Crude oil likely to sustain below $100/bbl

Oil subsidies to fall 44% in FY15

Brent crude has gone below $100 a barrel for the first time in two years. This is good news, as India is a major importer of fossil fuel. But oil prices have to remain soft for sustainable gains. Analysts believe crude oil prices should remain soft through the year, as the International Energy Agency has cut global oil consumption estimate from 1.3 million barrels per day in January to 0.9 million barrels per day at present. What this suggests is that the world demand for oil continues to decline and this should keep a check on prices.

High oil prices have been the undoing of India's economy over the last few years, as they impact not only prices but put pressure on the import bill. As exports slowed over 2010-13, India's import bill surged on higher gold and oil imports, the fiscal and current account deficits reached unsustainable levels. So, the decline in prices of key commodities such as coal, oil and gold is expected to have a positive impact on India’s external account and the earnings of state-owned oil companies. The government in India subsidises diesel, petrol, liquefied petroleum gas and kerosene. The government bear the subsidy burden. With crude prices falling, the burden of subsidies is expected to decline, which would impact the earnings of these companies. According to Deutsche Bank Markets Research, "If global oil prices sustain at current levels, we estimate oil subsidies to fall 44 per cent year-on-year in FY15 — the sharpest drop in any one year since FY10 — to $13 billion and by a further 42 per cent in FY16 to $9.6 billion."

However, state-owned oil marketing companies (OMCs) have already returned 100 per cent year-to-date, as investors have played the diesel decontrol theme, with the new government continuing with the monthly increases. Analysts now believe that the OMCs (downstream companies) are richly valued and there is little steam left in them. Analysts believe that further upside in marketing companies would depend on marketing strategy of private players, intervention of the government in future pricing and margin trajectory.

Antique Stock Broking says, "It is prudent to book profits in the sector with stocks like BPCL/HPCL trading at 1.4/0.9 times FY16 adjusted price/book with return on equity of 14/10 per cent." With the oil prices coming down and subsidy burden expected to decline, analysts are seen to prefer upstream companies like ONGC and Oil India Limited. UBS Investment Research prefers upstream companies like Reliance Industries and ONGC, given near-term operational catalysts, better balance sheets, ROEs and their relatively attractive valuations.