Positive triggers from falling oil prices

The collapse in crude oil and gas prices over the last month has accentuated existent trends. It has been accompanied by a fall in the price of other energy commodities such as coal. As of now, some analysts expect crude oil prices to stay down over the long term. Current prices are now in the range of $31-32/ barrel. In the futures market, 2019 and 2020 crude futures contracts are now trading at $50/ barrel. The fall will have inevitable repercussions.

At these prices, shale cannot really compete with conventional oil and most of the shale and other tight oil production will be forced to shut-down if prices stay this low for any length of time. If shale goes out of business, that would hand control of market share back to Saudi, Iran, Russia and Opec in a more generalised way. At some stage, Opec, led by Saudi Arabia would hope to be able to reassert its dominance as a cartel. However, Iran and Russia could prove to be cartel-breakers in this respect since both nations desperately need oil revenues. Also crippled production in war-torn areas such as Libya and Iraq could come back online.

It is very easy to misjudge this market because supply fluctuations will be tied to a great many geopolitical uncertainties. However, demand is weak and likely to stay that weak until such time as global growth recovers. And, shale being knocked out of the equation should be good for conventional exporters as that will eventually give them pricing power of sorts.

The consequences for India should be broadly positive. As petro imports drop in value, the pressure on the trade account eases. On the domestic front, the subsidies on the petro front also reduce, enabling a fall in the twin deficits (fiscal and current account). This is clearly good for government finances, the government has been able to raise a fair amount of revenue by simply keeping retail prices constant and hiking the excise component.

So, long as low prices persist, the Indian refiners and marketers will do reasonably well and the exploration and production (E&P) companies will struggle. The public sector E&P companies, ONGC and OIL, along with GAIL, will also benefit from the fact that they don't have to share in the subsidies to the downstream companies. The private sector players like Essar and Reliance will have to rely on lower raw material costs in refining operations. More activity in the city gas sector and viable gas-based power supply are other positives.

The downsides are more insidious. First, although policy reform, meaning free market-based pricing would be easier to implement under circumstances when prices are low, the compulsion is less. It is quite likely that kerosene will continue to be subsidised and so will fertilisers (which are petrochem based). Second, there will be less enthusiasm for creating solar and wind-based power capacities if coal, gas and naptha remain cheap. Third, there will be less investment into the exploration and production sector while prices remain low. There will also be less incentive for the government to rejig the NELP, which is supposed to move through multiple policy changes.

A more insidious problem could arise, affecting any company with serious debt exposure or any lender. Lower energy prices result in lower inflation. Lower inflation means lower nominal growth in revenues. Lower nominal revenue growth usually translates into lower profits. That implies stress in debt servicing. This is already evident in some cases, debt coverage ratios have worsened in many cases. Unfortunately, India's corporates (and the government) lack experience in handling low inflation situations and this could turn into a major threat.

The author is a technical and equity analyst