Cheap crude an opportunity to acquire assets abroad, create infrastructure

Not every one is lamenting the drop in crude oil price.

To exploration and production (E&P) companies the fall in crude oil prices is a good opportunity to acquire assets abroad. The E&P companies are also expecting oil field services to become cheaper and consider this a good time to create infrastructure.

"The crude oil fall makes international assets more viable now. We all know crude oil prices will eventually go up so this is a good investment opportunity to companies. We are positive," said a senior official from Oil India. Oil India does not see any change in its investment plans going forward, the official added. In 2012-13 the company made capital investment of Rs. 2,938 crore.

Global crude oil prices have declined by 55 per cent from $112 per barrel in June 2014 to $50 per barrel at present due to increase in supply with US crude oil production at a 25 year high due to shale oil boom; growth slowdown in Europe, Japan and China and cut in speculative positions.

Analysts expect crude oil prices to drop as low as $40 per barrel and the trend of low crude oil prices to continue for the next year or two.

To state-run Oil and Natural Gas Corporation (ONGC), the drop in crude oil price is both positive and negative. "Yes, it is a good opportunity to invest in quality assets abroad and our overseas arm is looking at some assets but for ONGC it is not a positive situation. With crude oil prices at $50 a barrel and our subsidy share at $56 a barrel, we are in a fix," said a senior official from ONGC on the condition of anonymity.

ONGC had last month made a request to the Ministry of petroleum and natural gas to reduce its subsidy burden. The ministry is said to be reworking the fuel subsidy sharing formula to cut ONGC's payout. The official added that ONGC would go ahead with its planned capital investments.

In a note released today, ICRA said while exploration activity in India is not expected to witness material decline, significant fall in day rates would lead to weakening of the financial profiles of the domestic oilfield services companies, except for companies with long-term contracts or those with sufficient liquidity to tide over the downcycle.

K. Ravichandran, Senior Vice-President and Co-Head, Corporate Ratings, ICRA said: "Lower crude oil prices however, would impact profits of crude oil producers.The operating profit of Cairn India Ltd. could decrease by 35 per cent year-on-year this financial year, state-run Oil and Natural Gas Corporation and Oil India could take a hit of around 15 per cent on operating profit in FY15 as their subsidy burden is likely go down with fall in under-recovery levels."

Also, while the under-recovery sharing discount will decline from $59 per barrel in FY14 to $40-45 per barrel in FY15, the decline could impact cash generation of overseas ventures of ONGC Videsh Ltd, OIL and Reliance Industries Ltd (RIL) would decrease significantly.

To the oil marketing companies though, drop in crude oil prices means reduced working capital requirement, partial relief from under recoveries on the sale of sensitive products and improved profitability and liquidity, it brings along concerns of huge inventory valuation losses and reduced gross refining margins.

"Though drop in crude oil prices is good news for consumers, it will result in huge inventory losses for us. Given the fall is pretty rapid, it may result in Rs 5000-5500 per kilo litres of losses and reduced refining margins," said a senior official from the IndianOil Corporation, India's largest oil marketing company. Oil marketing companies maintain an crude inventory of 90 days. The official did not quantify how many kilo litres of inventory would IndianOil be holding.

As of November 2014, IndianOil Corporation, has seen its borrowings down by Rs 25,000 crore. "Till last year we were hovering at about Rs 85,000 crore of borrowings and today we have around Rs 60,000 crore in borrowings. Our interest cost has also come down from Rs 1,700-1,800 crore to Rs 1,100 crore," Ashok Balasubramanian, chairman and managing director, Indian Oil Corporation (IOC) said last month.

"The underrecovery has fallen, due to which interest on borrowings has also come down. Decline in crude oil prices have brought borrowings down. Also, with our foreign exchange borrowings sliding, our foreign exchange risk will also ease. This is a big advantage," said a senior official from Hindustan Petroleum Corporation. HPCL said it has seen its borrowings drop from Rs 38,000 crore in November 2013 to Rs 22,000 crore till November 2014.

Gross refining margins however, are expected to be negative or remain subdued in Q3 FY15 on account of large inventory valuation losses, though partly offset by higher crack spreads witnessed during the quarter for several products, added ICRA