The recent fall in crude oil prices will ease pressure on the government’s treasury, but refining companies are likely to take a hit. The future course of prices will depend on the global financial market turmoil to a large extent
THE RECENT unexpected fall in crude oil prices has followed the unprecedented financial sector crisis that the world is currently facing. As global liquidity dries up, there has been a blanket sell-off in various asset classes — crude being one of them. Although economic growth concerns have been weighing on demand for petroleum products, they surely do not seem sufficient enough to cause a nearly 45% fall in crude prices to below $80 per barrel, after hitting a peak in July.
Crude oil is the world’s most widely consumed commodity and any move in its prices has a global impact. One would assume that the sudden, steep fall in crude prices will bring cheer to the domestic petroleum industry, which has been reeling under heavy under-recoveries. However, the impact of this crash will vary for different participants, and will also differ in the short- and long term. A basic understanding of these forces and their inter-relationships is necessary for investors, so that they are able to make the right choice when the tide turns.
EFFECT ON INDIAN ECONOMY:
The fall in crude oil prices has come as a boon for the Indian economy, which is witnessing a very high level of inflation triggered by sky-high crude prices. Although crude price was one of the reasons for the sharp rise in India’s inflation, the recent steep fall is not likely to reflect immediately on the inflation numbers. Since the government and oil companies absorb a major portion of the burden, rather than passing it on to consumers, the fall in crude prices will first ease the country’s fiscal deficit and provide some relief to oil companies. The total under-recoveries, which were predicted to reach Rs 240,000 crore for FY09, may now be restricted to Rs 160,000 crore.
FOR PRODUCERS:
Normally, a fall in crude prices is bad news for oil producers, but this is not the case for India’s largest oil producer, ONGC. Since the company is a beneficiary of nominated oil blocks, it has to sell crude at a discounted price to public sector refining companies. Its net realisation stood at only $70 in the quarter ended June ’08, although global prices averaged around $126. The recent fall in crude price will only reduce ONGC’s discounts, while keeping its net realisations unchanged. Hence, the company, which had received $55.9 per barrel in the quarter ended September ’07, is likely to earn better returns in the second quarter of FY09, despite the fall in crude prices. And till crude price stays above the $70 level, its fluctuations will have little impact on ONGC’s earnings. However, for other relatively smaller players in the private sector, the normal rule will be applicable. Companies like Cairn India, Selan Exploration Technology, Hindustan Oil Exploration and Reliance Industries (RIL) will see a drop in their future realisations from production of crude oil.
FOR REFINERS:
Although crude oil is the raw material for petroleum refiners, movement in the price of crude alone does not affect them. What really matters is the differential in the price of crude oil and refined products. Refiners benefit if the fall in prices of petrol and diesel is less than the fall in crude oil prices. However, this logic holds in an ideal situation. In reality, there is a 30-day gap between the purchase of crude oil and selling of output. So, if the price at which crude oil was bought is higher than the price at which its refined products are sold, then refiners book inventory losses and vice-versa. Hence, the one-way fall in crude oil prices results in heavy losses for refiners in the particular quarter. The fall in crude prices has been so steep during the past three months that the entire refining margins for several refiners may be wiped off. Standalone refiners such as Mangalore Refinery & Petrochemicals (MRPL) and Chennai Petroleum (CPCL), as well as private sector players like RIL and Essar Oil, are all expected to witness a substantial fall in their refining margins. However, this scenario will rectify itself in the next quarter, once crude prices stabilise.
FOR MARKETERS:
For oil marketing companies (OMCs) — which sell refined products in the retail market — the fall in crude prices does not mean much. Firstly, since their purchases are dollar-denominated and sales are rupee-denominated, the rupee’s depreciation takes away a chunk of the benefits they would otherwise have enjoyed from a fall in crude prices. The rupee has lost nearly 14% in the past three months and is hovering around 48.4 versus the dollar, making imports costlier.
Secondly, OMCs’ refining operations, which would otherwise absorb a part of their marketing losses, will witness heavy erosion in profits. As a result, their profitability will continue to depend on the amount of oil bonds issued by the government. Going forward, even if these companies are able to trim their losses, the same will be reflected in a fall in oil bonds issued to them by the government.
FOR EXPLORATION SUPPORT INDUSTRY:
There are a host of companies which offer various services to oil majors in exploration and production. With crude prices rising steadily, exploration activity across the world has increased substantially, boosting demand for the services and assets offered by such companies. These include exploration support companies such as Aban Offshore, Great Offshore, Jindal Drilling, Shiv-Vani Oil & Gas and Dolphin Offshore. However, this industry mainly operates on long-term contracts, which range from six months to five years. At the same time, petroleum exploration is a lengthy activity — it usually takes several months, if not years, to determine the presence of hydrocarbon reserves, as well as their commerciality. Hence, the sudden slump in crude prices is unlikely to have any immediate impact on the players in this field. Going forward, if crude prices continue to stay around the present levels for a prolonged period — say, more than a year — then these companies may witness some impact on their order flow.
SUMMING UP:
Just like any other sharp and secular movement, the recent fall in crude oil prices has brought its own set of problems. On the one hand, it is easing pressure on the government’s treasury, but on the other hand, refining companies are set to take a hit. Globally, the balance between demand and supply of crude oil will continue in the months to come. The future course of crude prices will depend on the global financial market turmoil to a large extent. In the medium term, crude prices are expected to stay range-bound near current levels.
THE RECENT unexpected fall in crude oil prices has followed the unprecedented financial sector crisis that the world is currently facing. As global liquidity dries up, there has been a blanket sell-off in various asset classes — crude being one of them. Although economic growth concerns have been weighing on demand for petroleum products, they surely do not seem sufficient enough to cause a nearly 45% fall in crude prices to below $80 per barrel, after hitting a peak in July.
Crude oil is the world’s most widely consumed commodity and any move in its prices has a global impact. One would assume that the sudden, steep fall in crude prices will bring cheer to the domestic petroleum industry, which has been reeling under heavy under-recoveries. However, the impact of this crash will vary for different participants, and will also differ in the short- and long term. A basic understanding of these forces and their inter-relationships is necessary for investors, so that they are able to make the right choice when the tide turns.
EFFECT ON INDIAN ECONOMY:
The fall in crude oil prices has come as a boon for the Indian economy, which is witnessing a very high level of inflation triggered by sky-high crude prices. Although crude price was one of the reasons for the sharp rise in India’s inflation, the recent steep fall is not likely to reflect immediately on the inflation numbers. Since the government and oil companies absorb a major portion of the burden, rather than passing it on to consumers, the fall in crude prices will first ease the country’s fiscal deficit and provide some relief to oil companies. The total under-recoveries, which were predicted to reach Rs 240,000 crore for FY09, may now be restricted to Rs 160,000 crore.
FOR PRODUCERS:
Normally, a fall in crude prices is bad news for oil producers, but this is not the case for India’s largest oil producer, ONGC. Since the company is a beneficiary of nominated oil blocks, it has to sell crude at a discounted price to public sector refining companies. Its net realisation stood at only $70 in the quarter ended June ’08, although global prices averaged around $126. The recent fall in crude price will only reduce ONGC’s discounts, while keeping its net realisations unchanged. Hence, the company, which had received $55.9 per barrel in the quarter ended September ’07, is likely to earn better returns in the second quarter of FY09, despite the fall in crude prices. And till crude price stays above the $70 level, its fluctuations will have little impact on ONGC’s earnings. However, for other relatively smaller players in the private sector, the normal rule will be applicable. Companies like Cairn India, Selan Exploration Technology, Hindustan Oil Exploration and Reliance Industries (RIL) will see a drop in their future realisations from production of crude oil.
FOR REFINERS:
Although crude oil is the raw material for petroleum refiners, movement in the price of crude alone does not affect them. What really matters is the differential in the price of crude oil and refined products. Refiners benefit if the fall in prices of petrol and diesel is less than the fall in crude oil prices. However, this logic holds in an ideal situation. In reality, there is a 30-day gap between the purchase of crude oil and selling of output. So, if the price at which crude oil was bought is higher than the price at which its refined products are sold, then refiners book inventory losses and vice-versa. Hence, the one-way fall in crude oil prices results in heavy losses for refiners in the particular quarter. The fall in crude prices has been so steep during the past three months that the entire refining margins for several refiners may be wiped off. Standalone refiners such as Mangalore Refinery & Petrochemicals (MRPL) and Chennai Petroleum (CPCL), as well as private sector players like RIL and Essar Oil, are all expected to witness a substantial fall in their refining margins. However, this scenario will rectify itself in the next quarter, once crude prices stabilise.
FOR MARKETERS:
For oil marketing companies (OMCs) — which sell refined products in the retail market — the fall in crude prices does not mean much. Firstly, since their purchases are dollar-denominated and sales are rupee-denominated, the rupee’s depreciation takes away a chunk of the benefits they would otherwise have enjoyed from a fall in crude prices. The rupee has lost nearly 14% in the past three months and is hovering around 48.4 versus the dollar, making imports costlier.
Secondly, OMCs’ refining operations, which would otherwise absorb a part of their marketing losses, will witness heavy erosion in profits. As a result, their profitability will continue to depend on the amount of oil bonds issued by the government. Going forward, even if these companies are able to trim their losses, the same will be reflected in a fall in oil bonds issued to them by the government.
FOR EXPLORATION SUPPORT INDUSTRY:
There are a host of companies which offer various services to oil majors in exploration and production. With crude prices rising steadily, exploration activity across the world has increased substantially, boosting demand for the services and assets offered by such companies. These include exploration support companies such as Aban Offshore, Great Offshore, Jindal Drilling, Shiv-Vani Oil & Gas and Dolphin Offshore. However, this industry mainly operates on long-term contracts, which range from six months to five years. At the same time, petroleum exploration is a lengthy activity — it usually takes several months, if not years, to determine the presence of hydrocarbon reserves, as well as their commerciality. Hence, the sudden slump in crude prices is unlikely to have any immediate impact on the players in this field. Going forward, if crude prices continue to stay around the present levels for a prolonged period — say, more than a year — then these companies may witness some impact on their order flow.
SUMMING UP:
Just like any other sharp and secular movement, the recent fall in crude oil prices has brought its own set of problems. On the one hand, it is easing pressure on the government’s treasury, but on the other hand, refining companies are set to take a hit. Globally, the balance between demand and supply of crude oil will continue in the months to come. The future course of crude prices will depend on the global financial market turmoil to a large extent. In the medium term, crude prices are expected to stay range-bound near current levels.
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