Falling gas and coal prices are not priced into valuations yet

The beneficial effects have shown up in lower inflation and oil PSUs repairing their balance sheets

Brent crude oil prices dropped from $110 a barrel in January 2014 to recent lows of $47-48, a decline of 57 per cent. India is the third largest crude oil importer in the world. Consumption is 3.8 million barrels a day or 190 million tonnes per annum and 80 per cent is imported. The Indian crude basket is slightly cheaper than Brent but highly correlated in price. In 2013-14, India paid $165 billion for crude imports. The April-November 2014 import bill was $90 billion and the full financial year bill will probably be $115 billion.

The beneficial effects have shown in lower inflation. Reduced subsidies have allowed oil public sector units (PSUs) to repair their balance sheets. Raw material costs have dropped for petro-chemicals and fertilisers, and costs have also dropped for telecom operators, railways, aviation and shipping.

India is also a major gas importer. About 30 per cent of consumption is met by liquefied natural gas (LNG) import. Gas prices are tricky, with major regional variations. But most standard international contracts have declined 25-30 per cent in 12 months.

A lot of gas-based power capacity went idle once domestic production from KG-D6 reduced. This could be economically viable, if prices drop enough. Any domestic pricing formula also reflects lower costs if linked to international prices. The current formula (as of October 2014) adds the total cost of gas consumed in US, Mexico, Canada, EU, Russia and other former Soviet states, and divides this by the total   consumption of those places.

Low prices don’t offer incentive for exploration, so there might be little expansion in domestic supply. Also, there will be a temptation to build pipelines, city gas networks, port terminals, etc, assuming prices stay at these levels thus, miscalculating demand. This could mean investments going sour when the price cycle turns.

The price of coal has also dropped 30 per cent or so in the past year. India is again, among the largest importers of high-quality coal. In volume terms, thermal coal imports have risen from 100 million tonnes in 2011-12 to an estimated 190 million tonnes in 2014-15. In the next financial year (2015-16), imports are expected to hit 220-240 million tonnes. It could go even higher if Coal India (CIL) fails to boost production. That is likely, given unease among CIL's unions. Falling international prices would keep import bills under some control in value terms.

Domestic coal prices vary according to calorific content, as well as being differentiated for end-users. Domestic prices are cheaper than international equivalents. (Coal India's e-auctions usually fetch higher prices than the normal set rate but less than the equivalent imports).

The government has several tricky problems. It must re-allocate coal blocks as per Supreme Court orders. It will benchmark block valuations according to domestic coal prices. Plus, it is looking to improve Coal India's performance. CIL has averaged only two-three per cent compound annual growth rate (CAGR) in production and the aim is to double production over the next five years (14-15 per cent CAGR). Plus, there is the intention to disinvest some CIL stake. This will fetch less if coal prices are down.

Also, the bulk of Indian power capacity is thermal coal. The power sector has massive accumulated losses but it could stem the rot if coal prices dip while power tariffs are kept realistic. In turn, power-intensive businesses could also lower their cost if they have captive thermal capacity, which brings us full circle to coal block allocations.

Some of the positive effects of lower energy prices have already been discounted, especially in crude. But policy issues in gas and coal are quite complex. The nuances and implications of falling prices have not been priced into valuations yet.

The author is a technical and equity analyst