Low crude oil price benefit to recede

It seems fuel prices will continue to run low through 2016-2017 because global growth is low and unlikely to see a rapid pick up

Fuel prices have swung down in international energy markets over the past two years. Crude and gas prices were very high in January 2014, with Brent grade crude ranging between $105 and Rs 115 to the barrel. In September 2014, prices fell to around $94. By December, crude oil had fallen to around $55. Prices have moved between $45 and $60 in calendar 2015. Gas (and coal) prices have fallen as well.

Speculators have bought cheap crude and parked offshore in tankers in the hope of making major gains, as and when prices go up. Spot LNG cargoes have become cheaper than long-term contracts negotiated when gas prices were high.

Gas and coal imports have dropped in value to the point where power plants have been able to run on these fuels and remain financially viable. The government has found the courage to decontrol diesel, while imposing taxes and cesses. Coal India has also somewhat improved domestic delivery of coal to thermal power generators.

The impact on the energy value chain is interesting. Crude oil producers have struggled. Although the PSUs are happy to be freed from the burden of sharing subsidies, their realisations have fallen a lot. At the same time refiners and marketers have seen improved bottom lines. In the last quarter, July-September 2015, Indian Oil Corporation has substantially reduced losses; BPCL has more than doubled its net profits, compared to the July-September 2014 quarter.  

The power sector has seen some sort of a turnaround with generators registering enhanced profits.  Tata Power and Adani Power for instance, have both seen turnarounds with Tata Power registering strong profits in second quarter, 2015-16, compared to losses in Q2, 2014-15. Adani has substantially reduced its losses. Other companies such as Torrent Power, NHPC and NTPC have also seen major gains in terms of profits.  There are other reasons for the improved power sector results. For example, bailouts of bankrupt state government distribution companies may have meant more prompt payment.

Down the line, transport businesses such as airlines have seen turnarounds as fuel costs have fallen substantially for them. Costs will also have reduced for the telecom services segment since telcos consume a lot of diesel to generate backup power. There may have been some sort of push created in the automobile industry where cheaper fuel costs may tempt consumers into buying new vehicles. But this is not really apparent yet in terms of enhanced sales.

How sustainable is this cyclical turnaround? First, the base effect will not be so pronounced in the October-December 2015 quarter (current) because fuel prices had already moderated in October-December 2014. The base effect will be eliminated in January-March 2016 because fuel prices had more or less hit current levels by then. Hence, profits will not be radically enhanced simply by lower energy costs.

At the same time, it seems that fuel prices will continue to run low through 2016-2017 because global growth is low and unlikely to see a rapid pick up. It is possible that there would be temporary supply constraints given the multiple conflicts in the Middle East. Also Opec could try to squeeze supply using its old-style cartelisation methods. But, supply would come back from the offshore stockpiles and the shale gas industry of North America would also increase production. Iran is also coming back into the game. So prices will, almost certainly, stay down. In that case, the trends in the above industries might stay more or less the same though profit growth will flatten as base effects wear off.

The author is a technical and equity analyst