 1H2024), it is highly unlikely that the government will pass the entire rise in crude prices to the consumers. The state-owned energy companies and the central government shall bear the brunt of the higher fuel prices.

Considering that the oil & gas PSUs and private refiners (through enhanced windfall tax) could be made to bear the bulk of the burden, the impact on fiscal conditions may not be significant in FY24. There could be some pressure on current account deficit

However, if the higher oil prices are sustained for longer, i.e., beyond FY24, we may see some of the hikes getting passed to consumers having a second-round impact on inflation. We may see material pressure on the current account balance, bond yields, and INR exchange rate during FY25.

Investors need to watch the developments in the oil market carefully. For me, public sector oil marketing and upstream companies are a definite “No Go” zone; while I shall be watching private refiners closely.

Insofar as Indian equities are concerned, historically their correlation with the crude has been positive.

Friday, February 28, 2020

Lower crude prices not necessarily good for economy and markets

In past few days many market experts have highlighted that the recent fall in crude prices is a major positive for Indian economy. Through my interactions with some investors I learned that many investors do take the publically expressed random opinions of these experts quite seriously and actually base their decisions on these.

Besides, small investors are also usually seen following the actions large celebrity investors. Even in recent past, there have been many instances where small investors have emulated the actions of large investor buying a meaningful stake in a stressed asset.

From the regulatory standpoint there is no violation in both these cases. The market experts are free to publically express their opinions and views about the market trends and events. The companies, stock exchanges and investors are in fact obligated to make public disclosure of large secondary market deals. But there could be an ethical lacuna in these practices.

For example, one reputed fund manager, who presently runs an investment management and advisory firm and had been CIO of one of the top AMCs in the country, recently tweeted "$40 for crude in 2020 coming soon. Big positive for India!"

Obviously he made this assertion in zest and may not have any particular design in mind while writing this tweet at midnight. However, his numerous followers may find it an "advice" and accordingly act upon it.

It would therefore be better if the "experts" had also highlight that crude prices usually have positive correlation with India's GDP growth. In past 20yrs, all three episodes of sharp rise in crude prices have resulted in rising trend in India's GDP growth rate, and vice versa.

2004-2007: Brent Crude prices jumped from under $30/bbl to over $140/bbl. In this period India's GDP growth accelerated from about 3% (FY03) to 9.5% (FY08).
2010-2012: Brent crude prices again jumped from $40/bbl to $$120/bbl. In this period, India's GDP growth improved from 5.5% in FY13 to 8.25% in FY12.
2016-2017: Brent crude prices jumped from below $30/bbl to over $80/bbl. In this period also India's GDP growth improved from 7.5% in FY15 to 7.75% in FY17.

It would be pertinent to note that crude prices fall in response to demand slowdown. A fall in crude prices has not particularly shown to be pushing the growth higher. Besides, the Indian markets have not shown any significant correlation with the rude prices in the past.

Lower crude prices hurt many businesses like oil & gas producers and oil marketing companies.

Lower crude prices hurt state revenues (excise and customs) which are ad valorem to crude prices. Since the fuel pricing is not market driven and subsidies have been virtually eliminated, the offsetting positive impact on fiscal in form of lower subsidies is no longer available.

Moreover, if the crude prices are falling due to demand slowdown, the benefit to the consumer industries is limited as they are not able to increase production at lower cost. So lower crude prices may help in protecting margins to some extent during the demand slowdown period, but may not necessarily result in higher profits.

It may be noted that sharp fall in crude prices in 2008-09 and 2014-16 did not result in any major gains for Indian stock markets.